[UPDATED] Wages, productivity, progressive policies, and serial correlation: I weigh in on an important, interesting debate.

November 20th, 2017 at 10:00 am

UPDATE: See below, at the end of this post, for Anna Stansbury and Larry Summers’ thoughtful response to my blog. My goodness, a rational conversation…what a strange and rare event these days!

There’s an interesting sort of argument going on between Stansbury/Summers (SS) and Mishel/Bivens (MB). My name has been invoked as well, so I’ll weigh in. It’s a “sort-of” argument because there’s less disagreement than first appears.

It all revolves around this chart, which plots to the real compensation of mid-wage workers against the growth in productivity. For years they grew together, then they grow apart. The levels of both variables almost double, 1948-73, but since then, productivity has outpaced the real comp of blue-collar, non-managerial workers (mid-wage workers) by a factor of 6.

That wedge between productivity and middle-class wage growth has become one of the more important developments in political economy, representing the rise of inequality and the disconnect of paychecks and growth. It’s even on a tee-shirt, produced by the group, Fed-Up.

SS agree that the split is real and important, but their motivation appears to be not throwing out the baby with the bathwater. That is, they’re concerned—not without reason—that progressives see those two lines and conclude the growth and productivity don’t matter. In a follow-up oped, SS cite me as suggesting that in the age of inequality, we can’t count on growth to reach middle-class families: “Faster productivity growth would be great. I’m just not at all sure we can count on it to lift middle-class incomes.”

That’s true and even axiomatic, as per the figure above, but SS’s point is that even so, it doesn’t mean productivity growth doesn’t raise median wages. It just means there’s a bunch of other stuff pushing back in the other direction. That’s true too.

[Note: it’s very important in this debate to distinguish between median and average compensation. As inequality increases, they diverge. Since this debate is about inequality—i.e., the “other stuff” that’s driving the gap—it’s important to focus on the median as opposed to the average.]

In a series of regressions of median or middle-wage compensation (the latter is for blue-collar and non-managerial workers, for which there’s a longer time-series) on productivity growth and unemployment, SS shows that the coefficient on productivity is often close to 1, meaning a 1 percent increase in productivity maps onto a 1 percent increase in wages. Again, this doesn’t deny the gap. But it does say growth matters for wages, even at high levels of inequality, weak worker bargaining power, persistently slack labor markets, etc.

I’m sure that’s right and it’s one reason why so much of my work in recent years has focused on running full employment, full-growth-potential economies. I’ve written extensively and bemoaning-ly about the productivity slowdown, often trying to push back on those arguing its mostly measurement error. I’ve called it one of the biggest economic problems we face. Just a few weeks ago, I tried to show the critical role slower productivity growth was playing in current wage growth that’s slower than it should be at such low unemployment (see 2nd-to-last figure here).

But, as I wrote in one of the links above: “Faster productivity growth is not by itself sufficient to raise the living standards of all who help to generate it, but it surely is necessary.

SS focus on the “necessary,” which is fine and important, but in doing so, they create a bit of a straw man by casting those of us who focus on the “not-sufficient” as inadequately committed to faster productivity growth. That’s inconsistent with our writings. FTR, I do think Summers has done a particularly good job in recent years putting equal weight both sides of this equation, lending his heft to not just growth issues, but inequality issues as well (he’s also been on a recent and admirable tear against the awful tax cut plan).

I won’t belabor this because the MB response is so thorough and I’ve little more to add. I will, however, underscore one key policy point they make and add a neat econometric point to which I’d like SS to respond.

MB write:

Our contention all along has been that this pay deceleration did not just reflect slower productivity growth, but that it in fact reflected a number of intentional policy decisions that undercut typical workers’ ability to demand and achieve higher pay. One such policy decision was exactly over how aggressively the Federal Reserve and other macroeconomic policymakers should target low unemployment. Others included decisions about whether or not to protect workers’ rights to organize and bargain collectively (the country obviously chose not to) and whether or not to raise the federal minimum wage in line with inflation or productivity growth (again, we chose not to).

