Blog Post

Blogs review: the productivity-compensation wedge and the mark-up puzzle

What’s at stake: While our understanding of the origins of the productivity – median compensation wedge – that is, the fact that real median hourly wages in the US have remained close to stagnant over the past 3 decades – progresses, a new puzzling fact has recently been uncovered for which we still have few […]

By: and Date: May 4, 2012

What’s at stake: While our understanding of the origins of the productivity – median compensation wedge – that is, the fact that real median hourly wages in the US have remained close to stagnant over the past 3 decades – progresses, a new puzzling fact has recently been uncovered for which we still have few good explanations: that most of the inflation in nonfarm business prices during the past decade has been due to a rise in the price markup over unit labor costs rather than to rising unit labor costs in the US. After reviewing these two facts, we discuss the extent to which they reflect the same underlying developments.

The productivity – median compensation wedge

Lawrence Mishel has a recent paper on this issue for the Economic Policy Institute. During the 1973 to 2011 period, labor productivity rose 80.4 percent but real median hourly wage increased 4.0 percent, and the real median hourly compensation (including all wages and benefits) increased just 10.7 percent. If the real median hourly compensation had grown at the same rate as labor productivity over the period, it would have been $32.61 in 2011 (2011 dollars), considerably more than the actual $20.01 (2011 dollars). Consequently, the conventional notion that increased productivity is the mechanism by which living standards increases are produced must be revised to this: productivity growth establishes the potential for living standards improvements and economic policy must work to reconnect pay and productivity.

Paul Krugman writes that it’s two-thirds the inequality, stupid. One third of the difference is due to a technical issue involving price indexes. The rest, however, reflects a shift of income from labor to capital and, within that, a shift of labor income to the top and away from the middle. What this says is that widening inequality makes a huge difference. Income stagnation does not reflect overall economic stagnation; the incomes of typical workers would be 30 or 40 percent higher than they are if income inequality hadn’t soared.

The price mark-up puzzle

The 2012 Economic Report of the President dug up another related but somewhat different puzzle for the US in the 2000s (note that the wedge between productivity and median compensation has been growing for the last 30 years not just the last 10). According to the report, “most of the inflation in nonfarm business prices during the past four years has been due to a rise in the price markup over unit labor costs rather than to rising unit labor costs.”

Nominal hourly compensation has risen at a roughly 2.3 percent annual rate during the four years since the business-cycle peak in December 2007, but this growth has been mostly offset by growth of labor productivity at an annual rate of about 1.7 percent during the same period, leaving unit labor costs essentially unchanged. Historically, prices of nonfarm business output have risen in a roughly parallel fashion to unit labor costs, so the markup of prices relative to unit labor costs has been flat. As can be seen in Figure 2-11, this long-term property of the U.S. economy appears to have broken down over the past decade or arguably even as early as the mid 1990s. The markup has now risen to its highest level in post–World War II history, with much of that increase taking place over the past four years.

If you want to reproduce the diagram from the Council of Economic Advisors’ ERP, Menzie Chinn has a useful do it yourself guide.

Shifts in price mark-ups and labor shares

The Economic Report of the President concludes that “because the markup of prices over unit labor costs is the inverse of the labor share of output, saying that an increase in the price markup is the highest in postwar history is equivalent to saying that the labor share of output has fallen to its lowest level.” In turn, the labor share can decline due to either lower compensation per hour worked, or due to less labor required to produce a given level of output. The latter is mostly driven by technological changes in the production structure of advanced economies, and is thus not necessarily a negative development from a welfare standpoint.

The markup puzzle is indeed picking up some of the declining labor share, but not only. In particular, notice that ULC=nominal hourly compensation/hourly productivity (see the OECD for more on these definitions) and that nominal compensation has been growing faster than productivity in the US over the past 2 decades at least. This implies ULC has been growing (with the exception of the last 4 years since the start of the Great Recession), not declining, and hence the rise of the markup ratio from the early 2000s to 2007 cannot be explained by a decline in the denominator of the mark-up-ULC ratio. Rather, it must be that the profit share (as defined below) is growing faster than labor costs (note the ratio can be expressed either as price of output/ULC or equivalently as total profits/total labor compensation).

Given this, there are several possible factors other than a declining labor share that may have driven the markup/unit labor cost ratio over the past decade especially:

The ratio could be partially driven by compensation inequality at the firm level between managerial and non-managerial compensation, since stock options are not fully included in the BLS measure of labor compensation. In particular, they happen to be included only once exercised. Non-exercised stock options (a rising item in executive compensation) could have thus played a role. This relates to the idea of a shift in bargaining power in the labor market. Michel Dumont, Glenn Rayp, and Peter Willemé as well as Lourdes Moreno and Diego Rodríguez Moreno have, for example, recent papers differentiating the rise of bargaining power by high-skilled workers due to the preeminence of R&D versus a decline in bargaining power by low-skilled workers driven by increasing global market competition.

