Why Aren’t Wages Growing?

By Robert VerBruggen

Monday, September 04, 2017

Note: This article originally appeared in the July 31, 2017, issue of National Review magazine.

After adjusting for inflation, hourly wages in the private sector grew 0.4 percent between April of last year and April of this year. The four-fifths of these workers who labor in “production and nonsupervisory” roles saw growth of just 0.1 percent.

These were surprising numbers, given the state of the economy. Not only are we well into a recovery, but the unemployment rate has finally returned to its pre-recession level. Normally, employers need to start raising wages once they no longer have a deep reserve of unemployed workers they can turn to if someone threatens to quit.

But in general, slow wage growth is not really news to Americans. The liberal Economic Policy Institute, after all, is fond of claiming that despite significant growth in the overall economy, wages have been stagnant for the typical worker since the 1970s. The picture EPI paints is a bit too gloomy, owing to the use of a problematic inflation adjustment. But when the very existence of wage growth hinges on one’s choice of deflator, it’s safe to say there’s a problem.

That problem is multifaceted. Indeed, every step of the process that leads to wage growth seems to be faltering. And to make matters worse, economists disagree on even the most basic facts of what’s happening and why. The matter presents an urgent challenge to policymakers across the political spectrum, and an opportunity for Republicans to do right by the voters who put them in charge of the House, the Senate, and the presidency all at once. Getting wages headed in the right direction again, or at least ameliorating the effects of sluggish wage growth, is at this point an imperative.

Writing in 2014, Barry P. Bosworth of the Brookings Institution offered a handy breakdown of the “primary determinants” of wage growth: “(1) gains in labor productivity, (2) the division of earned income between labor and capital (profits), and (3) the allocation of labor compensation among wages and nonwage benefits.”

Productivity growth is the ultimate root of wage growth: If workers aren’t producing more output for each hour they work, employers cannot raise hourly wages without also raising prices, which eats away the wage gain through inflation. And productivity growth has been abysmal for the decade since the end of the tech boom. Even more troubling, the tech boom aside, it’s been flagging for much of the past 40 years.

Explanations for the falloff abound. Some say it’s a statistical artifact of one kind or another. Maybe the numbers are failing to capture the benefits of major technological gains that don’t cost a thing to the user (and thus produce no measurable “output”), such as Internet search engines. Maybe the data are thrown off by the increasing tendency of companies to stash profits overseas, removing them from the measured output of American workers. Maybe people are spending more time goofing off in the workplace, and their productivity during the time they actually work has gone up.

Or maybe productivity really isn’t growing as fast as it used to. This is a view most prominently espoused by the Northwestern University economist Robert Gordon, who asserts that today’s technological advancements — even the continuing exploitation of the Internet’s many possibilities — simply don’t compare with, say, the harnessing of electricity. Tyler Cowen, an economist at George Mason University, eloquently drives this point home in his book The Complacent Class: If the pre-1973 pace of productivity growth had continued, he notes, median household income would be $40,000 a year higher than it is today. Most people would happily go without the Internet for that amount of cash. So while some benefits of technology are indeed excluded from productivity statistics, we shouldn’t get carried away with that talking point.

When productivity does improve, the next step of the wage-growth process is for at least some of the gains to be given to workers rather than owners of capital. For a long time, economists assumed that the “labor share of income” was more or less fixed around 62 percent — but it fell markedly starting at the turn of the century, hitting a low of 56 percent before finally ticking up again over the past few years to about 58 percent.

Here too there are a variety of potential causes. Some economists point to the automation of routine tasks (which is to say, the substitution of capital for labor). Others point out that in developed countries, globalization typically takes the form of offshoring the most labor-intensive tasks. Further possibilities include massive accumulation of capital by the wealthy (the view of lefty superstar economist Thomas Piketty); a fall in investment prices, making capital more attractive relative to labor; and the declining bargaining power of workers thanks to the demise of unions and the consolidation of major industries.

Statistical artifacts may play a role here, too. Government agencies do a poor job of classifying the income of the self-employed, who present a difficult situation because they provide both labor and capital. The standard measure of the labor share fails to account for capital depreciation (i.e., it measures the total income of capital owners, including money they have to spend replacing equipment that went bad). And by one analysis, much or even all of the disproportionate growth of capital can be traced to the rising value of housing, which is certainly “capital” but not really what we think of when we fret about the falling labor share of income.