With this in mind, those who would close that gap, which include SS, MB, and JB (that’s me), would, I suspect, readily admit that we have a lot more confidence in our knowledge of gap-closing policies in the space MB reference above versus ideas to boost productivity growth. The latter, I regret to say, remains largely a mystery to economists.

So, pushing for higher minimum wages, full employment (direct job creation), progressive taxation, collective bargaining, overtime rules, gender equity, a robust safety net, more balanced trade, financial market regulation (a complement to full employment—we can’t have them blowing up the economy every cycle), and so on are gap-closing ideas that we know will help. What’s more—and this part is important given SS’s findings—these measures are not anti-growth.

The punchline is thus twofold. Of course, 1) faster productivity growth is a necessary component of faster wage growth. But so is 2) re-linking wage growth with the ongoing productivity growth we have. And we know more about how to achieve #2 through progressive policies than #1.

Two econometric points:

First, Biven shared the data with me and I replicated one of SS’s main findings: a coefficient of 1 on the productivity variable in a simple specification of mid-wage comp on productivity growth and unemployment. But they neglect to mention that the residuals are serially correlated in that regression (DW=0.54), implying an omitted variable bias. That’s not surprising: you can’t explain a complex variable like mid-wage comp with just productivity and unemployment. But it is a problem for their trade-off conclusions if what’s missing correlates—shares explanatory power—with productivity growth.

Which appears to be the case: when I add an AR(1) term to whiten the residuals, the productivity coefficient falls by half (to 0.5) and DW=1.5. To be clear, that doesn’t undermine their point. The half-a-percent is an elasticity very much worth tapping! But it’s important recognize an omitted variable bias that likely has to do with the “other stuff” in that big gap in figure 1.

Second, MB show that much of the juice in SS’s findings come from a period I’m highly obsessed with: the latter 1990s, when true full employment ultimately prevailed, productivity growth was strong, and real pay throughout the wage scale rose quickly, in step with productivity (which is why the correlation drops when you take out that period). This observation does not at all disprove SS’s findings, but it did lead me to think about the role of full employment in these dynamics.

I and others have argued that in persistently weak labor markets, employers do not need to uncover efficiency gains to maintain profitability. But in truly tight labor markets, where pressure on labor costs cuts into profit margins, that calculus changes, and in order to avoid higher unit labor costs (comp relative to productivity) and lower unit profits, you’ve got to find efficiency gains. This is the full-employment-productivity-multiplier about which I’ve hypothesized.

In this story, the causality goes from full employment to both faster productivity growth and faster wage growth. It also creates non-linearities in the data that complement the missing variable point above. Going for 7 to 6 percent unemployment will do less in the model I’m thinking about here than going from 4 to 3 percent.

BTW, this would imply that the current low unemployment rate should be juicing productivity growth a bit.  In fact, averaging the past six months, year-over-year productivity growth has accelerated to 1.4 percent, a nice bump, though with these jumpy numbers, nothing you’d want to read much into. And, as noted, wage growth still hasn’t caught as much of a buzz as I’d like to see.

It will take both faster growth and much more progressive policy to close the big gap in the figure. On that, I suspect we all agree.

STANSBURY AND SUMMERS RESPOND:

We very much appreciate Jared Bernstein’s comments on our recent paper on the link between productivity and pay. As he noted, there’s a lot more agreement than disagreement between our perspectives: on the importance of raising productivity growth, on the problem of the stagnation of typical workers’ pay, as well as on policy approaches towards both of these – all of which he has written about extensively and thoughtfully (e.g. on recent slow wage growth, the productivity slowdown, boosting productivity growth, and in his book the Reconnection Agenda).

He raises a couple of points on our paper, on which we’d like to respond.

Jared argues that faster productivity growth is necessary but not by itself sufficient to raise living standards, and that by focusing only on the “necessary” part of this argument we risk straw-manning others’ arguments. This certainly hasn’t been our intention, so we think it’s useful to clarify which mechanisms we were looking to distinguish between with our paper.

