2/3/2020 On the link between US pay and productivity

On the link between US pay and productivity

Anna Stansbury, Lawrence H. Summers 20 February 2018

Since 1973, there has been divergence between labour productivity and the typical worker’s pay
in the US as productivity has continued to grow strongly and growth in average compensation
has slowed substantially. This column explores the causes and implications of this trend.
Productivity growth appears to have continued to push workers’ wages up, with other factors to
blame for the divergence. The evidence casts doubt on the idea that rapid technological
progress is the primary driver here, suggesting rather that institutional and structural factors are
to blame.

Pay growth for middle class workers in the US has been abysmal over recent decades – in real
terms, median hourly compensation rose only 11% between 1973 and 2016.1 At the same time,
hourly labour productivity has grown steadily, rising by 75%.

This divergence between productivity and the typical worker’s pay is a relatively recent
phenomenon. Using production/nonsupervisory compensation as a proxy for median
compensation (since there are no data on the median before 1973), Bivens and Mishel (2015)
show that typical compensation and productivity grew at the same rate over 1948-1973, and only
began to diverge in 1973 (see Figure 1).

Figure 1 Labour productivity, average compensation, and production/nonsupervisory

compensation 1948-2016

Notes: Labour productivity: total economy real output per hour (constructed from BLS and BEA data). Average
compensation: total economy compensation per hour (constructed from BLS data). Production/nonsupervisory
compensation: real compensation per hour, production and nonsupervisory workers (Economic Policy Institute).

What does this stark divergence imply about the relationship between productivity and typical
compensation? Since productivity growth has been so much faster than median pay growth, the
question is how much does productivity growth benefit the typical worker?2

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A number of authors have raised these questions in recent years. Harold Meyerson, for
example, wrote in American Prospect in 2014 that “for the vast majority of American workers, the
link between their productivity and their compensation no longer exists”, and the Economist
wrote in 2013 that “unless you are rich, GDP growth isn't doing much to raise your income
anymore”. Bernstein (2015) raises the concern that “[f]aster productivity growth would be great.
I’m just not at all sure we can count on it to lift middle-class incomes.” Bivens and Mishel (2015)
write “although boosting productivity growth is an important long-run goal, this will not lead to
broad-based wage gains unless we pursue policies that reconnect productivity growth and the
pay of the vast majority”.

Has typical compensation delinked from productivity?

Figure 1 appears to suggest that a one-to-one relationship between productivity and typical
compensation existed before 1973, and that this relationship broke down after 1973. On the
other hand, just as two time series apparently growing in tandem does not mean that one causes
the other, two series diverging may not mean that the causal link between the two has broken
down. Rather, other factors may have come into play which appear to have severed the
connection between productivity and typical compensation.

As such there is a spectrum of possibilities for the true underlying relationship between
productivity and typical compensation. On one end of the spectrum – which we call ‘strong
delinkage’ – it’s possible that factors are blocking the transmission mechanism from productivity
to typical compensation, such that increases in productivity don’t feed through to pay. At the
opposite end of the spectrum – which we call ‘strong linkage’ – it’s possible that productivity
growth translates fully into increases in typical workers’ pay, but even as productivity growth has
been acting to raise pay, other factors (orthogonal to productivity) have been acting to reduce it.
Between these two ends of the spectrum is a range of possibilities where some degree of
linkage or delinkage exists between productivity and typical compensation.

In a recent paper, we estimate which point on this linkage-delinkage spectrum best describes the
productivity-typical compensation relationship (Stansbury and Summers 2017). Using medium-
term fluctuations in productivity growth, we test the relationship between productivity growth and
two key measures of typical compensation growth: median compensation, and average
compensation for production and nonsupervisory workers.

Simply plotting the annual growth rates of productivity and our two measures of typical
compensation (Figure 2) suggests support for quite substantial linkage – the series seem to
move together, although typical compensation growth is almost always lower.

Figure 2 Change in log productivity and typical compensation, three-year moving average

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Notes: Data from BLS, BEA and Economic Policy Institute. Series are three-year backward-looking moving
averages of change in log variable.

Making use of the high frequency changes in productivity growth over one- to five-year periods,
we run a series of regressions to test this link more rigorously. We find that periods of higher
productivity growth are associated with substantially higher growth in median and
production/nonsupervisory worker compensation – even during the period since 1973, where
productivity and typical compensation have diverged so much in levels. A one percentage point
increase in the growth rate of productivity has been associated with between two-thirds and one
percentage point higher growth in median worker compensation in the period since 1973, and
with between 0.4 and 0.7 percentage points higher growth in production/nonsupervisory worker
compensation. These results suggest that there is substantial linkage between productivity and
median compensation (even the strong linkage view cannot be rejected), and that there is a
significant degree of linkage between productivity and production/nonsupervisory worker
compensation.

How is it possible to find this relationship when productivity has clearly grown so much faster
than median workers’ pay? Our findings imply that even as productivity growth has been acting
to push workers’ pay up, other factors not associated with productivity growth have acted to push
workers’ pay down. So while it may appear on first glance that productivity growth has not
benefited typical workers much, our findings imply that if productivity growth had been lower,
typical workers would have likely done substantially worse.

