Keep The Labor Market Flexible To Maintain Productivity

Veronique  de Rugy
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Posted: Jun 02, 2016 12:01 AM
Keep The Labor Market Flexible To Maintain Productivity

One of the assets of the American economic model is a relatively flexible labor market, especially when compared with labor markets in many European countries. It explains some of the consistently lower U.S. unemployment rates and higher economic growth. Unfortunately, this flexibility is increasingly threatened by government policies that would increase the cost of employing workers. These policies include the Department of Labor's recent overtime rules, the call for employer-paid family leave and a minimum wage increase.

Some of these calls are driven by pure politics and self-interest. The typical union business model, for instance, is built on the notions that workers are treated unfairly by employers, that abuse is systemic to the labor market and that things get worse over time. The argument is that hamstringing employers into paying workers more for the same amount of work would be beneficial to workers, in spite of evidence to the contrary.

Sometimes the support for intervention in the labor market is based on widespread beliefs that are quite wrong. Take, for example, the idea of a large "productivity-pay gap" in the marketplace -- meaning that workers' productivity rose at a high rate over the past four decades but real earnings growth failed to keep pace and instead was nearly flat.

A popular chart produced by the Economic Policy Institute shows that net hourly productivity has grown by 91 percent since 1973 while hourly compensation has only grown by 10.5 percent. The data, EPI believes, prove that most employers unfairly force their employees to work long hours, at a much higher productivity level, without adjusting compensation appropriately. Many people, from President Barack Obama to Labor Secretary Tom Perez, have used the data to make the case for the DOL overtime rules that expand the scope of coverage of employees eligible for overtime pay and other labor market restrictions.

This would be disconcerting if the data were actually accurate. Thankfully, this terrible portrait of American workers' standing in the labor market is only the product of errors and poor methodological choices, e.g., comparing the pay of just some workers with the productivity of all employees, counting productivity growth of the self-employed while excluding their pay growth, and using different measures of inflation to calculate pay growth and productivity growth.

If you want to understand why comparing apples and oranges (whether talking about inflation or workers) is a big no-no or why the world is a better place to most workers than we are often led to believe, you must read the new paper by labor economist James Sherk, called "Workers' Compensation: Growing Along with Productivity."

When you adjust for the problems listed above and a few others, Sherk finds that since 1973, net hourly productivity has grown by 81 percent while hourly compensation has increased by 77.7 percent. In other words, contrary to conventional wisdom, worker compensation is actually very closely tied to worker productivity.

Sherk is far from being the only one making that claim. As his paper reminds us, "academic economists largely reject this analysis and the conclusion that salary no longer grows with productivity." That's true on the right of the political spectrum, as well as the left. The paper references the work of Dean Baker, the director of the Center for Economic and Policy Research, and Harvard professor Robert Lawrence, who served on President Bill Clinton's Council of Economic Advisers. They found, in Sherk's words, that "pay growth tracks productivity growth when comparing the same groups of workers and using the same measure of inflation." Sherk adds that after examining the apparent gap between pay and productivity, "George Washington University professor Stephen Rose -- a former Clinton Administration Labor Department official currently affiliated with the Urban Institute ... concludes that productivity growth continues to benefit working Americans."

Setting the record straight is important to reassure workers that there's no widespread abuse by American employers. It's also important because false claims such as this one are used to justify the implementation of such idiotic regulations as the overtime rules -- which will most likely turn salaried employees into hourly workers and lower base compensation over time. Increases in the minimum wages also keep lower-skilled workers out of the workforce. Armed with Sherk's new paper, we will better be able to fend off future attempts to turn our labor market into its more rigid European cousin.