December 20, 2005

#197: Slowly retreating from his dire predictions...

P. Krugman


Paul Krugman has been slowly retreating from his longstanding, dire predictions about the direction US economy. We don’t hear much about impending “banana republic-hood” or the “irresponsible Bush tax cuts” or “W’s Double-Dip.” Instead we hear such weary comments as:

“Yet by some measures, the economy is doing reasonably well. In particular, gross domestic product is rising at a pretty fast clip. So why aren't people pleased with the economy's performance?”

The retreat we are talking about is reflected in PK’s answer. The overall numbers look pretty good, he says, but many Americans are being left behind as reflected in lagging median wages. He has a small point here (the word “median” is important), but, as we will explain, it is a very small point indeed.

Let’s begin with brief discussion what actually drives labor compensation –– productivity. Chart I shows the growth rate in output per hour of labor input (labor productivity) and average real business wages since the late 50’s. We have followed the normal practice of smoothing the quarterly/monthly data (in this case we used a 3-year moving average) because the shorter-term observations are so erratic that longer run patterns are difficult to discern.

labor productivity and wages chert

Chart I shows a phenomenon familiar to all economists. Productivity (the blue line) was high coming out of the 50s and into the 60s, fell off a cliff beginning roughly with the 70s, then, despite some occasional fits and starts, did not begin a full recovery until the mid-90s. The simplified explanation for this pattern is that by the end of the sixties the “old economy” based on electricity and combustion engines had run its course and the “new economy” incorporating information technology did not kick in until the mid-nineties.

We think this scenario is essentially correct, but it raises an obvious question about why IT did not have an impact earlier? After all, computers had been around in abundance since the 60s. Most economists believe this is because major new technologies have long incubation periods before they actually change the way enterprises organize and function. So, just as electricity had been around for many prior decades, it was not until the 1920s that it had a major impact of business methods and productivity. The technology conundrum is that the cycles are so long and variable that it is hard to know contemporaneously where we are in any particular cycle. Thus Nobel winning economist Robert Solow is famous for quipping in 1987 “you can see the computer everywhere but in the productivity statistics.” His frustration with the computer “conundrum” was to last another 8 years.

But what does this have to do with labor compensation? This should be obvious from a look at real wages (the green line) in Chart I. Wages follow productivity! Always have and always will. However, over the last few years there has been a modest disconnect as wages have not followed productivity increases into new high ground. We would argue this is temporary and due in most part to the bursting of the stock market bubble in 2000, 9/11/2001 and the subsequent recession.

However, this is where Krugman pounces. He’ll have no part of bursting bubbles or recessions (which he blames on Bush and Greenspan, anyway). Furthermore, he claims that a MEDIAN measure of wage growth (instead of an average measure) would show even slower growth because those at the top end pull up the average wage. This is a variation on his familiar “tax cuts for the rich” theme. Unfortunately there is no way to check his argument. He has used the terms “the hourly wage of the typical worker” in The Big Squeeze (10/17/05) and “real median household income” in The Joyless Economy (12/05/05). We searched the databases of both the Labor Department and the Commerce Department and could find no data on median wages or family incomes.

Nevertheless, we suspect that Krugman has a minor point about the median wage lagging. However, rather than venality on the part of the Bush Administration, it is most likely due to globalization The undeniable fact is that the wages of semi-skilled labor in this country will have a hard time keeping up with wages generally when the world market for semi-skilled labor is determined in south China.

But we have been here before as a nation and as an economy and the solution is the same as always. American labor will take advantage of the vast and deep educational opportunities in this country and upgrade their skills so that they participate and benefit in a more technologically advanced economy. It’s happening as we write. Local community colleges are overflowing with ambitious students all across the country.

Inevitably a few will be left behind. That’s life. If Krugman wants to spend his time whining about a few laggards, that is his choice. But most workers, especially younger ones, are too busy getting ahead to sit around feeling sorry for themselves. We think the result will be an upturn soon in wage growth as it continues to track long term productivity.

[The Truth Squad is a group of economists who have long marveled at the writings of Paul Krugman. The Squad Reports are synopses of their discussions. ]

Posted by John Weidner at December 20, 2005 6:38 PM
Weblog by John Weidner