Cafe Hayek: The Dark Lining of the Silver Cloud

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April 10, 2006

The Dark Lining of the Silver Cloud

Russell Roberts

Lou Uchitelle, in yesterday's New York Times, is desperate to find proof that workers are losing ground. He hangs his rhetorical hat on a subtle issue in trying to measure GDP, the treatment of research and development. Is it an expense or is it investment? Current calculations of GDP treat it as an expense, but a good case can be made that it's actually an investment. That changes the calculation of business profit and makes measured profits higher. That seems reasonable. But Uchitelle tries to make the case that workers are doing evven worse than we thought. Here's his summary of reclassifying R&D as investment:

This reclassification leaves no doubt that workers are being left behind as the G.D.P. expands. When R & D is counted as profit, the employee compensation share of national income drops by more than one percentage point. In a $12.5 trillion economy, that's big money.

What does the phrase "left behind" mean to you? Standing still? Falling back? Moving forward but not as fast as others? All of the above? It's a vague phrase to give Uchitelle some wiggle room. But even so, a 1% change in compensation's share is not a big change unless you saw it persist year after year. There's always going to be some fluctuation. And is labor's share falling? Or is this 1% reduction a change in the level that has always been there but now we're measuring it properly?

Uchitelle immediately lets us know that workers even though they're being "left behind" are actually not really becoming worse off:

Measured in dollars, wages aren't actually falling, but workers are losing ground. "If capital income is going up and wages stay the same, then the share of total national income that goes to labor goes down," said Sumiye Okubo, an associate director of the bureau, who is directing the experimental project.

So we're back to a favorite theme at the Times's. People are still getting ahead but some are getting ahead faster than others.

In fact, labor's share of the economic pie, measured in the traditional fashion without the correction for R&D as an investment, is remarkably constant, as this report from the St. Louis Fed by Michael Pakko shows:

The top line is compensation going to workers. It is remarkably steady at 70% of national income going back to 1948. It doesn't go any higher than 73% and it doesn't fall below 67%. The lower line is wages and salaries, a series that some pessimists use because by ignoring the increasing role of benefits in compensation, it misleads about how labor is doing relative to profits. This picture makes it clear that labor's share measured in the traditional manner without accounting for the intangibles, hasn't fallen since the 70's. Or the 1950's even. This picture is makes it difficult for the pessimists to claim that the top 1% are getting everything or that corporations rule the world. So I can understand the desire to reclassify GDP calculations to find a gloomier conclusion.

Changing the way we account for R&D and moving this number around by something on the order of 1% isn't going to be much of a story. But there are other changes that people are considering in how to measure labor and business's share in GDP—how to treat advertising, for example, or the adoption of technology:

Such intangibles now approach $250 billion a year, up from only $11 billion in the 1970's, the three economists calculate. If these intangibles, along with R & D, were incorporated into G.D.P. on the profit side as capital investment, labor's share of national income would decline from a fairly steady 65 percent in the 1950's, 60's and 70's to less than 60 percent today.

I don't know where Uchitelle gets his numbers. The Fed study shows the share steady at 70% not 65%.

The long decline doesn't show up in the standard G.D.P. accounts, which ascribe nearly 65 percent of national income to labor. "The hidden earnings from these knowledge investments have not been shared equally with workers," Mr. Hulten said.

I can believe that if you reclassify some expenses as investments, you can boost business profits and business's share of GDP. There may even be a decline over time in labor's share as Uchitelle and the authors of the study he mentions are right. But is there any reason that all gains should be shared equally? Is there an economic reason? Here are Uchitelle's reasons for the decline he perceives:

Two reasons seem likely. Some of the profit is probably going to the wealthiest Americans — the upper 1 percent whose incomes have risen sharply, in part from dividends and other forms of corporate earnings.

The economic argument that Uchitelle and Hulten (one of the study's co-authors) seem to be making is that since 1970, there has beena big increase in technology and R&D and advertising. These changes have increased inequality by lowering labor's share. But do they really believe that increases in R&D and technology are bad for workers? I'd think that workers benefit from technology and R&D. Does Uchitelle really believe that the benefits of R&D and technology accrue mostly to the top 1%? But here's the real kicker:

Then, too, most of the nation's workers are bereft of bargaining power. Unless that returns, labor's share of national income seems likely to continue its decline.

Bereft of bargaining power? What does that mean? I assume Uchitelle means the decline of unions. But the steadiness of labor's share goes back to the 1950's. And unionization in the private sector has been falling steadily since the 1950's. Tough thesis to prove.

Ironically perhaps, just above Uchitelle's piece, in the print edition of the paper, was this piece by Ben Stein arguing that envy is a destructive emotion:

Years ago, I went to a 12-step program on Point Dume, a lovely area in Malibu, Calif. At the time, I was making a modest living and was petrified about money many nights. I would walk my magnificent German short-haired pointer, Trixie, near the homes of fabulously wealthy stars and moguls and then return to my shabby rented cottage.

