Wages and Productivity

Two oft-cited measures of progress reveal much about the West's enduring economic and political fragility

If the political tumult of the past year has revealed anything about public sentiment, it’s the predominating sense of gloom surrounding our economic prospects. Donald Trump’s election and Britain’s decision to leave the EU were powered by claims that we in the West are worse off than we used to be. Opposition politicians such as Jeremy Corbyn lament that Britons are set to get poorer under the current policy regime, supported by think tanks such as the IFS which predicts that young people in Britain may be less well-off than their parents at every stage in life.

Hearing this, one would assume we were in a period of enduring economic stagnation – with unemployment high, and growth absent or negative. Nothing could be further from the truth – in both Britain and America unemployment has been firmly under 5% for over a year. Compared to the 1970s, which is often hailed as a time of peak prosperity and social unity, the West is immensely wealthier. What’s more, real GDP per capita has grown at an average pace of 1.2% in Britain and 1.3% in the US since 2010. Whilst these figures may seem small, over time the compounding effects are immense. If growth continues at these levels, in just 30 years real GDP per person will be 47% higher in the US and 43% higher in Britain. Thus, in a technical sense, far from being poorer than the past generation, our next one is likely to be the richest in history.

So, is all this gloom merely manufactured by political opportunists? Unfortunately, it is not. Whilst they may be wrong in a narrow economic sense when we look at GDP per capita, they are right in perhaps a much more fundamental respect. The fact is, immense economic gains have not been translated into income gains for the average worker. What has happened over the past several decades is known as ‘decoupling’ – productivity growth has consistently exceeded wage growth. In the US for example, many would be surprised to know that whilst real output per worker is over double its 1970 level, median household income is barely 20% higher. Though the US is markedly the worst, the OECD documents this problem of decoupling throughout developed nations since the 1990s. In Britain, wages are still below their 2007 level.

Economists have been fixating on productivity growth recently and for good reason – in the UK it is stagnant and the US it is anaemic. In the long run, the only way average living standards can increase is for productivity to do so. There are some sensible ways for governments to help: by investing in infrastructure (which is incredibly cheap at the moment due to historically low interest rates) they can raise the capital stock per worker. Done effectively, an increase in the amount and quality of public capital (e.g. roads, transport links, communication) should raise productivity. Furthermore, encouraging innovative small businesses and investing in education should have similar results.

However, I fear that whilst these initiatives may be necessary for raising living standards, they are no longer sufficient. Decoupling has shown that the ordinary mechanism which used to link productivity with wage increases has broken down. Productivity gains, especially in America and Britain, are either going to the owners of capital or the highest paid wage earners – failing to reach the middle household. As a result, inequality has sky-rocketed since the 1970s. This means that even if we were to return to robust productivity growth tomorrow, most households may only see paltry, if any, income gains. As such, political upheaval and social discontent would endure.

It may seem narrow minded to claim that these figures explain the whole of our public discontent – for there are undoubtedly a multitude of social and cultural influences. But in my view, this connection between productivity and wages is fundamental for the legitimacy and sustainability of our current system. If wages had grown in line with output per worker over the past several decades, I am confident we would be living in a far happier, cohesive world. People rightly feel dissatisfied with a system that concentrates a vast amount of gains in the hands of the very richest. Indeed, such a situation tramples on the ideals of liberalism, which emphasises the paramount importance of widespread and relatively even societal progress. Commonly cited explanations for this worrying trend include globalisation and cross-border competition. This, the theory goes, has reduced the bargaining power of domestic workers in the West, allowing companies to keep wages low. Yet, as an OECD paper highlights, the fact that decoupling has occurred to very different degrees across rich nations (for instance, France has seen much more solid wage growth when compared to the US) indicates that domestic policy choices have a huge role to play in influencing pay structures.

What is vitally needed, yet sorely lacking, is a reassessment of the institutions that govern work and pay. The recent Taylor Review commissioned by the British government into the ‘gig-economy’ highlighted some of these issues and proposed some sensible reforms: including introducing real distinctions between those who are legitimately self employed and those who function as dependent contractors, nominally self-reliant but ultimately dependant on the parent company (think Uber drivers). Yet the gig economy is only a recent development, and this productivity-wage mismatch has been afflicting us for decades. Structures around work and pay are highly decentralised and undoubtedly complex, meaning any changes should be implemented cautiously and with significant planning so as to avoid unintended shocks to employment and the economy as a whole. Whilst I am unsure about how exactly this issue can be solved, I am sure that, if it continues to be neglected, division will only grow and societal cohesion only weaken – breeding political tumult that will make Brexit and Trump’s election appear at most mild events.