Tuesday, May 06, 2008

Did Wages Reflect Growth in Productivity?

Yes, according to Martin Feldstein. From the abstract of the paper this post is titled:

The level of productivity doubled in the U.S. nonfarm business sector between 1970 and 2006. Wages, or more accurately total compensation per hour, increased at approximately the same annual rate during that period if nominal compensation is adjusted for inflation in the same way as the nominal output measure that is used to calculate productivity.

Total employee compensation as a share of national income was 66 percent of national income in 1970 and 64 percent in 2006. This measure of the labor compensation share has been remarkably stable since the 1970s. It rose from an average of 62 percent in the decade of the 1960s to 66 percent in the decades of the 1970s and 1980s and then declined to 65 percent in the decade of the 1990s where it has again been from 2000 until the most recent quarter.

I don't usually study this line of the literature, so I'm somewhat surprised the "productivity-compensation conundrum" was a problem of dividing by the wrong measure of inflation. All economists know that wages should reflect their marginal revenue product (w=pMRP), and real wages are just a trivial division (w/p=MRP). Since we usually think of compensation in real terms, I guess economists were primarily dividing by consumer measures of inflation. But the p here should have been the price relevant to firms, which is essentially what Feldstein seems to have done (though I'm sure it was much more complicated to sort out).

We can sleep easier at night knowing one of our most fundamental theories matches the data once again.


Gabriel said...

Actually, I think it's easier than that... he basically says... let's use the same price index throughout.

Anonymous said...

MRP = P*MP, so W = P*MP, or W/P = MP