Productivity, Profits & Paychecks

TODAY'S headlines suggest an alarming paradox in the American economy: While productivity and profits are soaring, paychecks are shrinking. This emerging trend, however, is based on simplistic interpretations of flawed facts that paint a compelling - but inaccurate - picture of the economic landscape. The truth is more complicated - and more positive.

Higher productivity leads to economic growth. Increasing productivity and profits boosts employee paychecks. There is a strong, historical connection between productivity and compensation growth. Alarm bells about a rupture in the link between productivity and pay are premature. An evaluation of data shows that productivity and compensation move together over time.

Pundits are often guilty of presenting data without a clear understanding of their reliability, measurements, or adjustments. For example, reports examining productivity and compensation often use two different measures of inflation to obtain real comparisons.

Current accounts suggest that labor's share of national income is getting smaller, while corporate profits are gobbling up a bigger share. In fact, just the opposite is true. Compensation as a percent of national income has increased over time. What has changed is the mix of the total compensation package. Wages as a percent of national income have fallen, but nonwage compensation, including health care, retirement, and Social Security benefits, has increased.

Concern that companies are failing to share their profits with workers is misplaced. A look back at corporate profits shows how erratic they have been over the past 30 years. While they have recovered in the 1990s, profits do not represent an increasing share of national income. Conventional measures of pay focus only on wages, or salaries, and not on the total compensation package. Real compensation per hour in the nonfarm business sector rose by just 0.1 percent from 1993-94 using the Consumer Price Index-U (CPI-U). A broader measure of inflation produces a different picture of wage growth from 1993-94. The implicit price deflator (the ratio of current dollar spending over constant [1987] dollar spending), used to derive measures of real output and productivity, shows that real compensation grew by 0.9 percent.

The real story is found by looking at the long-term record, not a single year. Hourly compensation growth has slowed, even using the implicit price deflator. From 1959-72, real hourly compensation in the nonfarm business sector rose by 2.4 percent annually, compared with a 0.8 percent growth rate between 1973-94.

Why has compensation growth slowed since the early 1970s? Because productivity growth slowed. From 1993-94, real output per hour, or productivity, in the nonfarm business sector rose by 1.9 percent (using the implicit price deflator). Real compensation per hour rose by only 0.1 percent (using the CPI-U). Yet this is an apples-and-oranges comparison. The numbers must be adjusted by using the same price deflator.

PRODUCTIVITY and compensation have tracked each other over time. From 1959-72, output per hour in the nonfarm business sector rose by 2.4 percent a year, while compensation per hour rose at the same rate. From 1973-94, productivity growth slowed to 1 percent a year, and compensation grew 0.8 percent a year. These data show that productivity improvements are translated into compensation gains.

What are the implications for business? First, productivity, profits, and paychecks are inextricably bound. Business should focus on the long term. Second, productivity growth is the key to maintaining our high standard of living. The challenge for business is to sustain the recent rebound in productivity. Finally, the best way to keep productivity, profits, and paychecks up is to invest in a quality work force. Highly skilled people are more productive, add more value to the corporate bottom line, and, not coincidentally, command higher wages.