Real Wages, Total Compensation and related Statistics Posted by: Jon Henke
on Friday, December 09, 2005
Matt Yglesias at TAPPED responds to my recent point that the labor force is not growing by 150,000/month as is often claimed. Essentially, he agrees, observing that, while the population is growing more quickly, the actual labor force is only growing at about 110,000/month.
Given all that, disputes about the unemployment rate can get a little metaphysical. The best thing to focus on is probably the wage picture, which is relatively unambiguous.
This notion that "Real Wages are rising for the top quintile, but not for the vast majority of Americans (as measured in quintiles), whose wage gains are being eclipsed by increases in inflation" has been the predominant Democratic economic talking point in recent times. It has the benefit of being accurate.
But it's far from the whole story. I don't intend to lay out all the numbers right now, but I think there are three important considerations worth adding to this incomplete picture.
INFLATION IS INFLATED:
In 1996, the Boskin Commission studied the Consumer Price Index and discovered that "the CPI overstated inflation by 1.1 percent per year in 1995-6." The BLS has made adjustments to CPI to reduce the upward bias, but it's still estimated that CPI has an upward bias of .65%. [the 1.1% figure is an estimate: "The range of plausible values is 0.8 to 1.6 percentage points per year."]
From a historic perspective, this paragraph from the Executive Summary of the Boskin Report is the most important item:
Changes in the CPI have substantially overstated the actual rate of price inflation, by about 1.3 percentage points per annum prior to 1996 (the extra 0.2 percentage point is due to a problem called formula bias inadvertently introduced in 1978 and fixed this year). It is likely that a large bias also occurred looking back over at least the last couple of decades.
So, inflation has been overstated by 1.3 percentage points every year going back decades. That's got to have a very substantial effect on the notion that wages have fallen due to inflation.
TOTAL COMPENSATION:
Real Wages only tell a partial story. People are not only paid in wages. Benefits have increasingly become a significant part of compensation, now accounting for 32.2% of total compensation.
Here's a look at the last ten years of nominal total compensation growth....
It's not adjusted for inflation, so the energy price spikes have pushed inflation slightly above total compensation, but for the vast majority of recent years, total compensation has exceeded inflation. (and let's not forget that upward bias in CPI!)
REAL DISPOSABLE PERSONAL INCOME:
But what about what people actually see—what about what people actually get to touch and spend? Well, that's measured, too, and it's adjusted for inflation.
The December 2005 Personal Income and Outlays statement by the Bureau of Economic Analysis points to a year-over-year increase of .9% in Real Disposable Personal Income.
The "wage picture" Democrats are painting might be "relatively unambiguous", but it's far from complete. And the more complete picture is far more nuanced than many pundits might suggest.
Jon—I’d be very skeptical of the Boskin Commission’s claims about inflation, personally. The Commission itself was stacked with five economists who had already publicly claimed that they believed inflation was overstated. Their methods were dubious, and hardly uncontroversial, and they got the result they wanted.
That’s ad hominem, but still. The idea that inflation is wildly overstated is ludicrous if you follow its logical consequences—which you hint at, but don’t discuss. If the Boskin Commission is right, and wage growth has been 1.3 percent higher per year than we’ve been led to believe, then extrapolating back, the majority of Americans in 1960 must have been living below the poverty line. News to them, perhaps. Looking forward, this means that by 2040, the typical wage-earner will be making about double (in real terms) what they are now. There’s no getting around the power of compound growth. If we’ve been overstating inflation by 1.3 points, the ramifications are enormous.
On the bright side, if the Boskin Commission’s right, this means we don’t have to worry about Social Security or Medicare, period. In the future, Americans will be much, much richer than our projections indicate, so rich that they can easily afford both entitlements.
Also, "real disposable personal income" is an aggregate figure, no? So it doesn’t necessarily tell you how the median American worker is doing. For instance, big tax cuts for the upper income brackets would definitely increase RDPI. As could, say, a burst of stock dividend payouts.
I’m definitely not saying that’s what happened in 2005, just that this statistic has its own problems and imprecisions. In its favor, though, the RDPI supposedly does very well at predicting elections. Then again, the voting class is skewed towards the upper-income brackets, so maybe that means the RDPI is skewed that way too.
If the Boskin Commission is right, and wage growth has been 1.3 percent higher per year than we’ve been led to believe, then extrapolating back, the majority of Americans in 1960 must have been living below the poverty line.
