YOU DECIDE: On pay and productivity?

Date posted: October 15, 2010

Dr. Michael Walden is William Neal Reynolds professor of agricultural and resource economics at N.C. State University.Dr. Michael Walden is William Neal Reynolds professor of agricultural and resource economics at N.C. State University.

Media Contact: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

I like former U.S. Secretary of Labor Robert Reich. As a frequent debater of contentious public policy issues in the media, Reich is affable and good-humored, and someone who never — at least in situations I’ve observed — resorts to personal attacks. Reich is short in stature, and I remember when he stood behind the podium at an NCSU Emerging Issues Forum, he opened with the line, “Is this the picture of big government?”

Reich is a prolific writer, and his latest book is titled Aftershock. The thesis of the book is that the bargain between workers and the economy has been broken. Prior to the mid-1970s, workers could count on increased rates of pay commensurate with the increase in their productivity. However, since the mid-1970s, Reich purports to show that while labor productivity has continued to rise, worker pay has stagnated.

Hence, in Reich’s terms, the bargain has been broken. Average worker pay has been flat even though workers are contributing more to production. With income growth strongest at the highest end of the income ladder, most workers tread water while observing those at the top getting more. Reich’s solution includes higher taxes on the rich, lower taxes for others, and “wage insurance” for those losing their jobs.

Reich articulates his view of the economy very well. However, the big problem is that the assertion on which his entire argument rests — that workers have not been compensated for their increased work effort — is flat wrong!

Reich looks at what workers see in their paycheck: earnings. And indeed, if you plot average worker earnings against worker productivity (what the worker produces in a given time period) — being careful to adjust for inflation — then you do see the two moving in lockstep until the mid 1970s. After that, worker productivity continues to rise, but worker earnings are flat.

Yet in recent decades how workers are paid has dramatically changed. While workers still see money in their paycheck, what companies pay workers outside their paycheck has significantly increased. This outside the paycheck compensation includes overtime, bonuses, and — most importantly — the cost of benefits like company provided health insurance. The outside the paycheck compensation has almost doubled since 1970 – from 11 percent of total compensation then to 20 percent today.

If outside the paycheck compensation to workers is included with their paycheck earnings, then Reich’s argument falls apart. Calculations done by Harvard University economist Martin Feldstein, who also chaired the President’s Council of Economic Advisers in the 1980s, show total worker compensation — including both paycheck and outside the paycheck compensation — has continued to track worker productivity even since the mid-1970s.

So the economic bargain that Reich talks about — where workers are paid based on what they produce — hasn’t been broken. It’s just that today, compared to the past, workers are paid in a different way.

What about Reich’s other implication: that the rich have grown richer at the expense of the poor? This too, to be generous, is an oversimplification. The fact is that from 1975 to 2009, the U.S. Census Bureau shows that average income (adjusted for inflation) for all households on the income ladder has increased. Dividing the income ladder into five rungs, income at the lowest rung increased 10 percent, followed by gains of 13 percent, 17 percent and 27 percent for rungs two, three and four, respectively. Income for households on the highest rung of the ladder increased 57 percent.

With income gains being greatest for households on higher income rungs, the gap between the rich and the poor — income inequality — has increased. But clearly the data show this is not a result of the poor getting poorer and the rich getting richer. Instead, everyone has gained; it’s just those at the top have gained more.

And why is this? Easy. Those at the top usually have more education and training; traits that have become more valuable in our modern economy.

I still like Robert Reich, and if he ever sees this article, I hope he will take it in the spirit offered; as corrections to a flawed analysis!

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Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The Department of Communication Services provides his You Decide column every two weeks.

Related audio files are at http://www.ncsu.edu/waldenradio/

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