Even if productivity rises, and even if workers receive some of the gains, the new money might have to fund rising benefits rather than wages. Benefits are currently about 32 percent of total compensation in the U.S. They were below 28 percent as recently as the turn of the millennium and rose especially dramatically between 1950 and 1990.

One final issue is worth noting: American wages are facing demographic headwinds as well, as high-earning Baby Boomers retire and low-paid twentysomethings gain a foothold in the job market. This shift slowed during the recession, as many Boomers delayed retirement and many younger workers couldn’t find jobs, but is now making up for lost time. In a certain sense, this makes slow wage growth partly just a benign side effect of demographic trends, but it also highlights a deep structural problem for our economy: fewer productive workers supporting more retirees than in the past.

There are two ways for policymakers to address low wage growth: They can fight it at any or all of the choke points mentioned above, and they can ameliorate its effects.

For conservatives, one upside of the first approach is that it could involve a lot of things they want to do anyway. Many of the reforms that could spur economic growth, for instance, could do so in part by boosting productivity. Cutting away unnecessary regulations would allow workers to spend their time on tasks that actually create value rather than on compliance. Clearing out bad incentives in the tax code could encourage businesses to use their workers and capital in the most efficient way possible instead of chasing tax breaks.

Some causes of declining labor share also have ready-made conservative solutions. The Right has recently become quite concerned about the rise of crony capitalism and “rent-seeking” by powerful businesses; curtailing this activity could give workers a better bargaining position. Anticompetitive labor practices such as contracts with “non-compete clauses,” meaning that an employee who quits cannot take a job with a competitor for a specified period of time, deserve scrutiny as well. Conservatives might also take a hard look at trade agreements and ask how they might better serve American interests, bearing in mind the populist furor unleashed by Rust Belt job losses (which, to be sure, were only partly the result of trade).

As for the rising share of compensation consumed by benefits instead of wages, health-care costs are an obvious concern. If Republicans can reduce these costs by introducing more free-market incentives into the health-care sector, they can put more money in workers’ pockets. On this, all eyes are now on the Senate and its health-care bill.

All the reforms just discussed could improve the situation, but they are unlikely to reverse the trend entirely. Many of these phenomena — stalled wage and productivity growth, a declining labor share of income — are not unique to the United States but are seen across the developed world, in very different countries that pursue very different policies. It’s possible that, owing to economic and technological developments that will not be stopping anytime soon, we will simply be living with this issue for a while and need to take steps to cope with it.

This is a tricky matter for us conservatives, with our preference for limited government and skepticism of income redistribution. The one way we do like to make sure people have more money in their pockets — income-tax cuts — seems a dubious fit for this problem, because the lower- and middle-income Americans whose wages have stagnated don’t pay much in income taxes to begin with. But there are some helpful policies available here that apply conservative principles.

First, while the working and middle classes pay little in income tax, they typically do pay payroll taxes, the money taken out of paychecks to fund Social Security and Medicare. Cutting these taxes would be one option. Ideally, such cuts would be paid for with spending cuts elsewhere or reforms to the entitlements that the taxes fund. But regardless of the details, if Republicans enact tax reform this year — whether it’s a deficit-increasing ten-year tax cut à la George W. Bush or a long-term, deficit-neutral reform à la Ronald Reagan — they should certainly make sure that payroll taxes are included.

And second, Republicans can pursue safety-net reforms that are consistent with conservative values but also materially help struggling families. Conservatives have long touted the Earned Income Tax Credit (EITC), for instance, as a way to help the poor while encouraging work. As the name implies, the EITC boosts the incomes of those who earn low wages and is not available to those who don’t work. But while it’s called a “tax credit,” it’s “refundable,” meaning that in truth it’s a subsidy — those who qualify for the credit can receive it even if they don’t have any tax liability to offset.

Conservative scholars have suggested a variety of tweaks to this policy. It could be turned into a straightforward wage subsidy that injects extra money directly into workers’ paychecks as opposed to a benefit seen only at tax time, and it could do more to help childless workers, who are now largely excluded from participating. These ideas are especially attractive if they are funded by consolidating poorer-performing elements of the safety net rather than through tax increases or deficit spending.

Donald Trump, for all his flaws, has demonstrated the electoral possibilities of a conservatism infused with populist sensibilities and a concern for the working class. Flagging wage growth gives Trump a chance to show voters his rhetoric was sincere, and congressional Republicans a chance to win back a base disaffected with the GOP establishment.