Australia – real wages growth zero and the rip-off of workers continues

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1. The gap between labor compensation and productivity is interesting, but I’ve always thought that a deeper analysis was necessary to really understand the causal forces at work. So today I took a quick look to see what I could find in the way of other research. One interesting recent paper that I came across was from the U.S. Bureau of Labor Statistics (BLS):
   https://www.bls.gov/opub/btn/volume-6/understanding-the-labor-productivity-and-compensation-gap.htm

   It takes a look at the differences between the gap in different industries and also uses something more like a producer price index (computed separately for each industry) as a wage deflator rather than using a general consumer price index. This results in a much stronger correlation between industry productivity gains and wages paid in that industry. I’m still not clear on whether that is a reasonable thing to do (perhaps Bill can help there), but among other findings they point out that the size of the productivity / wage gap correlates with the amount of productivity gain. That is, industries with the largest productivity gains also have the biggest productivity/wage gaps. That makes some amount of intuitive sense to me for some specific ways in which productivity can be increased. If you outsource to get big productivity gains, then by definition you are cutting wage costs as well. The same can be said if you significantly automate to gain productivity. Also, companies that make the fastest productivity gains are sometimes making large and frequent capital investments (computer chip manufacturers come to mind) because production equipment is made obsolete so quickly. So for those sorts of industries it makes sense that a larger share of income might go towards capital replacement. I just have the feeling that more specific analysis by industry will help to better understand why this productivity/wage gap occurs.

2. Why do you think employers are not paying their employees according to their productivity growth? Its not even in their own interests in the long run

3. Paul , if we are talking about labor productivity, I very much doubt that US companies outsource production in order to improve that- they outsource to lower their costs with far cheaper labor and less stringent regulations- not to improve the production per hour of labor. But investment in automation of production almost by definition will increase labor productivity for a company. And capital replacement by a company is Investment- not profit share.

   While I understand that increasing labor productivity allows for increasing real wages in a totally non-inflationary way, I have never understood the claim that increased productivity will necessarily result in those wage gains. What is the mechanism whereby labor automatically captures some of the increased production per hour of their work?

4. Jerry, If you reduce labor costs for any given level of production, then by definition productivity improves. So sure, they’re trying to reduce labor costs, but that improves productivity. Those two objectives are met simultaneously.

   I’m not sure what point you were trying to make by saying that “capital replacement by a company is Investment- not profit share”. I was talking about shares of “income”, not shares of profit. A company that must use a relatively large share of income to replace equipment that becomes obsolete very quickly has, by definition, less income to spread around among other players who also get shares of income. That includes wage workers, suppliers, management, and stock-holders.

   Regarding the relationship between increased productivity and wage share, I don’t think anyone assumes that increased productivity will automatically increase wages. Certainly all the data since 1980 would disabuse you of the idea that this happens automatically. But over a long time previous to that there was at least a rough correlation between the two. That turned out to be a generally good thing to maintain ongoing economic growth. So the question that Bill and other economists have attempted to answer is why that correlation no longer holds. Sometimes their answer is “greed” when viewing management salaries. Sometimes the answer is the successful attack on labor unions which disadvantages workers in wage negotiations. My personal opinion is that the real answer has more to do with the changing nature of wage work. There is much less physical skill required than previously and much more intellectual skill required for many of the newer high-paying occupations. Thus the emphasis on people getting college educations to get the newer, higher paying, jobs. But even that amount of training is insufficient for many of the jobs that are available today, and there aren’t enough jobs for people with basic college degrees. Companies do less training themselves because they have discovered that they just lose the workers they train to competitors. As a society we have to decide what to do about that and that’s where people like Bill have a lot of insights to offer I think.

5. Hi Paul, my understanding of labor productivity is it is the amount of goods produced per unit of labor time. So if company A produces a house using 2000 labor hours that sells for $100,000 while company B produces the same house using 4000 labor hours, then A’s employees have a higher labor productivity than B’s. Even if company A has to pay it’s employees three times as much as B pays- labor cost is not figured into labor productivity, only hours worked and final output value.

