Wages Are Based More on Productivity, Less on Exploitation Capitalism isn’t broken. This is how it’s supposed to work.

By Michael R. Strain, Director of Economic Policy Studies at the American Enterprise Institute. Excerpt:

"The latest piece of evidence on this question comes from Stanford University economist Edward P. Lazear, who analyzed data from advanced economies and confirms a strong link between pay and productivity.
Like several previous studies, Lazear’s research finds that low-, middle- and high-wage workers all benefit from growth in average productivity. This suggests that improvements in overall economic efficiency help all workers, not just the rich.

But Lazear argues, correctly, that a relevant issue is not whether workers benefit from changes in average productivity. Instead, if you want to know whether workers are being paid for their productivity, you should look at whether changes in the productivity of, say, low-wage workers affect the pay of that specific group.

It is infeasible to measure the productivity of individual workers. (How much revenue per hour of work do I generate for Bloomberg?) So Lazear examines productivity at the industry level, and compares industries that employ highly skilled workers with those that employ lesser-skilled ones.

Using data on the U.S. from 1989 through 2017, Lazear finds that productivity in industries dominated by higher-skilled workers increased by (roughly) 34 percent in that period. The wages of those workers grew by 26 percent. For industries requiring lesser skills, productivity increased by 20 percent, while wages grew by 24 percent.

In other words, pay increased faster than productivity in industries with lesser-skilled workers, and slower than productivity in industries with higher-skilled workers. Another striking implication of this finding is that “productivity inequality” — the gap in productivity between workers — may have grown faster than wage inequality over this period. While wage differences have increased over time, differences in productivity between groups of workers have increased even more.

The upshot: Slower wage growth for lesser-skilled workers is not prima facie evidence that employers have significant power over wages or that productivity doesn’t determine wages. Instead, Lazear concludes that productivity growth for high-skilled workers has increased rapidly enough (actually, more than enough) to account for growing inequality.

What caused this? Lazear points to two familiar explanations. Technological change disproportionately benefits the highly skilled, increasing their wages and productivity. And the globalization-led shift to a services economy has reduced the productivity of goods-producing, lesser-skilled workers.

Lazear also suggests that colleges may have improved more than high schools in their ability to impart skills to graduates. If so, industries dominated by college graduates would be expected to have had faster productivity growth over the last three decades. This would have caused both a wider dispersion in productivity across industries and in wages across groups of workers.

Such research doesn’t settle the debate, of course. Yet it does strengthen my view that wages are heavily influenced by market forces, even if they are not entirely determined by them. While productivity sets the baseline for wages, deviations from that baseline occur.

So contrary to what Biden, Warren and (many) others say, market forces, not power dynamics, are the principal driver of inequality.

This gets at the heart of the moral properties of the market economy. Capitalism produces unequal outcomes: The wages for some grow faster than for others. Those disparities are palatable if they are caused by differences in risk-taking, work effort and skills. They are tolerable if people are getting, in some sense, what they deserve. But if wages aren’t determined by productivity — if hard work doesn’t pay off and if workers aren’t receiving just returns — then something has gone badly wrong with the system.

Fortunately, the system doesn’t seem to be broken. It does need to be fine-tuned, however, with the goal of increasing the productivity of the lesser skilled. And we should be confident that if their productivity increases, so will their wages."