The Three Wedges That Separate Workers From Their Pay

Nothing to show for higher productivity
Photograph by Cultura/Frank and Helena/Getty Images

Economists assure us that rising worker productivity is the key to better living. When workers produce more per hour of work, their earnings should go up correspondingly.

Since 1973, that hasn’t been happening. Productivity has risen at a healthy clip, but the pay of the average worker has stagnated. That simple fact explains why younger Americans today aren’t doing any better than their parents’ generation, and sometimes worse. A sense of the part of Americans that they’re not reaping the rewards of  hard work fuels the Occupy movement and the cries of “We are the 99 Percent.”

In 1994, economists Lawrence Mishel and Jared Bernstein were first to point out the gap that was already opening up between pay (low) and productivity (high). Bernstein later served as Vice President Joe Biden’s chief economist and is now a senior fellow at the Center on Budget and Policy Priorities. Mishel is president of the Economic Policy Institute.

Now, Mishel has done the most careful study to date of what accounts for the productivity/pay gap. He wrote a blog post called “Understanding the wedge between productivity and median compensation growth” on April 26. He also has a longer article on the EPI website. And if that’s not enough, there’s a technical article by Mishel and Kar-Fai Gee of Canada’s Center for the Study of Living Standards published in that center’s International Productivity Monitor (PDF).

Mishel zeroes in on three “wedges” and how much each has contributed during different periods to the growing gap between productivity and pay:

First wedge: Owners of capital are taking a bigger share of income. Ordinary Americans get most of their pay in the form of wages and salaries, while the wealthiest Americans get more of their pay in the form of income on capital, such as dividends and capital gains. The owners of capital have been claiming a bigger share of the national income. That trend shows up in labor’s share of overall compensation, which has fallen from 64.3 percent in 1973 to 58.5 percent in 2011.

Second wedge: Inequality among wage earners has grown. The highest earners have captured a disproportionate share of pay gains. Average pay, which factors in the salaries of chief executive officers and NBA stars, has gone up faster than median pay, which is the pay for the mythical person in the middle. Half of all workers earn more than the median and half earn less. Median hourly compensation isn’t dragged upward by a few big earners at the top. Adjusted for inflation, it grew just 11 percent from 1973 through 2011, while productivity grew 80 percent.

Third wedge: Consumer prices have risen faster than prices of what workers produce. The idea here is that workers’ pay is connected to what they produce, which includes some consumer goods and services but also a lot of things that consumers don’t buy, such as industrial machinery and business-to-business services. Prices of those things have gone up slowly, so the compensation of the workers that produce them has gone up slowly. Consumer prices, meanwhile, have gone up faster. So pay hasn’t kept up with inflation in the consumer’s market basket.

In the 1970s, according to Mishel, the third wedge was the biggest factor in the productivity/pay gap. From 1979 to 2000, the biggest factor was inequality of compensation (the second wedge). Since 2000, both inequality of compensation and shifts in labor’s share of income (the first wedge) have been powerful forces in widening the gap.

“This is the most technical analysis we’ve ever done. It’s a very formal decomposition,” Mishel told me. There should be a tight link between what workers produce and what they earn, he says. “They’ve become woefully disconnected for over 30 years—and never more so than the last 10. Policy needs to make sure they’re connected.”

Before it's here, it's on the Bloomberg Terminal.