We’ve encountered three broad classes of arguments about the link between productivity and typical pay:

  • Arguments that productivity growth does not affect typical workers’ wages at all. Instead other factors determine typical wages – and if workers become more productive, the benefits flow to higher-income workers or capital owners. The implication here would be that no matter what reforms are made to rectify inequality, marginal increases in productivity growth will not translate to increases in typical workers’ wages.
  • Arguments that productivity growth is necessary for typical workers’ wages to rise, but productivity isn’t currently able to affect typical workers’ pay because other factors are blocking that transmission mechanism (perhaps factors to do with wage inequality, such as low worker bargaining power). The implication here would be that given the current structure of the economy, marginal increases in productivity growth will not translate to increases in typical workers’ wages, but if certain reforms were enacted, productivity growth would once again affect pay. This is how we interpret the argument that productivity growth is necessary but not sufficient to raise pay growth.
  • Arguments that productivity growth exerts pressure to push typical workers’ wages upwards, but other orthogonal factors have simultaneously been exerting pressure to pull typical workers’ wages downwards. The implication here would be that even given the current structure of the economy and no reforms to address inequality, marginal increases in productivity growth will translate into increases in typical workers’ wages.

Few economists subscribe to argument (1). But having seen the chart displaying the divergence between productivity and typical pay since 1973, reasonable economists could differ as to whether they subscribe to argument (2) or argument (3). It’s this distinction that motivated our research and the right answer ex ante wasn’t clear. Having investigated the question in the postwar and post-73 data, we believe there is much more evidence for argument (3) than argument (2) (or indeed argument (1)). The evidence does more than just make the case that productivity growth is necessary for pay growth: it suggests that higher productivity growth even without changes in policy will have substantial benefits for workers (as Jared notes in his blog). Also of course this conclusion does not make the case against policies to promote fairness or redistribution. It’s our view that strategies that focus both on productivity growth and on labor market or redistributive policies are likely to have the greatest impact on living standards for typical workers.

Jared also raised a concern with our econometric strategy, to do with serial correlation. Our baseline estimation method uses moving averages, which mechanically introduces serial correlation into the regression. There’s a trade-off here: a moving average strategy is one of the most appropriate ways to get at the low frequency relationship we’re interested in, but by its nature introduces serial correlation. On the other hand removing the serial correlation removes much of the useful variation. We settled for the former and used Newey-West HAC standard errors so that our standard errors appropriately accounted for the serial correlation. Our second set of baseline regressions (Table 2 in the paper) use distributed lags, which are more robust to the concern about mechanically containing serial correlation. We used Newey-West HAC standard errors for these regressions in our paper. We’ve re-done these distributed lag regressions, correcting for serial correlation by assuming an AR(1) error process as Jared suggests. This doesn’t change the coefficient estimates importantly.

Whether using these corrections or Jared’s serial correlation-corrected estimate of 0.5 for middle-wage workers, the coefficient estimates we end up with are within the ranges that we concluded were most reasonable in our paper: that a one percentage point increase in the rate of productivity growth is associated with a two thirds to one percentage point increase in median compensation growth and a 0.5 to 0.7 percentage point increase in production/nonsupervisory worker compensation growth (“middle-wage” compensation).

Finally Jared discusses the benefits of a high-pressure economy (Larry Mishel and Josh Bivens raised a similar point in their response to our paper). We agree that this is a very important subject, worthy of further investigation – and indeed is closely related to hysteresis issues that one of us has pursued (e.g.  1988, 2014).

Jared closes with the comment that it will take both faster growth and much more progressive policy to close the big gap between productivity and typical pay. And he notes that policy-wise we know more about how to reduce inequality than about how to boost productivity. On both points, we agree.

No, progressive policies don’t hurt growth

November 14th, 2017 at 9:53 am

Neat new study out of CA, where they’ve created a virtual conservative, anti-interventionist’s nightmare of progressive policies. According to theory, the state should be tanking re growth and jobs, and yet…well, see for yourself.

