Wednesday, September 2, 2015

The minimum wage might transfer the benefits of the earned income tax credit to employers

See Minimum logic by Steve Landsburg
"The question is often raised: “Why would you ever want to raise the minimum wage when you could raise the earned income tax credit instead?”. In other words, if you’ve got a choice between two ways to increase the effective wage rate, why would you choose the one that reduces employment over the one that increases employment?

Paul Krugman has an answer. He’s argued on numerous occasions that the EITC and the minimum wage are complements, not substitutes — that is, each makes the other more effective. So, according to Krugman, once you’ve raised the EITC, the case for a minimum wage hike becomes stronger, not weaker.

Here’s his argument: When you raise the EITC, more people enter the labor market. The increased supply of labor tends to drive wages down, which transfers some of the benefit from the workers you intended to help to the employers and/or consumers who you presumably care about less. To prevent this perverse consequence, one needs a hike in the minimum wage.

The other day, a colleague (who I’m not naming because I’m not sure whether he’d want to be quoted) pointed out that this argument makes not a shred of sense. Here’s why: Any effective minimum wage (that is, any minimum wage set above the wage rate that would prevail in an unregulated market) suffices to do the job Krugman wants it to do. At best, then, Krugman has made an argument for having some minimum wage, not a case for raising it.
Here’s the picture:

Suppose the minimum wage is set at $5 an hour, just a hair above the unregulated equilibrium. Now we raise the EITC by the amount of the vertical blue line. Ordinarily, this EITC would drive the wage rate down to $3 an hour. But the wage is not allowed to fall below $5 an hour, so workers continue to earn that amount, plus the entire EITC. That is, they earn the amount at the top of the red line (which is the same length as the blue). Had the minimum wage been $6 or $7 or $8 an hour instead of $5 an hour, workers would have pocketed exactly the same 100% of the EITC.

Of course you might want to increase wages still further, and you can do this by increasing the minimum wage, but now you’re right back to the question: “Why would you ever want to raise the minimum wage when you could (further) raise the Earned Income Tax Credit instead?”

Because my sympathies are always with the underdog, I did my best to defend Krugman. Namely: the existing minimum wage of (let’s say) $5 might be effective in some labor markets (where the unregulated equilibrium is $4.50) but not in others (where the unregulated equilibrium is $6). Krugman’s argument is (as shown above) invalid in the first market, but could still carry water in the second. So if you’re constrained to have a single minimum wage that applies to both markets, you might want to raise it to $6.

Of course, even to make this work, you have to ignore a whole lot of economics, including this: If you increase the EITC in a market with an effective minimum wage, you’ll get a whole lot more workers competing for the same limited number of jobs, and this competition must continue until all of the benefits have either been dissipated or transferred to employers, who are now able to demand harder work and offer fewer perquisites. In other words, even if you go out of your way, as I have, to make sense of Krugman’s argument, you still end up with the same ironic bottom line: His stated goal is to prevent the benefits of the EITC from being transferred to employers, and to this end he proposes a policy whose certain effect is — to transfer the benefits of the EITC to employers. It’s almost enough to make you wonder whether he even bothers to give a minute’s thought to this stuff any more."

Tuesday, September 1, 2015

Does Compensation Lag Behind Productivity?

By Ben Gitis & Jacqueline Varas.


It is frequently asserted that growth in labor productivity is outpacing growth in compensation. This suggests that the economy is not properly compensating workers, and is one of the key reasons many believe it necessary to raise the minimum wage, expand overtime pay coverage, mandate paid family leave, and increase union membership. We examine this assertion and find that it is based on faulty statistical analyses that employ misleading tactics by comparing labor market data that are not directly comparable. In particular, these claims are based on an analysis that:

• Compares labor productivity of the entire economy to compensation for private sector production and nonsupervisory workers
• Uses two different price indexes, one to measure real productivity and another to measure real compensation.

After accounting for these issues, we find that real compensation has grown closely with labor productivity over the last fifty years.


