How concerned should we be about the downward trend in real wages?
Average hourly earnings have failed to keep up with inflation over the last two years, a fact noted with concern recently by
Deinonychus Antirrhopus, Economic Policy Institute, Sirotablog, and
Brad DeLong, among others.
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Dave Altig notes that this is in fact a continuation of a trend going back to 1974 that had been temporarily reversed in the late 1990’s, as seen in the graph at the right. However, Dave also points out that although wages have fallen behind inflation for over a generation now, other nonwage components of worker compensation, particularly health care benefits, have grown more quickly than inflation. The graph below shows that in fact total compensation shows a steady long-term upward trend relative to inflation that has if anything accelerated in recent years.
Is it a good thing from the point of view of workers to be receiving an ever-shrinking fraction of their total compensation in the form of wages? One’s first thought might be that cash beats an equivalent dollar value in perks, since you could always use the cash to buy the perks yourself. You’d be at least as well off if you bought the identical perks as provided by your employer, and better off if you made some substitutions that better reflect your own preferences. But such an argument abstracts from taxes– since the perks come free of income, payroll, and sales taxes, you might be better off with a big set of employer-provided perks, even if there are substantial efficiency losses relative to what you could do with an equivalent amount of tax-free cash. To try to reduce these inefficiencies, some have advocated taxing employer-provided health care expenditures as if they were the same as direct worker income.
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Even if there were no taxes, another reason why workers might prefer to receive income in the form of health care benefits rather than salary is the issue of adverse selection. If the insurance company cannot charge different premiums so as to fully reflect the different risks, healthy people end up paying more than they expect to get out, and so might not opt for the plan. The result is that the pool of insured is sicker, the premiums necessarily even higher, and many other people who might otherwise want insurance might get priced out. By insuring a pool of workers as a group through the employer, such adverse selection might be minimized, with the result that the average worker is better off than he would be trying to buy insurance on his own. This argument is persuasive to many economists, though Arnold Kling has his doubts.
But I worry whether other factors might be involved in the rising share of non-wage compensation. I wonder whether the people whose decisions determine this share really understand that the basic question is whether a given dollar of value-added that is produced by the worker goes to the employee in the form of salary or perks. I realize that I’m venturing out of economists’ usual rational-decision-maker framework in making such a claim. But let me give you two examples.
The first is based on observation of the political process. For example, one big component of nonsalary compensation is employers’ contribution to Social Security. Why did Congress set up a system in which, supposedly, the worker makes half the contribution and the employer makes a matching contribution? Economic theory suggests that it should make no difference who allegedly pays the payroll tax. The firm will look at the cost it pays for labor (which includes its Social Security contribution) in deciding how many workers it is profitable to hire, while the worker looks at what she personally gets paid (which excludes her Social Security contribution) in deciding on where and how much to work. The final outcome should be the same regardless of which party delivers the taxes to the government. And yet, the fact that the Social Security payment system is set up in the way it is suggests that there are at least some people who see the “employer contribution” and “employee contribution” as not coming out of one and the same pile of money.
The second reason I wonder about the efficiency of the size of current nonwage compensation is based on observation of the faculty benefits committee at UCSD. It seems there is a universal assumption of the noneconomists on this committee that the more benefits we get, the better off we are, as if the money were coming out of nowhere and had no implications for the budget for salaries. If professors act this way, I’m inclined to entertain the possibility that those who negotiate contracts for labor unions may have a similar mindset.
Finally, before we conclude that the solid trend in total compensation means there’s nothing to worry about in the declining trend in real wages, there is the difficult question of whether the growing non-wage compensation is acting to reduce or to exacerbate the rising gap between the wages of the top 10% and bottom 10% of earners; see for example the concerns raised by Kash at Angry Bear.
Should we worry about the declining trend in real wages? At least a little, I should think.
An obvious question about the rapidly rising cost of health care is what portion of that cost increase represents an improvement in medical care and what portion simply represents a medical inflation factor above that of the CPI. I would guess that it is more the latter since it would be hard to explain 10% annual increases in heath costs by people getting 10% healthier each year. This means we need to get a grip on why Americans spend twice as much on health care each year than most other industrialized nations, yet have poorer outcomes by most measures. Looking at it from the wage earners point of view, if wages are declining and he is getting no better health care, he can’t be happy about the situation.
I’m not sure how much an “average” tells us about what is happening in various segments of the labor market.
Also, Social Security “Compensation” isn’t actually compensation to an individual — its a transfer to the government. What goes in and what comes back is not the same across generations — nor is it the same for folks of different demographics. Black males for example aren’t being “compensated” via the Social Security system to the same tune as are white females. You can’t “count your chickens before they are hatched” as we all know — so for some this “compensation” is never realized.
Parking is the most fought-over non cash benefit I have seen at a university. Parking which has ‘no cost’ (and therefore the tendency is inevitably to give more permits than there are spaces– by making a resource free, you guarantee its scarcity relative to demand– think highway congestion at 5pm). I have seen Business School profs on $250k a year have screaming rows about whether they can park in front of their office, or at a lot a block away.
The other ‘non cash’ benefit is pensions. Where universities (and local and regional governments) have a strong incentive to treat pension concessions as ‘less expensive’ than salary concessions. Since these bodies are among the last providers of ‘gold standard’ defined benefit pension schemes, the fact that the accounting rules do not force them to fully recognise the future costs of those schemes is a severe moral hazard. I could name you the Universities in Canada that have been living off their ‘pension fund surplus’ which is actually simply the result of unrealistic and indefensible assumptions of future returns– something Warren Buffett has spoken about very stridently.
