Rebalancing factor shares: Another (great) source of non-inflationary wage growth

March 25th, 2016 at 12:32 pm

As Dean Baker pointed out to me this AM, the labor share of national income is slowly gaining back some of its losses, as shown in the figure below (see circled part at end). This is a good thing, and should, to some extent, reduce inequality by shifting some of the growth from profits into paychecks.

Since there’s a lot of inequality within labor’s share of national income, this development won’t reduce inequality that much. That is, income growth is still disproportionately going to higher paychecks, as Elise Gould shows here. But the shift you see below is a distributionally positive development, and evidence that the tight job market is delivering a bit more bargaining power to workers (these shares don’t sum to 100 percent because they leave out proprietors’ incomes, as it’s hard to break that down between wages and profits).

Source: NIPA tbl 1.12

Source: NIPA tbl 1.12

My point here, however, is a bit different, and it’s one targeted at the Federal Reserve. Nor is my point simply to badger them not to raise rates pre-emptively, potentially slowing the progress you see in the figure.

Um…well, maybe it kinda is, but with a bit of the sort of math they enjoy over there.

Chair Yellen has consistently maintained that as long as nominal wages grow no faster than the Fed’s inflation target of 2 percent plus productivity growth, which is running at (a truly yucky) 1 percent these days, wages can grow 3 percent without generating inflationary pressures.

In other words, in Fed land non-inflationary wage growth (NIWG) = i + p, where i is the inflation target and p is productivity growth. When last seen, wages were growing between 2-2.5 percent, so steady as she goes, based on this rule.

But based on the figure above, I’d like to add an x-factor to that above equation, such that:

NIWG = i + p + x

…where x represents the pace at which the gap you see above is closing. That is, there’s another component to NIWG: rebalancing labor’s share of national income. Usefully, the math of how that gap closes reduces to how much faster average compensation is growing compared to productivity (as the gap opened up post-2000, average comp growth consistently outpaced productivity).

In other words, if you’d like to see “factor shares”—the shares of income going to capital and labor—rebalance, then you want to allow for another source of non-inflationary wage growth: redistribution from profits to wages.

Thankfully, economist Josh Bivens, who wrote about all of the above for CBPPs full employment project, figured out that if x were, say 1 percent—i.e., if average compensation grew 1 percent faster than productivity growth—it would take over eight years for the gap to get back to its pre-recession level.

More to the point, it would lead the Fed to tolerate 4 percent versus 3 percent wage growth.

I don’t mean to push the precision of any of this too far. For one, p is, as noted, pretty depressed right now, and it could accelerate, providing more oxygen for NIWG. More importantly, the evidence of wage growth bleeding into price growth has been pretty hard to come by in recent years, so I wouldn’t put a ton of weight on the basic model in the first place.

My only point is that if, like the Fed, this is the model you’ve kind of got in your head, then there’s another factor—another source of non-inflationary wage growth—that you should seriously consider.

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7 comments in reply to "Rebalancing factor shares: Another (great) source of non-inflationary wage growth"

  1. Smith says:

    2% average inflation target dooms the economy to failure. It’s not secular stagnation, it’s Fed induced stagnation.
    The years when employment was less than 5% and inflation averaged 2% or less? 1998, 1965, 1956. That’s with an average of 2%, not a ceiling of 2%. Also 1998 came on the heals of a historic drop in oil prices.

    The assumption about the relationship between productivity and wages may be reversed. Instead of thinking that greater productivity allows wages to increase, try this on for size. Rising wages beyond productivity growth encourages and pushes increased productivity. Rising wages encourages all manner of change and investment to increase productivity. This is why the conservative mantra of cutting labor costs continues to undercut the economy. It partly explains why high wage Germany remains competitive. This makes sense, but I leave the proof to a nobel prize winning analysis, how about it? Part of this thought follows from the 1995 – 2005 2.98% productivity increase per year, and also aligns with the 3.17% increase for ten years predicted by Gerald Friedman for the hypothetical Sanders program.

  2. urban legend says:

    How does pressure get put on the Fed to address its policy choices in line with what the country wants? The country as a whole wants a reduction of inequality. Even Republicans say that. it wants a higher labor share, much lower unemployment and a much higher employment rate, and it wants considerably higher real wages for the majority of Americans. So where would the Fed get off squelching those things because it “knows better” than the American people what they want? The law applicable to the Fed names full employment before price stability as a goal. It seems to me if the Fed continues to give its first priority to price stability, manifested in decisions to raise rates under questionable decision rules that elevate inflation-fighting over full employment, it will be pursuing policy objectives at odds with the wishes of the American people. If that is the case, then its independence is anti-democratic and must be attacked, either with Presidential jaw-boning or the threat of legislation.