While advocating for policies like raising the minimum wage and expanding overtime pay coverage, many assert that compensation has not grown with labor productivity. They claim that since the 1970s there has been a stark divergence between the growth in worker pay and the growth in labor productivity. According to the Economic Policy Institute (EPI), productivity has grown eight times faster than worker compensation in recent years, as productivity rose 64.9 percent and hourly compensation only grew 8.2 percent from 1979 to 2013.[1] Taken at face value, these numbers are alarming. They suggest that rewards from productivity growth are going almost exclusively to company profits and those workers at the top, while regular workers are neglected. Fortunately, the putative trend is based on a number of analytical flaws, such as comparing labor productivity of the entire economy to compensation for private sector production and nonsupervisory workers. The result is a story that simply is not true.

Comparing the Purported Trend to Reality

Over the last few years, charts similar to Figure 1 have become increasingly prominent in labor market policy discourse.

Figure 1 is a reconstruction of a graph featured in a 2014 EPI paper.[2] Graphs similar to Figure 1 have been featured prominently by EPI, unions, and a presidential campaign, which use it to justify policies like raising the minimum wage, expanding overtime pay coverage, and increasing union membership. Figure 1 compares the growth in real hourly compensation to real labor productivity over time. The former represents what workers receive from the economy and the latter illustrates the value of what they produce in it every hour. According to the chart, the two metrics began to diverge during the 1970s and growth in labor productivity has been outpacing growth in hourly compensation ever since. As a result, since 1964 real labor productivity has increased 114.5 percent and real hourly compensation has only risen 15.8 percent.

Using official productivity and compensation data in the Bureau of Labor Statistics (BLS) multifactor productivity tables, we compared the growth in real productivity to the growth in real compensation since 1964.[3] As shown in Figure 2, the official data tell a completely different story.

While Figure 1 suggests that growth in real productivity and real compensation diverged during the 1970s, official data show that real compensation has followed productivity quite closely. In fact, a noticeable divergence does not occur until around 2005, which results in a much smaller productivity-compensation gap. From 1964 to 2013, real labor productivity of private sector workers grew 180.4 percent while growth in the real compensation received by those same workers tracked closely behind at 161.1 percent.

How could two measures of the same phenomenon be so different? In the following, we show step-by-step how the illustration of labor productivity and compensation in Figure 1 differs from official labor statistics.

Step 1: Figure 1 compares productivity for the entire economy to compensation for workers in the private sector

EPI calculated the growth in labor productivity for the entire economy and compared it to growth in compensation for only workers in the private sector. It did this by analyzing unpublished BLS productivity data. If the goal is to compare compensation and labor productivity in the private sector, then it is much more appropriate to compare growth in private sector compensation with growth in private sector productivity. Figure 3 below inserts into Figure 1 the official BLS measure of real private sector labor productivity (output per hour) located in the multifactor productivity tables.

It is important to note that official labor productivity data do not account for the depreciation of capital. This can create an imperfect comparison between productivity and compensation: the replacement of capital as it loses value contributes to overall output, but it does not contribute to any rise in national income or translate into higher compensation for workers.[4] Therefore, we likely overestimated the actual growth of labor productivity in the private sector. EPI’s measure of labor productivity, on the other hand, does account for capital depreciation, which actually reduces the real growth in labor productivity over time. So by not accounting for capital depreciation, the official private sector data in Figure 3 actually widen the gap between compensation and productivity growth. Since 1964, labor productivity net depreciation grew 114.5 percent and total labor productivity in the private sector grew 180.4 percent. From this point on, we use the official BLS measure of private sector labor productivity.

