Paying for productivity

One of the United States’ defining – and disheartening – economic trends over the last 40 years has been real-wage stagnation for most workers. According to a recent US Census report, the median full-time male worker earned $50,033 in 2013, barely distinguishable from the comparable (inflation-adjusted) figure of $49,678 in 1973. Because most households earn the bulk of their income from their labor, the absence of real-wage growth is a major factor behind the stagnation of family incomes. The average family income of the bottom 90% of households has been flat since about 1980. Real family income for the median household in 2013 was 8% below its 2007 level and nearly 9% below its 1999 peak.

Stagnating middle-class wages and family incomes are a major factor behind the US economy’s slow recovery from the 20072009 recession, and pose a serious threat to long-term growth and competitiveness. Household consumption accounts for more than two-thirds of aggregate demand, and consumption growth depends on income growth for the bottom 90%.

The heyday of US economic growth in the two decades after World War II was also a golden era for the middle class. The long boom of the 1990s, when the US enjoyed sustained full employment, was one of few periods in the last 40 years when incomes climbed at every quintile of the income distribution.

Many influential economists are now worried that the US faces anemic growth and “secular stagnation,” owing to a persistent gap between aggregate demand and full employment. Stagnant middle-class incomes imply weak aggregate demand, which in turn means slack labour markets and stagnant wages for most workers. In the absence of aggressive monetary and fiscal policies to support aggregate demand at fullemployment levels, the result is a vicious slow-growth cycle.

Two competitiveness gurus, Michael Porter and Jan Rivkin of Harvard Business School, recently warned that stagnant middle-class incomes undermine US companies in several ways. “Businesses cannot thrive for long while their communities languish,” they cautioned. Unless corporations step up to the plate, “American business will suffer from an inadequate workforce, a population of depleted consumers, and large blocs of antibusiness voters.”

Porter and Rivkin are not calling on businesses simply to pay their workers more. Instead, they are urging businesses to engage in a “strategic, collaborative” push to improve education and training to raise the skill levels of their workers.

That is a laudable goal. But, as Porter and Rivkin find in their survey of business leaders, companies often discourage investment in skills by their reluctance to hire full-time workers. Nearly half of the respondents indicated that, when possible, they prefer to invest in technology or outsource to third parties and hire part-time workers, none of whom receive much additional training or have a stake in their company’s long-term success.

There is also a disturbing implication in the Porter-Rivkin survey that workers themselves, along with America’s schools, are to blame for wage stagnation: If only workers were not so poor in math and science, so ill-equipped for the modern world, and so unproductive, they would earn higher incomes.

The reality is different. US productivity has been growing at a respectable pace for two decades. The problem is that productivity gains have not translated into commensurate wage increases for the typical worker or income growth for the typical family.

According to standard economic theory, real wages should track productivity. As Lawrence Mishel of the Economic Policy Institute has documented, this was the case from 1948 until about 1973. Since then, real wages for the typical worker have flat-lined, while productivity has continued to climb. Mishel calculates that productivity increased 80.4% from 1948 to 2011, while median real wages rose only 39% – almost none of the wage growth occurred during the last four decades.

True, highly skilled workers, especially those with sought-after technology skills and postgraduate degrees, have fared much better. But that prosperity has reached only a small elite. From 1979 to 2012, the real median wage increased by only 5%. But real wages climbed 154% for the top 1% of wage earners and 39% for the top 5%, while real wages stagnated for the bottom 20th percentile of workers and fell for the bottom tenth. Indeed, inequality in labor compensation has been the largest driver of yawning income inequality, except at the very top of the income distribution, where capital income has been more important.

Meanwhile, corporate profits have soared. The GDP share of after-tax corporate profits is at a record high, whereas labour compensation has plunged to its lowest share since 1950.

Strong productivity growth is an important policy goal. But it is not enough to increase most workers’ wages or most families’ incomes. Reconnecting productivity gains and wage gains requires both policy actions, such as an increase in the minimum wage with a link to productivity growth, and changes in corporate human-resources practices, such as broader reliance on profit-sharing programs.

Such programmes have intuitive appeal. Employees who have a direct stake in a company’s profitability are likely to be more motivated and engaged, and turnover is likely to be lower. This intuition is confirmed by empirical research.

Some 20 years ago, Alan Blinder of Princeton University corralled a number of economists, including me, to examine existing studies on the link between profitsharing and productivity. The overwhelming majority of the studies found a strong positive effect. Shared Capitalism at Work, a recent book edited by Douglas Kruse, Richard Freeman, and Joseph Blasi, confirms this conclusion with more recent evidence.

Various forms of profit-sharing – including grants of options and restricted stock, annual profit-based bonuses, and employee stockownership plans – have been growing as a share of labour compensation since the 1960s. But most workers are not covered by such plans, and the biggest beneficiaries have been CEOs and top managers, a significant fraction of whose pay is tied to productivity, as reflected in profits and stock performance. Such incentive pay schemes have driven the outsize increases in compensation for the top 1% of the wage and salary distribution.

America’s long-run living standards and economic competitiveness depend not just on productivity growth, but also on how that growth is shared. More equitable sharing of profits with America’s workers and their families would do much to address the worrisome stagnation of wages and middleclass incomes in recent decades.