The definition of the poverty line is "three times the cost of the economy food basket in 1963, adjusted for inflation". (Google "poverty line definition".) So if inflation has been overstated, then the modern poverty line has twice the real buying power compared to the historic original value set in the 1960s. This isn’t as implausible as you might think given the upward creeping definition of poverty in the US. Many people below the poverty line today can afford cable TVs and cars. The original definition was subsistence.
The real problem with wages is this: the cost of American labor is not competitive on the world market. Labor prices are a huge part of manufacturing costs especially in the US and other developed nations. This is having a major effect on business right now. The most obvious examples are in the industries with the most inflated wages like the steel and auto industries. Previously we have been able to keep on top of this through modernization to increase labor productivity, but other nations are modernizing and modernization is generally a path of diminishing productivity returns. This means we’ll either see the introduction of protective tariffs, a weaker dollar, or an inflation adjusted drop in US wages.
The problem here is, of course, the skyrocketing cost of healthcare. This wouldnt be so bad, of course, if it werent for the fact that the increasing cost dosent appear to be correlating with any greater quality of care. I imagine that to a large degree healthcare costs can be partially blamed for some of slips in wages we have seen.
Quintiles are useful statistical tools, but one ought to remember that individuals move freely and frequently among them, often as a matter of choice.
Additionally, inflation is a useful macro concept but its impact on the individual varies widely. Gasoline is up? So what. I work at home, or walk to work. Also, inflation is measured by a defined basket of goods priced monthly in selected markets. Any value shopping going on there? When beef goes up in price, is there an increase in lower-priced chicken consumption and a decline in beef consumption?
There are lots of lovely debates to be had here. Let’s add one more. Compensation is a direct function of the perceived value contributed. Productivity,howver derived, drives compensation.
The idea that inflation is wildly overstated is ludicrous if you follow its logical consequences—which you hint at, but don’t discuss. If the Boskin Commission is right, and wage growth has been 1.3 percent higher per year than we’ve been led to believe, then extrapolating back, the majority of Americans in 1960 must have been living below the poverty line.
I’m not sure that—once you control for quality and substitution factors—that’s not true. The actual poverty rate in 1960 was 22.2%.
But perhaps you’re looking at it the wrong way ’round. Perhaps the proper way to look at it is simply that being in, say, the 10th income percentile in the US today involves being much better off than being in the 10th income percentile in 1960. As little health care as 20k a year might buy you, it’s almost certainly better than what an inflation-adjusted equivalent would have bought you then. A 10 year old used car might not be terribly good today, but it’s almost certainly better than a 10 year old used care in 1960.
Also, it should be noted that some fairly prominent economists seem quite willing to accept the conclusions issued by the Boskin Commission. Paul Krugman, for example. In particular, this essay deals with the point you brought up:
Boskin may be right or wrong, but one argument by his critics is clearly wrong. They say: Suppose it’s true that inflation has been less than the official increase in the CPI over the past few decades. If you assume a lower inflation rate and recalculate real incomes back to—say, 1950—you reach what seems to be a crazy conclusion: that in the early 1950s, the era of postwar affluence, most Americans were living below what we now regard as the poverty line. Some critics of the Boskin report regard this as a decisive blow to its credibility.
The idea that most Americans were poor in 1950 is indeed absurd, but not because of Boskin’s numbers. After all, even if you use an unadjusted CPI, the standard of living of the median family (50th percentile) in 1950 America appears startlingly low by current standards. In that year, median-family income in 1994 dollars was only about $18,000. That’s about the 20th percentile today. Families at the 20th percentile—that is, poorer than 80 percent of the population—may not be legally poor (only about 12 percent of families are officially below the poverty line), but they are likely to regard themselves as very disadvantaged and unsuccessful. So even using the old numbers, most families in 1950 had a material standard of living no better than that of today’s poor or near-poor.
He goes on to point out some standard of living comparisons, which, I think, make the point fairly well.
If we’ve been overstating inflation by 1.3 points, the ramifications are enormous.
Indeed.
Also, "real disposable personal income" is an aggregate figure, no? So it doesn’t necessarily tell you how the median American worker is doing.
That’s very true, and the difficulty of digging into that breakdown is why I wrote that "I don’t intend to lay out all the numbers right now". I was just sort of hoping nobody would bring it up, because I’m not sure where, exactly, I can find that breakdown.
I’ve little doubt that there’s some real compensation/disposable income slippage among lower quintiles. As globalization picks up, I’m afraid, the labor pool for the lower income quintiles, especially, will increase very quickly. Competing with everybody in the US labor pool, plus millions of illegal immigrants, plus hundreds of millions of Chinese and Indians is going to become an increasingly bad deal for those who won’t or can’t increase their education/productivity sufficiently to maintain a comparative advantage.