Step 2: Figure 1 Compares Labor Productivity of All Workers to Compensation of Production and Nonsupervisory Workers

After replacing total economy labor productivity with private sector labor productivity in Figure 3, we run into another problem. In particular, Figures 1 and 3 compare growth in productivity for one group of workers to growth in compensation for another group of workers. Official productivity data, shown in Figure 3, represent labor productivity of all private sector workers, including highly paid managers. Compensation growth in Figure 3, however, only represents compensation for a portion of private sector workers. In particular, it represents compensation for production and nonsupervisory workers, who account for about 82 percent of the private sector workforce. The excluded 18 percent of the workforce consists of more highly compensated workers and supervisors. Thus, Figure 3 compares productivity for all private sector workers to a measure of compensation that excludes highly paid workers and has a downward bias.
As can be seen in Figure 4, tracking growth in real compensation for all private sector workers significantly closes the gap between productivity and compensation.

As shown above, replacing real compensation for production and nonsupervisory workers with real compensation of all private sector workers, available in the BLS multifactor productivity tables, substantially raises the growth in compensation since the 1970s. Since 1964, real compensation for all private sector workers rose 70.3 percent, compared to just 15.8 percent for private sector production and nonsupervisory workers.

EPI asserts that it uses compensation for production and non-supervisory workers to analyze how typical workers’ earnings are growing relative to labor productivity.[5] If this is indeed the goal, it would then be more appropriate to compare compensation for production and nonsupervisory workers to labor productivity for the same group. However, since there is no official labor productivity data available for production and nonsupervisory workers, the best way to make a fair comparison is to use data representing the entire private workforce for both compensation and productivity.

Step 3: Figure 1 uses two different price indexes to adjust productivity and compensation for inflation

Labor productivity for the entire economy (Figure 1) and the private sector (Figures 2, 3, and 4) is adjusted for inflation using the Implicit Price Deflator (IPD). In all of the charts, however, compensation is adjusted using the Consumer Price Index (CPI). In this context, it is misleading to use two different price indexes, one to measure real productivity and another to measure real compensation.[6] Since CPI generally estimates higher inflation than IPD, the two price indexes are not comparable. As a result, even after using average compensation for the entire private sector workforce, the real growth in compensation measured in Figure 4 likely overstates the gap between growth in productivity and compensation. In order to capture the actual gap, it is best to use one measure of inflation when comparing real growth in compensation to real growth in productivity.
So which price index should we use?  The fundamental difference between IPD and CPI is that IPD measures changes in the prices of goods and services produced by businesses and CPI measures the change in prices of goods and services that are consumed in America, including those that are produced outside of the United States. According to Martin Feldstein, President Emeritus of the National Bureau of Economic Research, a “competitive firm pays a nominal wage equal to the marginal revenue product of labor, i.e., to the marginal product of labor multiplied by the price of the firm’s product.”[7] In other words, a worker’s compensation is based on his or her benefit to the firm, which depends on the prices of the firm’s products not the prices of the goods consumed by all Americans. Thus, IPD is far more appropriate because the price changes of goods businesses sell have a more direct impact on employee pay than do price changes of other consumer goods. 
Figure 5 shows that simply adjusting compensation for inflation with IPD instead of CPI closes almost the entire remaining gap.

When adjusted with CPI, real hourly compensation for all workers in the private sector increased by 70.3 percent since 1964. However, when adjusting compensation with IPD, it grew by 161.1 percent. The blue and red lines in Figure 5 are the same shown in Figure 2.


Clearly, methodology matters in this discussion. When the private-sector growth of productivity and total compensation are compared using all private sector workers and the same output price deflator, it is apparent that compensation and productivity have grown hand-in-hand. As a result, the assertion that regular workers do not benefit from economic growth is based on a faulty analysis that essentially underestimates the growth in real hourly compensation during the last half century. Most troubling, these assertions inspire misguided policies, such as raising the minimum wage or expanding overtime pay, which have been shown to provide minimal benefit to those in need and often hurt the workers and families the policies aim to help."

The Unsteady Link Between Inflation And Unemployment On The Phillips Curve

See Phillips Art by John Cochrane.
"The Wall Street Journal gets a prize for Art in Economics for their Phillips curve article. Abstract expressionist division, not contemporary realism, alas.