Ben S and I did some of this sort of analysis awhile back re the ACA and jobs in the states.

We’ve got the facts; they’ve got the power. This must change, OTE’ers!!

The case for direct job creation

November 9th, 2017 at 9:55 am

Over at WaPo, and notice the support for the idea from all kinds of different bedfellows, from progressives like myself, Darity et al, to centrists like former Clinton Treas sec’y Rubin, to Trump’s chief economist!

The unknowable motives of mass murderers

November 7th, 2017 at 7:51 am

As you see from the title, I’m once again veering out of my econolane, but only briefly, and only to see if others share this sentiment.

My morning paper blares the banner headline “Texas Shooter Was In Domestic Dispute.” I understand that after these horrific events people want to understand what could motivate the killer. But here’s the thing: these motivations never come anywhere close to explaining the outcome.

And what possible could? What reported motivation would ever make you say, “Oh, I get it?” That’s partly because what the killer did was unimaginable to most people, and because there are always lots of people going through the same thing the killer was going through who didn’t do what he did.

We’re particularly interested in terrorist motivations, but here again, the above logic applies, does it not (I’m really asking)? I just can’t get myself to see any difference between the person who yells something “religious” in Arabic as he commits a mass crime or the person who has a background of domestic violence, a loner, or whatever. Certainly the result is the same. As humans, we strive for explanations so that we can take comfort by putting what happened into some familiar box. But this doesn’t work for me, because what these people did is unexplained by any coherent motivation.

Is not the motivation in this and every such case involving mass murder in the US some combination of severe mental illness/distress and access to guns? Is not the only headline that makes sense: “Shooter was a deeply disturbed person with an automatic weapon,” full stop? But even that motivation may fall prey to my own critique, as the vast majority of those with varying degrees of psychological stress never would engage in such murderous acts.

Back to econ, but do others share anything like this view?

The big, bad tax cut plan: Stuff you might have missed

November 6th, 2017 at 3:07 pm

[Two great, new updates.]

There is and will continue to be much digital ink spilled in analysis of the House Republican tax plan, and while OTE readers are, by definition, invariably well-informed, here are some links to worthy pieces you might have missed.

–Catherine Rampell at WaPo and Ben Casselman/Jim Tankersley at the NYT both dig in the weeds this AM. Rampell highlights the fact that the new pass-through loophole introduced by the bill is particular generous to what she calls the “lazy/idle” rich, as it lavishes its goodies especially on passive investors (those who do less actual work for the S corp, partnership, etc.). The Times piece reveals that the R talking point on how no middle-class families taxes will go up under the plan to be false. In fact, millions of such households face higher taxes under the House plan. The reasons are the same I note below from Kamin’s piece: the fading of the $300 child credit, the shift to the chained CPI, the loss of personal exemptions (which are indexed to inflation whereas the Child Tax Credit expansion is not), and the loss of various deductions.

–David Kamin does some very useful number crunching on some tricky details re the dynamics of the plan that, as he estimates, turn one of their examples of a tax cut, relative to current law, into a tax increase.

In rolling out their plan, House Republicans focused on an example family — a married couple making $59,000 per year and with two kids. They said that family would get a tax cut of over $1,182 in 2018 (compared to what they paid in 2017). But, what they didn’t say is that a family making $59,000 would face a tax increase by 2024 relative to current law, with the tax increase potentially rising to nearly $500 by 2027. This is even as tax cuts for those at the top are maintained.

The reasons are: the loss of personal exemptions, the expiration of a $300 family credit the plan initially offers, and the switch to a slower-growing price deflator to index brackets and other tax parameters (this means, e.g., that growing nominal incomes will pass into higher brackets more quickly than they would under current law and that tax credits indexed to inflation will rise more slowly).

