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 Topic: European Macroeconomics & Governance

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.

View comments
Read article More on this topic More by this author

Blog Post

The US retail crisis

What’s at stake: America is undergoing a retail sector crisis, partly related to the increase of competition from online commerce. We review recent contributions to this debate.

By: Silvia Merler Topic: Innovation & Competition Policy Date: July 17, 2017
Read article More by this author

Blog Post

The Universal Basic Income discussion

What’s at stake: the concept of a Universal Basic Income (UBI), an unconditional transfer paid to each individual, was prominent earlier this year when Finland announced a pilot project. It’s now back in the discussion as the OECD published a report illustrating costs and distributional implications for selected countries. We review the most recent contributions on this topic.

By: Silvia Merler Topic: European Macroeconomics & Governance, Global Economics & Governance Date: June 12, 2017
Read article More on this topic More by this author

Blog Post

President Trump’s budget: the 3% growth quandary

What’s at stake: the Trump administration released its full budget proposal. Economists have been arguing about the feasibility of the underlying growth assumptions, and on whether there is a double-counting implied. We review the most recent contributions to this debate.

By: Silvia Merler Topic: Global Economics & Governance Date: May 29, 2017
Read article More on this topic More by this author

Blog Post

Dial N for NAIRU, or not?

What’s at stake: The concept of the NAIRU (Non-Accelerating Inflation Rate of Unemployment) has recently divided the minds in the economic blogosphere. We review the most important contributions on its usefulness, its shortcomings, alternatives and we discuss why it is such a contested concept.

By: Pia Hüttl Topic: Global Economics & Governance Date: May 22, 2017
Read article More on this topic

Blog Post

UK economic performance post-Brexit

What’s at stake: Almost a year after the UK voted to leave the European Union, its economic performance has showed mixed results. The risks of a Brexit-induced recession do not seem to be materialising. On the contrary, up until the end of 2016 the UK saw a continuation of strong consumer spending and strong output in consumer-focused activities. However, the UK economy is showing signs of slowing down in the first quarter of 2017, with weak growth in the services sector and business investments. In addition, strong consumption growth started to cool down as individuals’ purchasing power declines due to a weaker exchange rate. This leads to a question whether it is the beginning of the Brexit slowdown. We review the contributions made on this topic in the last year.

By: Uuriintuya Batsaikhan and Justine Feliu Topic: European Macroeconomics & Governance Date: May 15, 2017
Read article More on this topic More by this author

Blog Post

The US and the productivity puzzle

What’s at stake: Productivity growth fell sharply following the global financial crisis and has remained sluggish since, inducing many to talk of a “productivity puzzle”. In the US, we may be seeing what look like early signs of a reversal. We review recent contributions on this theme.

By: Silvia Merler Topic: Global Economics & Governance Date: May 8, 2017
Read article More on this topic More by this author

Blog Post

The Trump tax cut

What’s at stake: on Wednesday, the Trump administration - now 100 days old - unveiled a draft tax plan including the intention to enact a radical cut to the corporate income tax, lowering it to 15 percent. While we are still missing details on how this and other measures would be implemented, we review some of the early reactions.

By: Silvia Merler Topic: Global Economics & Governance Date: May 2, 2017
Read article More on this topic More by this author

Blog Post

The decline of the labour share of income

What’s at stake: at odds with the conventional wisdom of constant factor shares, the portion of national income accruing to labour has been trending downward in the last three decades. This phenomenon has been linked to globalisation as well as to the change in the technological landscape - particularly “robotisation”. We review the recent literature on this issue.

By: Silvia Merler Topic: Global Economics & Governance Date: April 24, 2017
Read article More on this topic More by this author

Blog Post

Embracing the silver economy

What’s at stake: The oldest human in known history was a Frenchwoman called Jeanne Calment who celebrated her 122nd birthday in 1997. Thanks to advances in technology and medicine humans living until 100, if not 122, might not be an exception in the near future. Ageing, while described as a looming demographic crisis, also offers a silver lining. Business in rapidly ageing societies is already adapting their strategies to navigate the “silver economy”. This blogs review looks at the implications of the silver economy on growth, productivity and innovation as well as the opportunities offered by the silver industry.

By: Uuriintuya Batsaikhan Topic: Global Economics & Governance Date: April 10, 2017
Read article More by this author

Blog Post

Is China’s innovation strategy a threat?

What’s at stake: A number of recent contributions accuse China of acquiring technology from abroad without respecting international rules. This blog reviews the current debate that focuses on China’s supposed push to modernise its industry and the challenges for advanced economies. By leapfrogging to high-tech manufacturing products, the strategy threatens the competitive advantage of the US and the EU. The international rules-based order is put to a test facing large-scale government support to high-value added sectors and anti-competitive behaviour.

By: Robert Kalcik Topic: Global Economics & Governance, Innovation & Competition Policy Date: April 3, 2017
Read article More on this topic More by this author

Blog Post

The American opioid epidemics

What’s at stake: The US Department of Health and Human Services (HHS) declares that the country is “in the midst of an unprecedented opioid epidemic”. Since 1999, the rate of overdose deaths involving opioids - including prescription pain relievers and heroin - nearly quadrupled. We review contributions looking at the economic drivers and implications of this phenomenon.

By: Silvia Merler Topic: Global Economics & Governance Date: March 27, 2017
Read article More on this topic More by this author

Blog Post

Alice in gender-gap land

What’s at stake: The International Women’s Day on 8 March drew attention to the gender gap again, both in pay and in employment. Ongoing research on the topic shows that the gender gap persists worldwide, from finance to arts. For it to change, bold action is needed, ranging from targeted policies to rethinking gender norms.

By: Pia Hüttl Topic: Global Economics & Governance Date: March 20, 2017
Load more posts