Total Compensation Reflects Growth in Productivity The share of national income going to employees is at approximately the same level now as it was in 1970. The relation between wages and productivity is important because it is a key determinant of the standard of living of the employed population as well as of the distribution of income between labor and capital. If wages rise at the same pace as productivity, then labor's share of national income remains essentially unchanged. In Did Wages Reflect Growth in Productivity? (NBER Working Paper No. 13953), Martin Feldstein presents specific evidence that the share of national income going to employees is at approximately the same level now as it was in 1970. Feldstein notes that the level of productivity doubled in the U.S. non-farm business sector between 1970 and 2006. Wages, or more accurately total compensation per hour, increased at approximately the same annual rate during that period -- if nominal compensation is adjusted for inflation in the same way as the nominal output measure that is used to calculate productivity. The use of an incorrect inflation adjustment has confounded prior research, according to Feldstein, resulting in skewed findings showing a large and increasing gap between productivity and wages. According to Feldstein, the doubling of productivity since 1970 represented a 1.9 percent annual rate of increase. Real compensation per hour rose at 1.7 percent per year -- when nominal compensation is deflated using the same non-farm business sector output price index. In the more recent period between 2000 and 2007, productivity rose at a much more rapid 2.9 percent a year and compensation per hour rose nearly as fast, at 2.5 percent a year. Total employee compensation was 66 percent of national income in 1970 and 64 percent in 2006. This measure of the labor compensation share has been remarkably stable since the 1970s. It rose from an average of 62 percent in the 1960s to 66 percent in the 1970s and 1980s, and then declined to 65 percent in the 1990s where it has remained from 2000 until the end of 2007. Feldstein concludes that two principal measurement mistakes have led some analysts to conclude that the rise in labor income has not kept up with the growth in productivity. The first is a focus on wages rather than total compensation: because of the rise in fringe benefits and other non-cash payments, wages have not risen as rapidly as total compensation. Feldstein feels it is important to compare the productivity rise with the increase in total compensation rather than the increase in the narrower measure of just wages and salaries. The second measurement problem that Feldstein addresses is the way in which nominal output and nominal compensation are converted to real values before making the comparison. Although any consistent deflation of the two series of nominal values will show similar movements of productivity and compensation, Feldstein concludes that it is misleading to use two different deflators, one for measuring productivity and the other for measuring real compensation. -- Lester Picker The Digest is not copyrighted and may be reproduced freely with appropriate attribution of source.