6. Paul, I don’t remember what point I was trying to make about investment, so I am not surprised that you don’t know either :). I think it was something along the lines that a company will expect a return on investment of capital, since it has a real cost, and that therefore it is not surprising that while labor productivity will rise, wages of the firm’s employees might not. But investment in productive capacity creates demand for investment goods, which could allow wages to rise in that sector, which theoretically could allow for wage increases for employees of the original company.

7. I am thinking that the whole theory that productivity increases will cause real wages to rise hinges on the assumption of full employment in the economy. While neoclassical economists love to assume full employment, we know that historically, it has rarely been achieved without government intervention. But if we can implement the Job Guarantee like Professor Mitchell advocates, then we would see actual full employment and that would allow for real wage increases in line with productivity growth.

8. Jerry, I’ve been traveling all day, sorry for the delay in responding. Measuring labor productivity is sort of a tricky thing and I don’t claim to be any sort of expert except for having been in the position of a manager actually trying to measure it. I believe you are correct in saying that productivity is ideally measured as output/labor-hour or some equivalent.

   The problem is that not all labor-hours are equivalent (i.e. labor-hours are not fungible). So if you change your process in such a way that the number of labor hours used doubles (or is halved), for the same amount of output, have you automatically halved (or doubled) the productivity? Any manager would likely tell you that it depends on the wages being paid in each case. It’s just not reasonable to make comparisons of alternative labor configurations without taking costs into account.

   So rather than use labor-hours as the denominator for a productivity measure, you will see labor-dollars used. That’s what I did almost instinctively, without thinking about it too much or explaining it. Even that doesn’t solve all measurement problems because you may be exchanging other factors of production for labor (one way or the other), so you have to take the costs of both factors into account to determine if your overall process change gains or loses with respect to “productivity”.

   I once took a long look at the way that productivity changes are computed by economists as part of their estimation of price inflation. While I eventually sort of understood their intentions, I came away shaking my head because it never seemed completely reasonable to me. For example, if the same raw materials are used for two successive versions of a product and the labor done is substantially the same, then they are deemed to be equivalent, no matter how differently those raw materials might be used. In the case of computers, where I’m on familiar ground, that’s a ludicrous assumption, because how they are put together makes a huge difference. Gigahertz chips and Megahertz chips are manufactured with fundamentally the same materials and labor processes (using significantly different capital equipment). The increases in quality, utility, or other consumer value that new products typically have seem to hardly matter for economic metric purposes. A secondary effect of this is, I believe, that official measures of price inflation habitually overstate the actual value. With a central bank that is highly suspicious of any little bit of inflation and reacts by increasing interest rates in order to cool things down, that is a recipe for squelching economic growth.

   Now I want to qualify all that by saying that it’s been a few years since I last looked at the way things are measured and they may have changed somewhat. But since that would invalidate a number of long-running economic series I’m somewhat doubtful that much has changed. Send email if you want to discuss anything further.

9. Jack, if you’re asking why managers don’t increase worker wages when productivity increases, then I think the answer lies in the specific reason for the increase. I don’t want to make the explanation simpler than it actually is, but generally speaking you can get productivity increases either by virtue of some change in the worker (i.e. they gain or improve some skill that results in higher levels of production) or via some change in the production process (i.e. a new process or tool or whatever). Clearly for any change of the first sort it makes sense for employers to increase compensation for the more productive employees because otherwise they might lose them to a competitor who would get the benefit of their improvement. This clearly happens today for some employees (software developers, for example).

   For the second sort of productivity improvement additional worker skills may or may not be required to go along with the process/tool change. But even when new skills are required, they may not require a substantial amount of training or experience to acquire. Employers do not need to increase their compensation if other workers can be hired and trained at relatively little expense. Managers are primarily charged with increasing shareholder value and will not keep their positions long if they do not do that. Reducing labor costs is an attractive target. The macroeconomic effects of every company doing that are not even on the radar of managers and even if it were, the forces compelling them to further reduce labor costs means that if they don’t do it, someone else will be hired in their place who will.

