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Wages vs. Productivity

The following is from an Economist magazine email newsletter. It looks at whether American businesses pay a living wage. It does not look at whether the wages paid are actually worth to the business what it is paying in salaries. The other side of the issue is productivity. The worker has to pay for himself by adding profit to the business what it is paying for his labor. With rampant inflation, it has hard to tell, because each dollar of an increased salary is worth less than it was before. To keep pace with inflation, the business has to raise its prices, adding to the inflationary spiral. Thus looking at only one side of the issue, as this article does, is misleading. A living wage is one thing, producing enough value to financially justify a living wage is another.

A couple of years ago there was a heated debate about whether America should raise the federal minimum wage to $15 an hour. It’s only fair for workers, said supporters. It’s a death knell for business, said critics. How quaint. Combine a pandemic with an already-tight labour market, and $15 is far too low these days in much of the country. The average warehouse employee at Amazon starts at $19 an hour. What a time to be an American worker. Right?

Ultimately what matters when looking at wages is what you can afford to buy with them. Over the past couple of years, as wages have galloped higher, so have prices. An admittedly extreme example that we mention this week in an article about incomes in America: Cardi B, a hip-hop artist, was shocked recently to discover that her local grocer was selling lettuce for $7. Others have been left aghast by a doubling in egg prices. In other words, workers these days may be feeling cash-rich but egg-poor and lettuce-constrained.

To assess whether people are getting ahead or falling behind, economists control for inflation when studying wages. But that isn’t the whole story. Decisions must be made about how to measure both inflation and wages. This leads to dramatically different conclusions about the trajectory of incomes in America, especially over the past few decades.

If economists use a higher inflation index, as they do when relying on the most basic gauge of consumer prices, real wage growth ends up looking negligible over the past five decades. This results in a misleading narrative about Americans being left behind. By contrast, if economists use slightly more sophisticated gauges of inflation (for example, applying regular updates as consumers change their preferences), they can show that incomes have risen steadily, especially in the past few decades. This is the more accurate conclusion.

It’s also crucial to account for redistribution via the tax system and means-tested transfer programmes (such as Medicaid, which helps cover health-care costs). Before taxes and transfers, the richest quintile of Americans saw their incomes rise by 114% between 1979 and 2019, while the poorest quintile registered just a 45% increase. After taxes and transfers, the poorest quintile’s income growth more than doubled to 94%. Notwithstanding that improvement, America still ranks as one of the most unequal wealthy countries in the world. But it is a sharp contrast with the story often told about an America where incomes are stagnant and the poor are consigned to misery.

So what about those workers at the bottom of the income scale who have received big pay increases since the onset of the pandemic but have also faced rising prices? The good news is that they are the one group of Americans whose wage gains have actually outpaced inflation since 2020. As a result, for the first time in decades, America’s pre-tax income distribution has become a little more equal. Mind you, the emphasis is on “a little”. It’s not time to break out the luxury lettuce just yet.

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