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The Myth of the Great Wages “Decoupling”

As a rule, Americans do not envy the successful. Their attitude is: If you earned your success, then you deserve your income. This poses a problem for the people who want to take from successful Americans in order to fund the welfare state.

In order to make their agenda palatable, the welfare statists have developed a yawn-inducing litany of arguments which amount to the claim that market incomes don’t reflect a person’s productive contribution.

One of the most popular versions of this argument at the moment starts by noting that, according to free-market economists, rising productivity should lead to rising wages. But, they claim, the statistics indicate that although productivity has been rising in the U.S., wages haven’t been rising anywhere near as fast. Implication? The nefarious 1 percent have been somehow wrestling away the gains of the middle-class, leaving middle-class workers’ incomes to stagnate.

Two economists, Donald Boudreaux and Liya Palagashvili, pick apart these claims in a recent Wall Street Journal op-ed (unfortunately the whole thing is behind the Journal’s pay wall). They convincingly argue that there has been “no great decoupling of worker pay from productivity. Nor have workers’ incomes stagnated over the past four decades.” Claims to the contrary are based on two errors “routinely made when pay is compared with productivity.”

First, the value of fringe benefits are not included as part of workers’ pay — even though these have constituted an increasing share of people’s compensation. Second, the way that most of the relevant studies adjust for inflation involves using different inflation measures for wages and for economic output. After reviewing the numbers, the authors conclude:

The empirical reality . . . is consistent with economic reasoning. Firms cannot afford a misalignment of their workers’ pay and productivity increases — the employees will move to other firms eager to hire these now more productive workers. Higher economy-wide productivity, after all, means that workers add more to the bottom lines of employers throughout the economy. To secure the services of these more-productive workers, firms bid up worker pay. This competition for labor services is what links pay to productivity.

An earlier study from the Heritage Foundation reached similar conclusions. Here’s the Abstract:

Conventional wisdom holds that worker productivity has risen sharply since the 1970s while worker compensation has stagnated. This belief rests on misinterpreted economic data. Accurate and careful comparisons show that over the past 40 years measured productivity has increased 100 percent and average compensation has risen 77 percent. Inflated productivity measurements account for most of the remaining 23 percentage point difference. An apples-to-apples comparison shows that employee compensation continues to closely follow productivity. American workers continue to earn more as they become more productive. To help Americans advance economically, policymakers should seek policies that will increase productivity.

Bottom line: We don’t live in a free market and so it’s certainly possible for people to gain unearned income. But the solution is not to give the government more control over the economy — but less. The market, when it is allowed to function, rewards people for their productive contribution.