The importance of wages and productivity growth over time
The U.S. Bureau of Labor Statistics last Friday released new data on productivity and labor costs for the second quarter of 2014. The data show that productivity grew at a 2.5 percent annual rate during the quarter. On a year-on-year basis, productivity grew by 1.2 percent since the second quarter of 2013. And unit labor costs increased slightly as real compensation growth was higher than productivity growth during the second quarter. The data released today sheds new lights on short-term trends but should be considered in the light of long-term trends.
In the short term, the relationship between productivity and wage growth has ramifications for slack in the labor market. As economists Dean Baker and Jared Bernstein point out at The Washington Post, the growth in wages and compensation is critically important for the future path of Federal Reserve monetary policy. A faster pace of wage growth would be an important sign that the labor market is healthy enough for the central bank to pull back on loose monetary policy and raise interest rates. But the data don’t show accelerating wage growth. And the apparent uptick in compensation growth is only two quarters long and still below trends prior to the Great Recession of 2007-2009. Pulling back on stimulus based on this data would be premature.
But perhaps returning to pre-recession levels of wage and compensation growth would be aiming too low. Since the mid-1970s, compensation growth has trailed behind labor productivity growth. According to the Productivity and Costs data set from the Bureau of Labor Statistics, labor productivity, or output per hour worked, has increased by 106 percent. But average inflation-adjusted hourly compensation has only increased by 43 percent. Some of the gains of productivity have flown upward to high-income earners while others have gone have flown away from labor and toward capital in the form of higher profits.
Maybe wage growth should not just rise to pre-recession levels but exceed them. After decades of trailing productivity growth, wages could be allowed to catch up the gains they’ve missed out on in previous years. Not only should the Federal Reserve consider this in the short-term, but all policymakers should consider how to help boost wage growth in the long-run.