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Economic SYNOPSES short essays and reports on the economic issues of the day 2007 ■ Number 7 How Well Do Wages Follow Productivity Growth? Richard G. Anderson ver long periods of time, increases in “real” wages—that is, One reason, perhaps, is that the character of the productivity acceleration changed circa 2000. Prior to that date, studies have suggested wages adjusted for changes in consumer prices—reflect that the more important effect was an increasing ratio of capital increases in labor productivity. Economists now widely to labor (capital deepening) as businesses substituted relatively agree that labor productivity growth increased in the mid-1990s less expensive information technology and communication equipand remains at an elevated pace—at least relative to its anemic pace ment for labor. Since 2000, some studies suggest that the more between 1973 and the mid-1990s. Numerous studies have traced important factor has been a re-engineering of business practices, the cause of the productivity acceleration to technological innovawhich has increased the “skill bias” in the labor market, that is, tions in the production of semiconductors that sharply reduced the the premium paid for higher levels of technical, professional, and prices of such components and of the products that contain them managerial education and experience. For employers, variable pay (as well as expanding the capabilities of such products). solves, in part, the problem of monitoring the performance of such The impact of more rapid productivity growth on wages conworkers: Unlike traditional factory and retail service workers, tinues to be a topic of widespread economic research. Numerous whose hours at work are relatively easily monitored, many skilled news articles have discussed the apparent failure of wages to increase professionals work at varied locations and times of day. Finally, in line with productivity. Less appreciated, perhaps, is that the proincreasing reliance on variable pay also perhaps is a type of riskductivity acceleration has been accompanied by important changes sharing arrangement between businesses and workers. If the recent in the way businesses compensate their employees. Of particular productivity trend slows, reducing or curtailing variable pay may importance is the increased use of “variable pay,” that is, compenbe less offensive to professional workers than reductions in base sation tied either to the performance of individual employees or salaries. ■ to the business’s overall performance, including end-ofyear bonuses, “cash awards,” profit sharing, and stock options. Real Earnings, Nonfarm Business Sector The chart compares labor productivity in the non- O farm business sector to two measures of real labor compensation: average hourly earnings for non-supervisory and production workers (AHE) in the upper panel, and total compensation per hour in the lower panel. AHE measures the typical, scheduled hourly wage plus legally required benefits but excludes variable pay—overtime, bonuses, shift premiums, and employer benefits. Total compensation, in contrast, includes variable pay. Increases in these compensation series track productivity quite closely through 1999. Beginning in 2000, however, AHE falls increasingly below productivity and increases little after 2003. Total compensation remains close until 2003, but does not follow 2003’s uptick in productivity growth (behavior which remains a topic for future research). Economists long have noted that focusing on AHE rather than total compensation yields an inaccurate picture of labor compensation due to the omission from AHE of employer-provided benefits. The trend toward increased use of variable pay provides an additional reason for focusing on broader compensation measures. But, why has more of labor compensation become variable pay? And why has this trend widened since 2000? 1.40 Average Hourly Earnings 1.35 Productivity, Nonfarm Business Sector 1.30 1.25 Deflated by Core PCE 1.20 1.15 Deflated by PCE 1.10 1.05 1.00 Index (1995 = 100) 0.95 1995 1.40 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Total Compensation per Hour Productivity, Nonfarm Business Sector 1.35 1.30 1.25 Deflated by Core PCE 1.20 Deflated by PCE 1.15 1.10 1.05 1.00 Index (1995 = 100) 0.95 1995 1996 1997 1998 1999 2000 2001 Views expressed do not necessarily reflect official positions of the Federal Reserve System. research.stlouisfed.org 2002 2003 2004 2005 2006
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