I do not believe the Boskin Commission report that CPI is overstated. From what I’ve read CPI is understated and that GDP growth of 4.2% would be flat to down if adjusted for actual inflation. Anecdotally, it doesn’t appear to be right either! Mover Mike
I do not believe the Boskin Commission report that CPI is overstated. From what I’ve read CPI is understated and that GDP growth of 4.2% would be flat to down if adjusted for actual inflation. Anecdotally, it doesn’t appear to be right either!
Where have you read that? Were it true, it would mean that we’re materially worse off today than we were in the 1960s. That is, to say the least, a difficult proposition to imagine, considering the standard of living in the US.
Barry Ritholtz over at The Big Picture has been writing about inflation being understated in recent times. This has mostly to do with the housing cost adjustment (owners equivalent rent) to CPI as well as healthcare’s percentage of CPI. If housing costs reflected true ownership costs, it’s estimated that inflation would be somewhere around 5%.
Here’s another who states that inflation is in the 4%+ area, John Hathaway, portfolio manager, Tocqueville Gold Fund in Barrons on Nov 19th. Barron’s: You have written about gold benefiting from a bubble in the U.S. Treasuries market.
Hathaway: The bubble is a reflection of the lack of investment alternatives. It is also a reflection of the perceptions of risk and the notion that Treasuries are a safe haven so they should be priced in a different way. There is so much money sloshing around the system, to the extent it is risk-averse it goes into Treasuries. On the other hand, you have negative real rates throughout the yield curve. Latest 12-month inflation is running about 4.7 percent. An investor has to go out almost 30 years on the yield curve just to get even. There is so much paper around and returns on assets are so hard to come by that it is driving money in this direction, and that’s created the bubble. But these conditions are very favorable for gold.
Bottom line: no one believes the government statistics on inflation. Kudlow has said for months prior to gold jumping $100 that there was no inflation, just look at gold.
Bottom line: no one believes the government statistics on inflation.
Well, except for the guy you cite. He’s citing month-old CPI data. The "government statistic" that nobody believes.
In Sept, the year-over-year CPI growth was 4.7%. That’s a rolling figure, though, and it bounces around. September and October saw energy price-driven spikes.
Real gross domestic product—the output of goods and services produced by labor and property located in the United States—increased at an annual rate of 4.3 percent in the third quarter of 2005, according to preliminary estimates released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 3.3 percent.
Sure it’s a rolling figure, you toss out the old 13th month and add in the latest month. It is still 4.7%, amd that’s from the BLS which I think is understated. You call September and October "energy spikes". I see oil is still around $60 as of December, so those "spikes" seem pretty permanent. Finally, you say Q3 is +4.3% and Q2 is +3.3% adjusted for inflation. What is the inflation rate they used. I’ll bet you that it close to the "core" rate which they claim is 1%+! Try adjusting for 4% or 5% or 8-10%!
Sure it’s a rolling figure, you toss out the old 13th month and add in the latest month. It is still 4.7%, amd that’s from the BLS which I think is understated.
You keep saying it’s understated, but so far the only evidence is that....a guy with an interest in gold agrees with the official figure.
You call September and October "energy spikes". I see oil is still around $60 as of December, so those "spikes" seem pretty permanent
The price at the pump spiked. We had gasoline over 3 dollars a gallon for awhile. Now, it’s back down to a bit over $2/gal. The futures contracts don’t usually reflect short-term spikes like that, except when they’re predictable.
Finally, you say Q3 is +4.3% and Q2 is +3.3% adjusted for inflation. What is the inflation rate they used. I’ll bet you that it close to the "core" rate which they claim is 1%+! Try adjusting for 4% or 5% or 8-10%!
No, and if you’d read the link I gave you, you’d see what rate they used. I’m really not sure what a bunch of imaginary numbers have to do with GDP, inflation, etc.
I read the link but missed the stuff after the footnote. "The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 4.0 percent in the third quarter, the same as in the advance estimate; this index increased 3.3 percent in the second quarter. Excluding food and energy prices, the price index for gross domestic purchases increased 2.1 percent in the third quarter, the same as in the second quarter." So which did the government use 4% or 2.1%? They don’t say.
Methodology and assumptions are spelled out at the BEA site. You’re welcome to let us know of a heretofore unnoticed scheme to hide our deepening economic quagmire. Since we have, in fact, grown quite a lot since the 1960s, it’s hard to believe anybody seriously suggests that we’ve been experience negative economic growth in that time.
