Petrified paychecks: seven ways to raise wages.

• Author: Blinder, Alan S.
• Position: AMERICAN LIFE: AN INVESTOR'S GUIDE

A wage rate is a market price. The hourly wage is what it costs to purchase one hour of labor services of a certain type, in a certain place. Economists generally disbelieve in tampering with market prices unless there are good reasons. Are there good reasons to tamper with wages--specifically, to try to push them up? Maybe so.

First, unlike the prices of gasoline, shoes, or movie tickets, people's wage rates are the bases of their living standards. Impersonal markets may assign wages to particular "low productivity" people that are so meager that they can't support themselves, let alone their families. More generally, even when abject poverty is not the issue, market wages may lead to levels of inequality that many in society find intolerable. In such cases, governments may wish to intervene with measures such as minimum wages that are "above market" or so-called tax-and-transfer programs that raise after-tax net wages relative to pretax gross wages, such as the Earned Income Tax Credit.

Second, real wage growth (after accounting for inflation) has been abominable for most American workers for decades. Worse yet, what little wage growth there has been was concentrated at the very top. Wages at the median of the earning distribution and below have fallen or barely risen in thirty-five years. Figure 1 shows the dismaying "staircase" pattern of real wage growth by decile that has characterized the U.S. labor market since 1979--the approximate start of the Age of Inequality. At the 10 percent point of the wage ladder (counting from the bottom), real wages actually declined about 6 percent over thirty-three years. At the 50 percent point (the median), real wages rose a scant 5 percent. Even at the 90 percent point, the real wage increase was less than 1 percent per year. In stark contrast, real wage growth at the top 1 percent point--not shown here because it would be, literally, off the chart--was up 154 percent in thirty-three years.

Third, economists' standard explanation of how wages are determined--the idea that each worker's wage equals the value he or she adds to the production process--does not take us far in explaining what has happened to wages. Output per hour in the non-farm business sector ("labor productivity") rose 93 percent over the thirty-three years covered by Figure l, for a compound annual growth rate of 2 percent, but real compensation per hour (which includes fringe benefits) rose just 38 percent, a mere 1 percent per year. So even ignoring rising wage inequality, average American workers lost about 1 percent per year in wages relative to their productivity.

Markets are not supposed to work that way. Productivity is supposed to be rewarded in the pay packet. Indeed, markets did just that during the "golden age" of shared prosperity, 1947 to 1973. Doing the same calculation for those twenty-six years shows that labor productivity rose 2.8 percent per year while real hourly compensation rose 2.6 percent.

The entire postwar history of labor's productivity and compensation is summarized in Figure 2, which shows a widening gap between compensation and productivity since the early 1970s. The divergence is actually pretty minor through 1979, but grows large thereafter. Furthermore, research by U.S. Bureau of Labor Statistics economists Susan Fleck, John Glaser, and Shawn Sprague shows that until the turn of the twenty-first century much of the growing gap between real compensation and productivity was accounted for by differences in "deflation," that is, in how economists adjust wage and production data for inflation. Thereafter, labor's share started to erode. But the story is, in some sense, even worse than Figure 2 indicates because part of the rising compensation was merely to cover the increasing costs of health insurance, not to improve living standards.

This analysis of America's wage problem suggests several questions for...