And the Answer Is…Productivity

I teach Economics 1 with an “audience response system” similar to the ones you see on TV game shows. Think of the “Lifeline” on “Who Wants to be a Millionaire?” Each student in the lecture has a little hand-held transmitter. They press the keys on the transmitter to give their opinions on issues or answers to questions. Their answers come directly into my laptop computer and are immediately projected in a bar chart on the screen, creating an opportunity for discussion.

The question on the right generated a good discussion this week. I asked students to respond A through E at the start of the lecture, which was about labor productivity and wages. Later in the lecture I then presented and explained the chart below which shows that the best answer is B. Productivity growth is highly correlated with compensation growth over time as predicted by basic economic theory and leaves relatively little for A, C, D, or E to explain. But before seeing the graph many guess another answer, and I suspect most people are surprised that there is so little to explain after you take productivity into account.

In the chart, labor productivity (output per hour of work) and compensation (wages plus fringe benefits per hour of work) pertain to the nonfarm business sector in the United States. Compensation is adjusted for inflation by dividing by the price of nonfarm business output which corresponds with the output measure. In the past few years the consumer price index (CPI) has grown faster than the price index for nonfarm business output. So if you adjust compensation by the CPI rather than the price index for nonfarm business as in the chart, compensation per hour deviates slightly below the productivity line in recent years, but the basic story over the long haul is the similar.