Source: Wall Street Journal

(For the uninitiated: There is supposed to be a stable negatively sloped curve here by which higher inflation comes with lower unemployment. Beyond that correlation, most policy economists read it as cause and effect, higher unemployment begets lower inflation and vice versa. The point of the article is how little reality conforms to that bedrock belief.)"

The Great Job-Creating Machine (technology)

By Chelsea German of Cato.
"As the Guardian recently reported, technology has created more jobs than it has destroyed, and the new jobs it has created have been of higher quality. Technology eliminated many difficult, tedious, and dangerous jobs, but this has been more than offset by a rise in the caring professions and in creative and knowledge-intensive jobs, resulting in a net increase in jobs.  The sectors to lose the most jobs have been agriculture and manufacturing, which are both difficult and dangerous, while work opportunities in medicine, education, welfare, and professional services have become more abundant. (For example, there are more teachers per student, improving student-teacher ratios, and there are also more physicians per person than in the past).

In 1980, almost a quarter of the world’s employment was still in agriculture. Now, only around 15% of the world’s workers are engaged in agricultural labor. Yet we are feeding more people, undernourishment is at an all-time low, and food is becoming less expensive. Technological advances liberated humanity from toiling in fields by mechanizing many processes and boosting productivity, allowing more food to be produced per hectare of land, and freeing hundreds of millions of people to pursue less grueling work.

The elimination of so many unsafe jobs in manufacturing and agriculture means fewer worker deaths. According to data from the International Labor Organization, from 2003 to 2013, the number of work fatalities in the world decreased by 61% (i.e., over 20,500 fewer deaths). This occurred even as the world population grew by over 700 million over the same time period. If the most dangerous thing you have to face at work is the threat of a paper cut, you quite possibly have technological innovation to thank for that.

Even if in the future robots steal some jobs, advancing technology will likely make several higher-quality jobs available for every job lost. As the Guardian article cited earlier says, technology has proven to be a “great job-creating machine,” eliminating toilsome work but bringing into existence more—and better—opportunities than it takes away.

But note that behind every machine, there lurks human ingenuity. As Matt Ridley wrote in his book The Rational Optimist:
It is my proposition that the human race has become a collective problem-solving machine and it solves problems by changing its ways. It does so through innovation driven often by the market.
Learn more about what market-driven technological innovation has done to improve the state of humanity at"

Monday, August 31, 2015

Problems with Chinese fiscal stimulus

From Tyler Cowen.
"Remember back in 2009, and a bit thereafter (pdf), when so many people were praising China’s very activist, multi-trillion fiscal stimulus?

Yet some of us at the time insisted this would only push off and deepen China’s adjustment problems.  There was already excess capacity and high debt and favored state-owned industries, and the stimulus was making all of those problems worse and only postponing a needed adjustment.  The Chinese incipient contraction was based on structural problems, not a simple lack of aggregate demand.  As I wrote in 2012:
To keep its investments in business, the Chinese government will almost certainly continue to use political means, like propping up ailing companies with credit from state-owned banks. But whether or not those companies survive, the investments themselves have been wasteful, and that will eventually damage the economy. In the Austrian perspective, the government has less ability to set things right than in Keynesian theories.
Furthermore, it is becoming harder to stimulate the Chinese economy effectively. The flow of funds out of China has accelerated recently, and the trend may continue as the government liberalizes capital markets and as Chinese businesses become more international and learn how to game the system. Again, reflecting a core theme of Austrian economics, market forces are overturning or refusing to validate the state-preferred pattern of investments.
How’s that debate going?  While the final outcome remains uncertain, Austrian-like perspectives on China are looking pretty good these days.

