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Why one famous chart liberals love is flat-out wrong (as explained by Paul Krugman)

0106018 Worstall Blog Post photo
Larry Mishel, the former president of the Economic Policy Institute, and Jared Bernstein, created a chart which asserted that productivity was rising faster than hourly compensation. But Paul Krugman, the famous economist (pictured center), had written about the errors of this idea before. (Franck Robichon/Pool Photo via AP)

Larry Mishel – for those not in with the details of the Washington Swamp’s celebrity culture – has for some decades been the guiding light behind the Economic Policy Institute. He’s standing down as the president after some 30 years there. This is a good thing, and there’s even a possibility that economic debates are going to get better as a result.

You will, almost certainly, have seen the chart that he and Jared Bernstein created, supposedly showing that productivity is rising faster than hourly compensation:

This chart, this analysis, has been hugely influential. It really is one of the basic assumptions about how our world is. And it forms the underlying fact which drives much of the current set of policy recommendations. There’s really only one problem with it: It’s flat-out wrong.

Rather than me picking it apart, why not use a man of the Left to do so? A Nobel Laureate no less. Here's an excerpt of Paul Krugman writing on the same assertion:

One of America's new intellectual stars is a young writer named Michael Lind, whose contrarian essays on politics have given him a reputation as a brilliant enfant terrible. In 1994 Lind published an article in Harper's about international trade, which contained the following remarkable passage:

"Many advocates of free trade claim that higher productivity growth in the United States will offset pressure on wages caused by the global sweatshop economy, but the appealing theory falls victim to an unpleasant fact. Productivity has been going up, without resulting wage gains for American workers. Between 1977 and 1992, the average productivity of American workers increased by more than 30 percent, while the average real wage fell by 13 percent. The logic is inescapable. No matter how much productivity increases, wages will fall if there is an abundance of workers competing for a scarcity of jobs — an abundance of the sort created by the globalization of the labor pool for US-based corporations." (Lind 1994:)

What is so remarkable about this passage? It is certainly a very abrupt, confident rejection of the case for free trade; it is also noticeable that the passage could almost have come out of a campaign speech by Patrick Buchanan. But the really striking thing, if you are an economist with any familiarity with this area, is that when Lind writes about how the beautiful theory of free trade is refuted by an unpleasant fact, the fact he cites is completely untrue.

More specifically: the 30 percent productivity increase he cites was achieved only in the manufacturing sector; in the business sector as a whole the increase was only 13 percent. The 13 percent decline in real wages was true only for production workers, and ignores the increase in their benefits: total compensation of the average worker actually rose 2 percent. And even that remaining gap turns out to be a statistical quirk: it is entirely due to a difference in the price indexes used to deflate business output and consumption (probably reflecting overstatement of both productivity growth and consumer price inflation). When the same price index is used, the increases in productivity and compensation have been almost exactly equal. But then how could it be otherwise? Any difference in the rates of growth of productivity and compensation would necessarily show up as a fall in labor's share of national income — and as everyone who is even slightly familiar with the numbers knows, the share of compensation in U.S. national income has been quite stable in recent decades, and actually rose slightly over the period Lind describes.

Note what we’ve got here, the claim that something must happen if wages have not kept up with productivity. The labor share of the economy must shrink at the same time. This is an independent fact that we can check: If it’s not falling, then the original assertion must be wrong — it cannot be possible that total compensation to the workers has not been rising along with productivity.

That’s something we can check with the Federal Reserve here. There is some wandering around, certainly, but there just isn’t the sort of shift that the theory would require. Nor is the movement all one way, as again the theory would require.

The labor share just hasn’t changed in the manner which it must have if compensation has been consistently falling behind productivity. Therefore, compensation hasn’t been consistently falling behind productivity. There is, I’m afraid, no way out of this for the proponents of the idea – as Krugman says.

Larry Mishel is standing down as the president of the EPI. This is good news, as more of the debate in D.C. might now take place on the basis of reality, not concocted charts. We may need to change economic policy, but to do so we’ve not only got to have a clear idea of who we want to benefit from them, we’ve got to know how the universe is currently working. Yet, here we have one of those embedded “facts” of the political debate which is simply flat-out untrue. That just ain’t the way to run 330 million people now, is it?

Our only real problem here is that Mishel is staying on as a senior economist. The problem is that Mishel hasn't really been doing economics (and he presumably won’t start either); he’s been indulging in rhetoric. Rhetoric has its place in persuading people what should happen, but it's somewhere between vacuous and intensely damaging in the original analysis of what should be done.

Our problem is not that Mishel’s going, but that he’s not going far enough.

Tim Worstall (@worstall) is a contributor to the Washington Examiner's Beltway Confidential blog. He is a senior fellow at the Adam Smith Institute.

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