   You will get different theories about what is actually happening in the economy, but my own personal opinion is that for any number of reasons, the second sort of productivity enhancement has become much more common. So managers are rewarded for coming up with those sorts of changes and employees get very little of the increased income. I believe that this is simply a product of the microeconomic forces involved rather than some international plot by the rich to take advantage of the poor. But it is causing major macroeconomic problems as Bill so carefully documents. So the effect of what is going on may not be much different than if there actually were such a war being waged on the poor.

10. Hi Paul, I’ve thought much the same as yourself but can’t find anybody to agree. Surely, the provisioning cost of labour productivity by why of capital expenditure must have a deterministic effect. Would it be more appropriate to compare wages growth with total factor productivity so that the capital component is captured. TFP has pulling in the opposite direction to labour productivity for most of the last decade. I’m not an expert but it seems intuitive.

    Jerry, again I’m not an expert but my understanding of the mechanism for wages growth being linked to productivity gains is not via benevolent bosses. I believe that it is due to the rollout of technology requiring workers with higher skills. It is the higher skills that demands higher wages. No doubt that the collective workforce today has more skill than those of 10 years ago and those again of 20 years ago. So the incremental gains in skills is what really drives wages.

    Thanks for the blog Bill. Don’t comment much but read most days.

11. Crocodile?, I am sure you are right that wage growth is not due to benevolent bosses! There are some here and there but individual managers, bosses, owners cannot affect the overall, economy wide trend, in my opinion.

    As far as wage growth depending on higher skill levels than in the past, I think I disagree. It seems to me that the entirety of mass production since it was introduced has been focused on reducing the skill level required for each worker so that goods can be produced with less labor cost. Costs that would have to be paid for by the producer for that more highly skilled (and rare) worker.

12. Paul, thank you for the reply- I know what you are saying and I realize it is probably the more important consideration for a company exec deciding whether to outsource production to somewhere with lower labor costs. But being a labor guy, it is important to me that it is described accurately when a company makes that shift in production. I doubt very much that companies move because workers where they move to produce more per hour than their previous employees did. I think they move production to take advantage of lower labor costs and less regulation, and I think that needs to be acknowledged. Sorry.

13. Paul, I cut off the end of my comment somehow. It was “Sorry. Didn’t mean to take this out on you.”

14. Jerry, yes the key is production with less labour cost. This doesn’t mean less skill. The onward march of technology means that a single labour unit can produce more output. Due to technology, the skill level of the operator is higher. I think you need to look economy wide. For instance, a guy with a bulldozer can shift more dirt than a team with shovels. I guarantee that his pay rate would be higher. It goes on from there. Skilled workers such as engineers need to design the bulldozers, mechanics need to service them, they require sales outlets and fuel etc. All of these involved earn more than the guy on the end of a shovel. This is what I mean by incremental growth in technology over time that grows wages.

15. Jerry, I always appreciate your thoughts and I am not nearly so thin-skinned as some of our U.S. politicians! And I totally agree with you that outsourcing is generally about reducing labor costs. Cost reductions (including, but not exclusively for labor) are one way of producing more for the same $ expense. That is always a primary management objective. I often think that this is short-sighted because things like product quality may be neglected when making the assessment. But by effectively increasing the supply of potential workers by expanding the search for them world-wide, they can take advantage of less competition for labor in off-shore locales and thereby lower their costs.

    The other way to make more for less is to use better tools and technology. Often in the past this has resulted in a requirement for improved worker skills as well, as Crocodile pointed out. But since the productivity gain was caused by two different factors (technology/capital and worker skill) they shared in the gain in a proportion that was largely determined by the supply and demand for that particular sort of labor skill.

    I think this also accounts, at least in part, for the very high executive salaries. Figuring out how to design production in a cost-optimal way is not an easy task. Having seen up close how at least a couple of CEO’s work, I wouldn’t want that job for any amount of money. The stress on my own life, being a few levels down in a relatively small company, was enough to make me decide to retire early. Note that I am NOT saying that the stress on such people is anywhere near the equivalent of the stress experienced by very poor out-of-work people with families to support. Executives are well-compensated for their stress levels. I am only saying that their compensation levels are high partly for the specific knowledge and experience that they have for pulling together production in a way that optimizes shareholder value and partly because there aren’t that many people who can both do those jobs and are willing to pay the personal costs they require.