Just as you go to war with the army you’ve got, so must a country conduct fiscal stimulus with the policy instruments it has.  And most forms of Chinese fiscal stimulus make their imbalances worse rather than better.  Yet dreams of fiscal stimulus as an answer to the macro problems on the table never die:
Sangwon Yoon writes for Bloomberg:
China is sliding into recession and the leadership will not act quickly enough to avoid a major slowdown by implementing large-scale fiscal policies to stimulate demand, Citigroup Inc.’s top economist Willem Buiter said.
The only thing to stop a Chinese recession, which the former external member of the Bank of England defines as 4 percent growth on “the mendacious official data” for a year, is a consumption-oriented fiscal stimulus program funded by the central government and monetized by the People’s Bank of China, Buiter said.
“Consumption-oriented” is the key word there.  I don’t blame Buiter for speaking precisely, but few readers will pick up on his careful use of words.  Still, switching to more consumption is a surrender to lower rates of economic growth, not a way of keeping the growth rate high.  That is a good idea, but a funny kind of stimulus.

In the meantime, the consumption sector in China seems to be faring poorly.  On the way up, investment rose at the expense of consumption, but on the way down they are falling together.  Funny how things like that work out, and it does suggest that a consumption-oriented stimulus maybe can break the fall but it won’t restore prosperity.

It’s striking how little recent discussion I’ve seen of China’s much-heralded fiscal stimulus of 2008-2009.

This is an object lesson in relying too much on short-run macro models, or models in which sticky prices are the only imperfections, or models where the quality of investment is not a factor.  Whatever you think of the American Great Recession, the Chinese case is very, very different."

If you want to become and remain a monopoly, you will produce high quantity, and hence charge low prices

See The Monopoly Motive by Bryan Caplan of EconLog.
"Today's the first day of GMU's fall semester, and for some reason I'm thinking about a class I haven't taught in years: Industrial Organization.  I wrote the notes when I was much younger and more enamored of theory.  Much of the class was a critique of the Structure-Conduct-Performance model so prevalent at Berkeley and Princeton.  Slogan version of the model, to paraphrase Orwell: "Many firms good, few firms bad."

While I hate to claim vindication by vaguely-defined events, the last two decades seem wildly incompatible with the S-C-P model.  Many of our favorite new firms have no close competitors.  What's the next-best-thing to Amazon?  Netflix?  Facebook?  Starbucks?  Even weirder, a sizable chunk of these apparent monopolies give their product away gratis.  Meanwhile, the spread of occupational licensing and rise of Uber have raised awareness of the elephant in the IO room: governments' deliberate effort to make markets less competitive than they would naturally be.  (And don't get me started on immigration restrictions).

Still, it's easy to see the intuitive appeal of S-C-P.  Namely: If you are a monopoly, you'll charge high prices, and hence produce low quantity.

The problem with S-C-P is that it ignores an even more intuitive truism.  Namely: If you want to become and remain a monopoly, you will produce high quantity, and hence charge low prices.

In short, the desire to become and remain a monopoly leads firms to do the exact opposite of what they'd do if their monopoly status were a law of nature - or the law of the land."

Sunday, August 30, 2015

Insurers Win Big Health-Rate Increases

Some state regulators say new costs justify hefty increases under the Affordable Care Act

By Louise Radnofsky and Stephanie Armour of the WSJ. Excerpt:
"At a July town hall in Nashville, Tenn., President Barack Obama played down fears of a spike in health insurance premiums in his signature health law’s third year.

“My expectation is that they’ll come in significantly lower than what’s being requested,” he said, saying Tennesseans had to work to ensure the state’s insurance commissioner “does their job in not just passively reviewing the rates, but really asking, ‘OK, what is it that you are looking for here? Why would you need very high premiums?’”

That commissioner, Julie Mix McPeak, answered on Friday by greenlighting the full 36.3% increase sought by the biggest health plan in the state, BlueCross BlueShield of Tennessee. She said the insurer demonstrated the hefty increase for 2016 was needed to cover higher-than-expected claims from sick people who signed up for individual policies in the first two years of the Affordable Care Act.

Several regulators around the country agree with her, and have approved all or most of the big premium increases sought by the largest health plans in their states for the new sign-up season that begins Nov. 1."

"Now, insurers have found that business has been more costly than expected. Some have said they’ve incurred steep losses. The American Academy of Actuaries also said in a recent paper that some programs designed to cushion insurers against high-risk enrollees are ending."