Productivity and Wages from EPI

Productivity and Wages from EPI

A word economists love to throw around is productivity. The most important thing, we're told, is to increase productivity. The more we can produce, the more productive we are, the richer our society will be. And before there can be increases in real wages, there must be increases in productivity. If there isn't more stuff to go around, then, on average, we just can't have more stuff.

Yet, for 30 years, the US economy's productivity has continued to grow, and the average American hasn't had much of a pay raise, if any. The reason lies in the difference between productivity and surplus, and in the key observation is that it doesn't just matter how big the pie is, it matters how much of the pie you're getting. Let's explore this with a simple model.

Let’s take a really simple model. You’ve got one hundred workers working in your economy. The first year they cost $10/hour and produce $18 worth of goods an hour. If we take productivity to be value/time - their productivity is $18. Note that productivity in this model isn't related to pay rates.

Next year they’re producing $27 worth of goods and being paid $11. Their productivity has gone up 50% (27/18), but the surplus you’re getting from them has gone up 100% 16/8) and in absolute terms it’s gone from $8/hour to $16 hour. That’s $16/hour more in the owner’s hands.

Where that surplus goes is an important question. The owner could use it to increase his employees’ wages and benefits - thus reducing the surplus and making his employees better off. That’s the European solution and is one of the causes of so called “Eurosclerosis” - increases in productivity for much of the last 30 years have gone to those already employed much more than in the US.

You can hire new employees and try to make even more money. America did that during the 80’s and 90’s while Europe was increasing wages and benefits instead.

You can spend it on consumption - buy that yacht, or jewelry or expensive holiday you want. That’s another part of what the US has done and is why luxury retailers have done very well this last decade.

You can invest it in capital infrastructure. With better tools and methods your worker may improve his productivity even more and you might make even more money and more of a surplus.

You can invest it in the secondary security market or real estate and try and make returns that way. If everyone is doing this security prices go up relative to return and you might have a bubble. The US did this too.

Now what would happen if instead wages went up to $22 while productivity went up to $27? Well - productivity has increased - the worker is more productive, again by 50% - but the surplus has actually gone down by about 30% - and in absolute terms the employer has $2 less surplus an hour to spend. He’s probably not going to be hiring a new worker, increasing his spending on luxury goods, investing in capital or the secondary capital market.

But that money has gone somewhere. It’s gone to the workers. They are most likely to spend it on consumption - on buying goods. But they might save it, making it available for the owner to borrow to spend trying to increase productivity. However the key point is that there isn’t less money in the economy - there is still the same amount of money - it’s just that it’s going to someone different.

As noted, this is a very simplified model. Still, it illustrates some basic things about productivity and about surplus. Remember profit = surplus and when productivity goes up if wages and other costs remain constant, profit goes up. In the most recent period of productivity gain that’s pretty much what has happened - gains in productivity have gone to profits and to senior management - not to workers.

When this happens there are simple consequences. Demand for general goods doesn't rise as fast as it would otherwise, or if it does it is driven by debt, not by earnings. Since the rich spend more of their money on investment goods than real goods you get asset bubbles, whether in stocks, bonds, real estate or commodities. Money is power and if it pools in a few hands those people can use it very effectively to buy power, whereas when spread out it has less effect. Plutocracies tend to purchase their own continuation.

The structure of US markets is thus, in large part, a consequence of how productivity gains have been divided up. By giving them to people other than workers - to corporations and to the rich - the US has chosen a lower demand path which has pushed money into assets and thus into bubbles. As it has concentrated money, so it has concentrated power in the hands of the few.

Increasing productivity is like baking a bigger pie. It's who eats it that matters.