Q: What is the mechanism by which higher incomes from increases in productivity get back to workers?
A: Well, the problem is: it doesn’t. I mean, sometimes it does, and it should, but in recent decades, productivity growth has diverged from the compensation and incomes of middle- and lower-income families. This is really another way of saying inequality has grown.
For years, economists didn’t think much about this. They observed that average compensation grew at around the same rate as productivity growth and figured that all was well (in fact, a commonly used model, the Cobb-Douglas production function, embeds this assumption that average comp grows at the rate of productivity).
But of course one of the characteristics of growing inequality is that the average is less descriptive of outcomes throughout the income scale. For years, through the 1950s and 60s, real MEDIAN family income kept pace with productivity growth—both about doubled in those years. But since then, median family income has grown about one-third as fast as productivity growth.
What changed? A lot—fewer unions, the shift from manufacturing to service jobs (hastened by the increase in trade with lower wage nations), outsized returns to folks in certain sectors, like finance, and the growth of the educational advantage, to name some of the more important factors.
But no small part of this disconnect comes under the heading of “bargaining clout.” The benefits of productivity growth don’t naturally flow to those responsible for said growth. Some people have to fight for it. And I’m not just talking unions here.
I think one of the most important answers to your question is “full employment.” Labor markets were much tighter during the period noted above when median incomes grew with productivity, and when they got that tight for a moment in the latter 1990s, low- and middle-earnings again begin to rise with productivity.
In those years, employers had to bid compensation up to get and keep the workers they needed. In that way, low unemployment was the “mechanism” you seek. And yes, it’s been very much missing ever since.
Q: You seem very positive on switching to chained CPI. But it feels like it’s being proposed mostly as a cost cutting measure. Shouldn’t that decision be based on some data that shows that chained CPI is the more appropriate measure?
A: OK, I’ve been threatening to post on this for a while and promise I’ll do so any minute now. For the record, I don’t think I’m “very positive” about the change—how big a nerd do you think I am that I get all excited about switching deflators (that’s a rhetorical question)?
But I think it measures price growth, i.e., inflation, more accurately. More to come.
Q: All of this discussion around the “fairness or unfairness” of average tax rates and who pays what % of “income taxes” or “total taxes” obscures the cumulative effects of these rates on the even larger issue of wealth concentration and its effects on marginal propensities to consume. Isn’t the reduction in GNP from the increased savings on the part of the wealthy really a tax on everyone? How much bigger might the economy be if a considerable portion of these savings were redistributed to those with a high propensity to consume or spent by the government instead of being invested overseas?
A: First of all, you’re right the wealth is even more concentrated than income at the top of scale—see figure.
But while I kind of follow your logic, I’m not sure I’d go there. First of all, in normal times, savings gets used for investment that helps to boost growth. There are many complications, of course, like with lots of investment flowing abroad or into opaque and non-productive financial instruments (or into the bubbles such financial engineering helps to inflate). But savings is a good thing.
You make a good point re propensity to consume, especially in a downturn like now. And in fact, the President is onto this point, promoting a jobs plan that targets tax cuts, infrastructure, public sector jobs, unemployment insurance extension, and subsidized jobs for low-income workers, paid for by in large part by increasing taxes on high-income families.
Q: Any thoughts on this piece?
A: I found this to be an interesting and well-presented argument—that the Federal Reserve should target nominal GDP growth instead of emphasizing inflation so much. But I’ve got two prominent concerns that would lead me to be wary of getting behind this idea.
First, the big problem as I see it, and, bless his soul, as Fed governor Charles Evans sees it, is high unemployment, which is already half of the Fed’s mandate, so we shouldn’t outta have to undergo a big argument about what they should target, as a switch to nominal GDP would engender.
Second, though it’s not the case right now, I can easily imagine a recovery with nominal GDP growing quickly, say coming out of a recessionary trough, yet with inflation quiescent and unemployment high. And I wouldn’t want the Fed to tighten in that scenario.