Productivity and pay are linked – A rising tide still lifts all boats

The chances are that you will have seen a chart like this.

It seems to show that, since about 1973, pay has risen much more slowly than labor productivity. If this is the case, then we have an economic problem. If we cannot rely on rising productivity to raise pay, do we have to look again at policies like minimum wage laws?

But is it true? I’ve written before about how, when you analyse the data properly, this lag largely disappears. In a paper titled ‘Productivity and Pay: Is the link broken?‘, economists Anna M. Stansbury and Lawrence H. Summers “estimate the extent of linkage or delinkage in the productivity-typical compensation relationship by investigating the co-movement of growth in productivity and typical compensation, using the natural quasi-experiment provided by the fact that productivity growth fluctuates through time.” They find that

“Overall we believe that the evidence is supportive of there being substantial linkage between productivity and typical worker compensation, and between productivity and average compensation. Rather than the link having broken down, it appears that it is largely factors not associated with productivity growth that have caused typical and average compensation to diverge from productivity.”

Stansbury and Summers note that over the period 1948-1973, Hourly labor productivity rose at a 2.7% annual rate but that, between 1973 and 2016, hourly labor productivity rose by 75% or 1.3% per year.

As such, a period of slower productivity growth since 1973 has coincided with a period of even slower pay growth. Productivity has grown relatively slowly, average pay slower still, and median and production/nonsupervisory pay barely at all. 

They estimate that “if productivity growth had been as fast over 1973-2016 as it was over 1949-1973, (i.e. if net total economy productivity had grown at an average of 2.7% per year, rather than 1.3% per year), median and mean compensation would have been around 41% higher in 2015, holding other factors constant.” “These point estimates”, they continue, “suggest that 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.”

Possibly the main debate in economic policy today is growth vs redistribution: who gets how much of the cake, or should we try to bake a bigger cake? Arguments in favor of redistribution have rested on the idea that growth – a bigger cake – benefits only very few people. This research shows that to be untrue. A rising tide still lifts all boats.

John Phelan is an economist at the Center of the American Experiment.