At the meeting, I complained about the maddening truth that so many people near me on Point Dume had so much more money than I did, and a smart woman named Jennie said: "Instead of thinking about what you don't have, think about what you have. You have the handsomest son on the planet. You have the perfect dog. Concentrate on those. When you are tempted to feel envy, remember that envy is as bad as strychnine for you. Make a list of what you do have that is good in your life, and then the envy will lift."

Good advice.

Posted by Russell Roberts in Inequality | Permalink

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Comments

It is good advice in a Buddhist sort of way. Of course, if people actually followed this type of advice whole-heartedly, it would be extremely detrimental to economic progress; much of the effort people put into their work is due to their desire to keep up with the Joneses, so to speak.
It seems to me that you've been confronted with the difficult problem that human perceptions of relative status pose to free markets. Specifically, the problem that maximizing economic growth offers no guarantee of maximizing overall welfare if enough people are envious enough. But rather than work out a solution that would disrupt the Pareto-optimal ideal you favor, you've taken the tack of trying to delegitimate envy. I would expect an economist to 'play the ball where it lies', so to speak, and accept human nature as it is, rather than wish people were different than they are. That is after all something we lambaste the communists for.

Posted by: bbartlog | Apr 10, 2006 12:17:33 PM

"Of course, if people actually followed this type of advice whole-heartedly, it would be extremely detrimental to economic progress..."

This would be no great loss, since it would be due to a shift in preferences.

If I decide (ala Buddhism as you suggest) that material wealth is a drag on my spiritual well-being, and therefore decide to quit my well-paying tech job and work in fast food, and live an ascetic lifestyle...
1) my income and wealth go DOWN
2) my utility goes UP

#1 is obvious, #2 is true because #1 is more in line with my newly-altered preferences. Therefore if, en masse, people decided to stop keeping up with the Joneses and stop caring about relative measures of well-being, and this caused us to produce much less, we would be better off, not worse.

Posted by: Noah Yetter | Apr 10, 2006 3:17:38 PM

The number of hours worked per capita is increasing, so if the share going to workers remains the same, but more hours are worked, then workers are indeed falling behind.

Most of the extra hours relates to more women in the workforce. In 1970 there were 0.79 women working for ever man working. In 2004 there were 1.02 women working for every man working.

But I also understand that everyone is hours worked per week, in general, is increasing. Probably because a declining percentage of workers are covered by the required overtime laws.

Russell, is it possible for you to admit that maybe American workers ARE falling behind?

Posted by: Half Sigma | Apr 10, 2006 4:03:16 PM

And here's a link to the data source where I calculated those numbers above:

http://www.census.gov/hhes/www/income/histinc/p08ar.html

A very useful table.

Posted by: Half Sigma | Apr 10, 2006 4:04:30 PM

And furthermore, even with the total compensation to workers remaining the same, if the top 1% of workers' share of that is increasing, then the regular worker is falling behind, and this source of falling behind is in addition to the increasing hours worked per capita argument I made in the comment above.

Posted by: Half Sigma | Apr 10, 2006 4:07:16 PM

we would be better off, not worse.

Well, 'economic progress' and 'being better off' may or may not mean the same thing, depending how much of a utilitarian you are. I should also point out that the example you give ignores the effects on others. It is possible that the newly-minted ascetic is slightly better off, while overall, his effective withdrawal from the workforce has larger negative impacts on other people. Maybe if everyone really could switch at once...

As a thought experiment, consider whether we should (if we could) genetically engineer descendants who had the same extremely high degree of contentment under a wide range of conditions. We would maximize utility in some sense, but since these people would lack the discontent that drives us modern humans to work and achieve, they would not produce as much as we do. Would this be worthwhile? As you might guess I am not really a utilitarian and would find such an outcome abhorrent, but I am sure there are those who would disagree.

Posted by: bbartlog | Apr 11, 2006 4:17:32 PM

One question to ask is the amount of cash earnings earned by all workers vs the amount of the work done as measured in hours.

My tentative guess is that cash earnings per hour has slowly gone up, but not as fast as inflation has. I would also venture that Cash/hour is very dependant on education and possibly other hours as well.

Posted by: Market Participant | Apr 11, 2006 4:56:53 PM

MP -
your tentative guess is wrong. Real earnings per hour have gone up (in the USA anyway) for pretty much any time period you care to look at. If you want evidence that The Man is keeping people down or that Capital is sticking it to Labor or whatever you will need to look at something like the fraction of all earnings that go to the bottom fifth of earners, or the Gini coefficient, and come up with a more sophisticated argument.

Posted by: bbartlog | Apr 12, 2006 4:00:17 PM