–Steve Pearlstein made the same point in the WaPo that I made a few weeks back in the American Prospect: Hey, Dems! Plan beats No Plan. Though playing defense right now justifiably sucks up a lot, if not all, of progressives’ bandwidth, I’ve long felt that the absence of plan that embodies real tax reform is a big hole that should be filled. I like my ideas–surprise!–but Pearlstein and I share some of the same ones. This really isn’t rocket science: you’ve got to raise the necessary revenues, as progressively and efficiently as possible. That typically means closing a bunch of wasteful loopholes that squander resources on the wealthy, often subsidizing activities, like buying big houses or saving for retirement, that they’d do anyway. From my Prospect piece:

Real tax reform would begin from a clear-eyed assessment of the resources government will need to meet these needs, all of which fit neatly under the rubric of public goods, social insurance, and risks that will not be met by market forces. The raising of ample revenues, done in a way that balances efficiency and equity considerations—i.e., that minimizes the kinds of distortions you get by favoring one income type over another, while maintaining tax progressivity—that’s real tax reform.

–I thought this Washington Post editorial made a good point re non-credible claims that the tax cut will pay for itself by generating implausible growth effects:

If Republicans really believe that the experts [i.e., those of us who disbelieve the growth predictions] are wrong, they can put their legislative language where their mouths are. They can allow their tax cuts to phase in only so long as the federal government meets revenue targets. If early cuts appear to produce economic growth and significant new federal tax income, more cuts could automatically kick in. Alternatively, most or all of the cuts could begin immediately, and some could be scaled back if the federal budget takes a big hit. The GOP plan calls for phasing out the estate tax over several years. At the least, that egregiously unnecessary measure could be canceled if the budget suffers from the rest of the tax plan.

Republicans might worry that uncertainty about future tax rates would blunt the boost cuts would give the economy…[but they] could design a trigger that would close more unnecessary tax loopholes in case promised revenue does not appear, ensuring that the lower nominal tax rates they favor would not change [since in their supply-side fairy tales, it’s the rate reductions that do the magic]. If the deficit rises under the GOP plan, additional limitations on tax subsidies that help wealthy people buy expensive houses could automatically phase in, for example.

Of course, the editorial makes the mistake of taking the growth rhetoric seriously, as opposed to just part of the sales job.

–Also in WaPo, I feature an important, new bit of analysis by CBPP’s Chuck Marr regarding the tax plan’s extension of the Child Tax Credit. The tax plan extends the credit, but the extension is asymmetric: it only goes up, not down the income scale. That is, the current phase-out range is increased so higher income families with kids will now get the credit, but because the refundable part of the credit is unchanged, low-income, working families, who would benefit most from the extended credit, don’t get it (they end up with the same amount of the CTC they’re currently getting).

–Adam Looney provides a useful explainer to which you should really pay attention so that next time you hear whining and caterwauling about how US mulitnational corporates can’t access their offshore earnings, you will plug up your ears and run the other way (my bold).

Given how we talk about these earnings, you could be forgiven for thinking U.S. companies have stashed their cash inside a mattress in France. They haven’t. Most of it is already invested right here in the U.S.

U.S. multinational corporations can defer paying tax on profits they earn abroad indefinitely by agreeing not to use the earnings for certain purposes, like paying dividends to shareholders, financing domestic acquisitions, guaranteeing loans, or making investments in physical capital in the U.S. In short, the rules prohibit a company from using pre-tax money in transactions that benefit shareholders. No one believes this is  rational or efficient, and it is certainly onerous for shareholders, who would rather have that cash in their pockets than held by the corporation. But those rules don’t place requirements on the geographic location of the cash. Multinational firms are allowed to bring those dollars back to the U.S. and to invest them in our financial system.

I’ll update this post accordingly, and if you have any good items you think we should look at, please post the link in the comments section.

That said, I must say I’m reminded of the great Tom Lehrer song about the war against Franco: “Though he may have won all the battles, we had all the good songs.”

OTOH, resistance is not futile! Look at this recent Pew poll result, which shows a marked, 7 ppt swing towards D’s on taxes in late October.  OTOOH, we’re not talking about the world’s more representative group of politicians. To state what is, or at least should be obvious, they’re playing to their donor base, not to their constituents.