    It’s been 35 years since we’ve seen serious inflation. In some of those years the official unemployment rate dipped below 4% and the broader and more realistic U-6 went below 7%. That’s three percentage points lower than it is now, representing roughly 7.5 million jobs missing from the nation’s economy. The story suggested by the U-6 is far more consistent with the still-depressed employment rate than rosy one told by the official U-3. The low employment rate, which applies in the 25-54 age group as well as the full population of working age adults, cannot be explained away by baby boomer retirements. Isn’t it time for the Fed to indulge in some fresh thinking that puts people ahead of banks?

  3. Tom in MN says:

    A complaint about the scales on the plot. Left side has a range of 9 percentage points while the right has 16 (and the divisions make no sense). As you are trying to show loss in one goes to gain in the other, it would be much better if the scales allowed a direct comparison. As it is the labor change is really much less than it appears relative to the change in profit share.

  4. Doug Rife says:

    Good point but there is another factor that was not mentioned. Productivity growth is arguably sluggish due to weak aggregate demand growth. Secular stagnation has depressed business investment in productivity enhancing technologies and equipment. Investment is weak also because labor has been cheap and plentiful during this slow long recovery. Rather than invest businesses have used their record profits share to buyback stock and pay higher dividends to shareholders. Allowing wages to continue to rise should, in the longer run, boost productivity growth because businesses will be incentivized to find ways to improve the productivity of their workers in the face of tighter labor markets and higher labor costs. If the Fed were to continue hiking rates based on the current low rate of productivity growth for fear that inflation would accelerate, that would tend to keep productivity growth permanently depressed by preventing wage pressures from pushing businesses to investment in productivity boosting technologies.

    In other words, rather than productivity advances being the cause of higher real wages, the reverse may be true: Higher labor costs that crimp the profits share and boost the labor share are a necessary condition for higher investment rates which in turn will lead to higher productivity growth.

  5. Kaleberg says:

    Smith seems to understand the causality. We’ve seen 30+ years or rising productivity and flat wage growth. It’s wage growth that drives productivity. High English wages are what led to the Industrial Revolution. Places with cheap labor cannot industrialize on their own, and they can always throw warm bodies at the problem as it usually cheaper to hire more workers than rethink processes, design machinery and roll out new systems.

    • Smith says:

      Other factors keeping wages suppressed:
      – Women in the workforce get paid less. DNWR (Downward Nominal Wage Rigidity) masks the effect on men.
      – Similarly exploited immigrant labor without labor rights (all temporary and dual purpose immigrants), employer sponsorship being the key to suppressing wages (plus all of David Card’s papers and equations are wrong due to DNWR)
      – Fair Labor Standards Act generally doesn’t apply to office workers and other positions that corporations tag as professionals and/or managers, despite recent Obama hike of minimum applicable wage. The act is rendered useless in the modern white collar and service economy, everyone is salaried, everyone works non-paid overtime, everyone exempt, tech workers have special exemption from Clinton era regulation.
      – The war on organized labor to reverse new deal protections continues to benefit from the 1947 Taft-Hartley act which can stymie efforts to effectively combat the power of big business.
      – As the size of big business is allowed to grow, due to lack of anti-trust enforcement, their ability to counter wage increases with arbitrary price increases, fueling an inflation spiral, grows unchecked.
      – It’s not a zero sum game, it’s zero plus productivity all going to the 1%. You must tax away all the profits going to the 1% to cut their share back to 10%, remove incentive to steal it from workers, and leave money left to give workers raises. That means restoring higher marginal income rates, capital gains taxes, higher effective corporate rates, higher nominal rates, taxing foreign profits even without repatriation, and no tax holiday.
      – Unions can be their own worst enemy. Waste and fraud and self dealing leaders need to be rooted out and transparency regulated and enforced.
      – Federal $15.00 minimum, 1980 Reagan’s rate was $9.64 in 2015 dollars, and that’s without allowing for productivity increase. Has a ripple effect.
      – Single payer health care would free up a few percent of GDP. 1% is $180 billion or $1,500 for every full time worker.