Arnold Kling  

Comment of the Week, 2003-07-02

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In the discussion of perspectives on Social Security, I suggested that wages tend to rise with productivity, so that indexing Social Security to wages leads to higher benefits than indexing it to prices. Eric Krieg asked,


Arnold, why are wages and productivity neccessarily linked? Could international competition ensure that wages are static while productivity soars? Or could the opposite happen?

I think that in some of the classic models of international trade, in which "labor" is homogeneous and "capital" is homogeneous, you can get the result that when you open up trade between a high-wage country and a low-wage country, the workers in the high-wage country see their wages decline. Allowing more immigration would have a similar effect.

However, my instinct is to believe that immigration will not drive down real wages. I think that with heterogeneous labor, a native worker might be displaced to another industry, but this would not necessarily mean having to take a lower wage. But it probably depends on the how the consumption pattern of the immigrants affects the demand for skills, and how this in turn fits in with the skills of workers who are displaced. I do not see an unambiguous conclusion emerging.

Since this raised a new issue, feel free to post comments on this thread.


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COMMENTS (11 to date)
David Thomson writes:

"I suggested that wages tend to rise with productivity"

Even if wages do not raise---one should be able to purchase more with the same level of income. Isn't this more important? Moreover, I wonder if America is subtly becoming the country where just about everybody can earn the minimun required to live a decent life.

Do you realize how inexpensive food has beome? A good used car can be bought for a very modest sum. Even renting an apartment or owning a home can often be affordable. Only possible medical problems remain a legitimate threat. What is the unavoidable price tag for all this affluence? Might it be a willingeness to accept job changes when the gods of creative destruction demand their human sacrifices?

Bernard Yomtov writes:

What mechanism could make this happen? If productivity is higher than wages why aren't wages bid up? That's the Econ 101 version anyway.

Eric Krieg writes:

Aren't we seeing a situation right this minute where productivity is rising strongly, but demand is weak? There is a jobless recovery, in which I would expect to see no wage growth.

I don't see why wages have to be directly linked to productivity. I see how productivity can be linked to wages, but I don't see WHY they have to be linked.

David Thomson writes:

"What mechanism could make this happen? If productivity is higher than wages why aren't wages bid up? That's the Econ 101 version anyway."

Wages do not have to be up. There is only one thing that matters: the increase in one's buying power! Can you purchase more stuff with the same amount of money? And the answer to this is a definite yes. I am amazed, for instance, how inexpensive TVs, DVD players, microwaves, and so many other items are today. I can well remember when they were major purchases.

Bernard Yomtov writes:

Wages have to be linked to productivity. The reason employers hire workers is that the workers' product is worth more than the wage. As long as that's true, employers will hire more workers.

It's the value of the product, not physical quantity, that matters. That's why turning out more DVD's doesn't help if the price of DVD's is way down. Back to Econ 101: wage rate equals marginal revenue product.

I know the world is more complex than that, but it does seem obvious that there has to be a pretty substantial link between wages and productivity.

Eric Krieg writes:

>>Back to Econ 101: wage rate equals marginal revenue product

Bernard Yomtov writes:

Because employers are presumed to be rational profit-seekers.

As long as workers can be hired for less than they contribute hiring will continue, and wages will rise.

Eric Krieg writes:

Bernard, I understand the theory. But I don't understand how the theory can be made to apply to what is happening now.

Right now demand is weak. To expand production (and thus, jobs) requires price cuts (ask GM). Cutting prices results in LESS profit per unit. So the productivity increases are being refunded to consumers, not to workers.

Or productivity in and of itself is used to increase production, without adding workers, without touching wages. Prices fall accordingly.

Or maybe productivity is used to maintain a certain level of prodution, and jobs and wages are cut.

I think that the failure of the theory is because of the un-historic nature of this recession. When have we ever had a recession like this, where productivity is maintained throughout? We're in uncharted territory.

Eric Krieg writes:

http://www.businessweek.com/bwdaily/dnflash/jul2003/nf2003079_3133_db042.htm

Productivity does not always result in higher wages.

Bernard Yomtov writes:

Eric,

Let's be careful about whether we are talking about physical productivity - widgets/hour - or economic productivity - value of widgets produced per hour.

I am unfamiliar with current productivity figures, so I don't feel comfortable making any strong statements, but it is the value that counts. More specifically it is the marginal value, not the average value - what it gets you to produce one more widget. If demand is weak and you have to lower prices to sell another widget, then adding a worker may be costly, even though workers' average productivity is high.

I don't know that that's what's going on.

Eric Krieg writes:

>>physical productivity - widgets/hour - or economic productivity - value of widgets produced per hour

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