    I think that Crocodile’s point about total-factor productivity and labor-productivity diverging is right on. My own view is that the capital-or-technology/labor-skill ratio for new jobs has been increasing over time and in some cases has reached infinity as the need for any labor at all for a specific task goes to zero. My academic training was in AI and I am totally blown away by the progress that has been made in recent years and which is accelerating. Whole occupations (like drivers) will disappear in short order. What we’re seeing today is a pale shadow of the labor-market disruption that is on our doorstep and we’d better get our economic policy act together before massive social upheavals make life much worse for everyone. Much like nuclear war, economic war between capital owners and everyone else is not a winnable war. The result of such a clash would result, I fear, in a worldwide regression into the economic stone-age with the inevitable personal costs for everyone that this would entail.

    The basics of any new economic policy must, I believe, eliminate (or at least moderate) the fundamental driving force of capitalism as we currently have it, which is maximizing shareholder value. It will take worldwide government regulation of some sort that favors economic equality for the masses to make such a change. With entrenched money interests that will fight this tooth and nail, I am not currently very optimistic. Economic education for the masses will be the key I think. And for that reason I am very grateful for Bill Mitchell.

16. “The on-going subdued economic activity will also undermine the Government’s fiscal strategy, which can be summarised as squeezing net public spending out of the economy in the hope that they will achieve a fiscal surplus by 2020-21.”

    Is this for real? Is this actually what they are aiming for?

17. Yes Dingo, it is unfortunately true. It has worked it’s way into the narrative over time now and almost impossible to turn back. The punters now firmly believe that surplus = good, deficit = bad. People associate with debt and the tricksters have been successful in promoting the myth that a national economy is akin to a big household. The householders haven’t quite worked out yet that clearing government debt simply transfers the debt to the private sector.

18. It is little wonder the neoliberal myths live on – NSW (and probably other Aus states) indoctrinate /misinform a fresh batch of HSC economics students every year.
    My son is Yr11 NSW studying “Economics” for the HSC – the textbook in use (“The Market Economy” written by Tim Dixon and John O’Mahony) is full of neoliberal miss-information that must be ‘learnt’ and parroted to achieve a ‘pass’ in the subject.
    Both he and I comprehend the macroeconomic reality of MMT – yet to pass exams he must regurgitate the many unreal economic lies and fallacies taught.
    He is a diligent high achieving student (straight A’s/occasional YrDux) in every subject, yet he must write (what he knows is) complete rubbish to pass the HSC course exams.
    In the subject of economics, his learning experience is an exasperating exercise in rehearsing/regurgitating contrived deceit – fearful that he might inadvertantly write MMT truth and be marked down.

    In the teaching of HSC economics there is little distinction drawn between state or federal government financial constraints/operation, except to define broad areas of responsibility. Currency issuer vs currency user is never mentioned in his workbooks, let alone considered in class.

    The following is from his class notes – he says drawn from class textbooks:
    “Governments borrow deliberately to increase the level of economic activity and to finance major infrastructure projects such as roads or bridges. Governments will also borrow if their spending unintentionally grows faster than their revenue, or to give tax cuts and to stimulate the Australian economy. Governments mainly use government bonds to borrow money but occasionally take out government loans from banks…”

    Some random quotes from his lesson notes:
    – Commonwealth government is funded by the taxes they impose on the public such as individual income tax, excise duty and company taxes…..
    – the level of savings in an economy places downward pressure on interest rates as when savings are high there are ample loanable funds available…
    – inflation expectation -…if inflation is expected to increase then lenders require a higher interest rate to compensate the depreciation of their asset; ergo even if the real rate of return remains constant, high expected inflation will lead to higher nominal interest rates.
    – Govt. Budget …if a government has a fiscal deficit it is a borrower of funds which can result in higher interest rates; if it is a net lender [surplus] downward pressure will be placed on interest rates….

    Annually there is a future batch of economic illiterates being turned out by our school education systems.
    How does one fight such institutional intellectual corruption?
    It is pointless trying to discuss the inadequacy of the HSC economics course with the relevant High School, as they just point to the set HSC curriculum.
    What can one do to change this most unsatisfactory situation.