The ratio could also be driven by what Jesus Felipe and Utsav Kumar call "unit capital costs", the ratio of nominal profit rate to capital productivity. The markup over labor compensation ratio is intrinsically misleading because the numerator does not equal firm operating profits. In fact, it includes gross value added before taxes and financing costs. Rising debt or equity costs, as well as increases in the tax burden, could therefore also play a role. Harris Della and Ana Fernandes discuss theoretical channels through which increased financial sector concentration could drive up markup indexes in non-financial product markets by tightening financing constraints in financially dependent sectors.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Topics

Tags

Comments

Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

Blaming the Fed for the Great Recession

What’s at stake: Following an article in the New York Times by David Beckworth and Ramesh Ponnuru, the conversation on the blogosphere was dominated this week by the question of whether the Fed actually caused the Great Recession. While not mainstream, this narrative recently received a boost as Ted Cruz, a Republican candidate for the White House, championed it.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: February 1, 2016
Read article More on this topic

Blog Post

IMG_20151009_103117 (3)
Pia Hüttl

Lost in assumptions: assessing the economic impact of migrants

What’s at stake: Many research institutes have estimated the economic impact of migrants, in particular regarding fiscal budgets and the labour market. These studies often give contradictory results. This blogs review looks at the different assumptions and approaches behind these results.

By: Nuria Boot and Pia Hüttl Topic: European Macroeconomics & Governance Date: January 18, 2016
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The use of models by policymakers

What’s at stake: The latest discussions on the blogosphere have been dominated by a back and forth trialogue between Larry Summers, Paul Krugman and Brad DeLong on the appropriate use of models as policy guides. While they all agree that the Fed’s decision to raise rates was a mistake, they disagree on the intellectual reasons behind it.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: January 11, 2016
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

Finland and asymmetric shocks

What’s at stake: Finland exemplifies the difficulty of dealing with asymmetric shocks within a Monetary Union as the Finnish economy has struggled to recover from a series of idiosyncratic shocks – the decline of Nokia, the obsolescence of the timber industry, and the fallout of the Russian crisis.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: December 21, 2015
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The predictability of political extremism

What’s at stake: The rise of the extreme right in the latest French election has mostly been treated as surprising or reflecting special circumstances like the November 13 Paris attacks. But a large literature linking extreme right votes to persisting depressed economic conditions suggests that longer run factors are at play.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: December 14, 2015
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The puzzle of technical dis-employment and productivity slowdown

What’s at stake: Larry Summers made an important speech a few weeks ago at a Peterson Institute conference on the productivity slowdown arguing it is hard to see how recent technical change could both be a major source of dis-employment and not be associated with productivity improvement.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: December 7, 2015
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

Unlearning economic paradigms

What’s at stake: Both the crisis, its aftermath, and the empirical econ revolution have changed our understanding of economics. Conventional wisdoms about the supply side of the economy, the length of the short run, or the international adjustment process are all being challenged. Even conventional microeconomic wisdoms about the role of minimum wages and welfare programs are being challenged by new data raising questions about how economics should be taught and used to guide policymaking.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: November 30, 2015
Read article More on this topic More by this author

Blog Post

augustin_lagarde

The economic debates behind COP21

What’s at stake: France will chair and host the 21st Conference of the Parties to the United Nations Framework Convention on Climate Change (COP21) at the end of the year. While the scientific community has reached a consensus that climate-warming trends are very likely due to human activities, the discussion about how to address is mired in huge political disagreements.

By: Augustin Lagarde Topic: Energy & Climate Date: November 23, 2015
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The persistence of slow growth

What’s at stake: The persistence of slow economic growth in the Great Recession has been puzzling. Two recent papers have tried to present a coherent framework for understanding this phenomenon. The first paper argues that we may have underestimated the importance of hysterisis effects. The second paper argues the global safe asset shortage cannot be resolved by lower world interest rates once we reach the zero lower bound. It is instead dissipated by a world recession that rebalances global asset markets.

By: Jérémie Cohen-Setton Topic: Global Economics & Governance Date: November 16, 2015
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The uncertain decline of the natural rate of interest

What’s at stake: Controversies over whether and by how much the natural rate of interest – the rate compatible with full employment and stable prices – has declined in the past few years has shaped views about the pace and extent to which central banks should normalize policy rates.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: November 9, 2015
Read article More by this author

Blog Post

Jérémie Cohen-Setton

QE and investment

What’s at stake: Quantitative Easing has been criticized for generating inflation risks, financial stability risks, and distributional risks. The newest criticism from Kevin Warsh, a former Fed Governor, and the 2001 Nobel Prize laureate Michael Spence is that QE actually reduced investment!

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance, Global Economics & Governance Date: November 2, 2015
Read article More on this topic

Blog Post

Uuriintuya Batsaikhan
Pia Hüttl

The global debt overhang

What’s at stake: Seven years after the financial crisis, recovery is still weak in most parts of the global economy. The general debt overhang across sectors, which was not reduced in the last years, has often been cited as as the main factor weighing on global growth and inflation.

By: Uuriintuya Batsaikhan and Pia Hüttl Topic: Global Economics & Governance Date: October 26, 2015
Load more posts