If the link between productivity and pay hasn’t broken, what

has happened?
The productivity-median compensation divergence can be broken down into two aspects of
rising inequality: the rise in top-half income inequality (divergence between mean and median
compensation) which began around 1973, and the fall in the labour share (divergence between
productivity and mean compensation) which began around 2000.

For both of these phenomena, technological change is often invoked as the primary cause.
Computerisation and automation have been put forward as causes of rising mean-median
income inequality (e.g. Autor et al. 1998, Acemoglu and Restrepo 2017); and automation, falling
prices of investment goods, and rapid labour-augmenting technological change have been put
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forward as causes of the fall in the labour share (e.g. Karabarbounis and Neiman 2014,
Acemoglu and Restrepo 2016, Brynjolffson and McAfee 2014, Lawrence 2015).

At the same time, non-purely technological hypotheses for rising mean-median inequality include
the race between education and technology (Goldin and Katz 2007), declining unionisation
(Freeman et al. 2016), globalisation (Autor et al. 2013), immigration (Borjas 2003), and the
‘superstar effect’ (Rosen 1981, Gabaix et al. 2016). Non-technological hypotheses for the falling
labour share include labour market institutions (Levy and Temin 2007, Mishel and Bivens 2015),
market structure and monopoly power (Autor et al. 2017, Barkai 2017), capital accumulation
(Piketty 2014, Piketty and Zucman 2014), and the productivity slowdown itself (Grossman et al.
2017).

While we do not analyse these theories in detail, a simple empirical test can help distinguish the
relative importance of these two categories of explanation – purely technology-based or not – for
rising mean-median inequality and the falling labour share. More rapid technological progress
should cause faster productivity growth – so, if some aspect of faster technological progress has
caused inequality, we should see periods of faster productivity growth come alongside more
rapid growth in inequality.

We find very little evidence for this. Our regressions find no significant relationship between
productivity growth and changes in mean-median inequality, and very little relationship between
productivity growth and changes in the labour share. In addition, as Table 1 shows, the two
periods of slower productivity growth (1973-1996 and 2003-2014) were associated with faster
growth in inequality (an increasing mean/median ratio and a falling labour share).

Taken together, this evidence casts doubt on the idea that more rapid technological progress
alone has been the primary driver of rising inequality over recent decades, and tends to lend
support to more institutional and structural explanations.

Table 1 Average annual growth rates of productivity, the labour share and the mean/median ratio
during the US’ productivity booms and productivity slowdowns

Note: Data from BLS, Penn World Tables, EPI Data Library.

Policy implications
The slow growth in median workers’ pay and the large and persistent rise in inequality are
extremely concerning on grounds of both welfare and equity. There are important ongoing
debates about the factors responsible for this phenomenon, and what must be done to reverse it.

Our contribution to these debates is, we believe, to demonstrate that productivity growth still
matters substantially for middle income Americans. If productivity accelerates for reasons
relating to technology or to policy, the likely impact will be increased pay growth for the typical
worker.

We can use our estimates to calculate a rough counterfactual. If the ratio of the mean to median
worker's hourly compensation in 2016 had been the same as it was in 1973, and mean
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compensation remained at its 2016 level, the median worker's pay would have been around 33%
higher. If the ratio of labour productivity to mean compensation in 2016 had been the same as it
was in 1973 (i.e. the labour share had not fallen), the average and median worker would both
have had 4-8% more hourly compensation all else constant. Assuming our estimated
relationship between compensation and productivity holds, if productivity growth had been as
fast over 1973-2016 as it was over 1949-1973, median and mean compensation would have
been around 41% higher in 2016, holding other factors constant.

This suggests that the potential effect of raising productivity growth on the average American’s
pay may be as great as the effect of policies to reverse trends in income inequality – and that a
continued productivity slowdown should be a major concern for those hoping for increases in
real compensation for middle income workers.

This does not mean that policy should ignore questions of redistribution or labour market
intervention – the evidence of the past four decades demonstrates that productivity growth alone
is not necessarily enough to raise real incomes substantially, particularly in the face of strong
downward pressures on pay. However it does mean that policy should not focus on these issues
to the exclusion of productivity growth – strategies that focus both on productivity growth and on
policies to promote inclusion are likely to have the greatest impact on the living standards of
middle-income Americans.

Endnotes
[1] As measured using the CPI-U-RS consumer price deflator. Using the PCE consumer price
deflator, median compensation has risen by about 26% over the period rather than 12%. We use
the Economic Policy Institute’s measure of median compensation, which they calculate from
median wages (BLS) and the average wage-total compensation ratio (BEA NIPA).

[2] Note that we focus in this column on the divergence of median or typical pay from average
productivity. The divergence of average compensation from average productivity – equivalent to
the declining labour share – has been smaller and more recent. Analyses of the average
compensation-average productivity divergence can be found in Feldstein (2008), Lawrence
(2016) and our recent paper (Stansbury and Summers 2017).

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