I am not sure how this interfaces with TIAA/CREF in the US. Do college professors bear the full risks of their pensions themselves (defined contribution/ money purchase)? Or are the schemes defined benefit?
There was an article in the NYT magazine by Roger Lowenstein about how state and local governments were doing the same thing. The current accounting laws do not force them to recognise the future deficits on their schemes– and policemen, for example, retire at 50.
The ultimate John Law (Louis XV’s France and the invention of ‘paper money’ and its subsequent collapse) case of this I have seen was Illinois, which borrowed $18bn (? on the amount) at 6.5% (I think), and ‘solved’ its pension fund deficit (assumed return on the fund of c. 10%). Any economist would instantly recognise the ‘money machine’ principle at work here– for the same risk level, Illinois’ return rate cannot be different from its borrowing rate. Ponzi would be proud.
GM pulled a similar trick. Eventually, via the Pension Benefit Guarantee Corporation (or local taxation in the case of Illinois), the taxpayer will pick up the can. Which given the ethnic makeup of the US in 30 years time (white retirees and a ‘minority’ dominated workforce) could be entirely explosive, politically.
I would like to ask, if the two graphs are really comparable? Do they have the same basis (the same set of employees)? Do the the non-wage benefits include also bonuses and options? It is known that the top 10% gets increasing share of their compensation in this form, so it should show in the second graph – and so it seems. On the other hand we know that the share of workers with no medical insurance has increased – but it doesn’t show here. We could think that the income increase in the second graph is really a sign of growing income inequality.
Joseph, there hasn’t been any “medical inflation.” Expenditures for medical care have been rising primarily because of the cost of new technologies, but these technologies are *more* efficient at producing health, not less. If you don’t believe me, ask yourself this: if you got cancer, would you rather have $25000 of medical care in 1960 (adjusted for inflation so it would be less than $4000 in 1960 dollars) or $25000 of todays medical care? I know which I would choose…
“It seems there is a universal assumption of the noneconomists on this committee that the more benefits we get, the better off we are, as if the money were coming out of nowhere and had no implications for the budget for salaries. If professors act this way, I’m inclined to entertain the possibility that those who negotiate contracts for labor unions may have a similar mindset.”
Professor Hamilton, I think I can respond to this from two perspectives. For several years my father negotiated contracts for petrochemical workers in Louisiana. He was a smart man, as are most union negotiators. Dad understood exactly where the money for benefits came from. I’ve heard him explain to his union how they might need to trade wages for benefits, and he regularly solicited their input before negotiating.
I worked with company negotiators at a major airline for a couple of years. They believed the union negotiators understood the economics of wages and benefits. But the company negotiators thought the average union member was ignorant of such economics. That’s what the union negotiators sometimes implied. It’s not always in the best interest of a union to let the company know how informed the members are.
My opinion is that union members understand compensation packages and company positions very well – much better than many educated professionals. I think that’s because their representatives keep them well informed.
Ed, you say there is no medical inflation, but how do you explain 9% to 15% annual increases in health care? It has almost doubled in the last seven years. Are we really getting twice as good health care as seven years ago?
The point being, although the cost of benefits to employers has increased rapidly, it has not resulted in that much benefit to employees.
Or even the benefits that have occurred have benefitted fewer and fewer employees.
One problem with benefits is the individual has relatively little say over cost and care. They can’t choose last years care at last years cost even though I expect most would be fully satisfied with it. Perhaps segmentation into first 50k or 100k, and subsequent care would allow those who really want expensive care to pay for it and allow those who don’t a less expensive option.
Joseph, expenditure on computers has also gone up a lot over the last couple of decades. Do you think that means computers are getting more expensive? How do you answer the question I posed about what you would prefer if you got cancer, todays care at todays prices, or yesterdays care at yesterdays prices?
If you really want to hit the point, would you rather be treated for cancer in 1960 with $100,000 (in 1960 dollars) or in 2005 with $100,000 (in 2005 dollars)? Without controlling for inflation of 1960 dollars you would still choose to spend money in 2005.
the two charts “real wages” and “real compensation” represent different things
“real wages” are “real” (money given to a person in exchange for something) while “real compensation” is not “real”, it is a lot of different things, an abstraction
sesame street uses a device “which of these things is not like the other” to teach children to differentiate between classes of objects
“wages” and “benefits” are two different classes of objects
salary and bonus are the same kind of object – money that is given to a person in exchange and which the person has the power to use independently
“employee benefits”, “health benefits” – “salary plus benefits”
benefits is an important and powerful concept
a person benefits from membership in the company or institution by being provided with health insurance
this health insurance is exactly what it is – health insurance
it is not compensation – it is a “benefit” – all workers regardless of renumeration rate get the same benefit – it something good that accrues to you because you belong to the group
in the US it has been the case that if you work for a company or institution you get the benefit of health insurance, state and federal law and insurance company marketing practices dictate this situation
if you do not work you do not get the benefit of health insurance unless you qualify for government spnosorship of a health benefit,
if you are self-employed you have historically had problems finding a way to purhase health insurance at a reasonable rate and the government has done little to support your benefit cost with tax relief – you are not a part of the group
fdr used the postal workers to develop the concept of health insurance and the practice of employer-sponsored health insurance, it caught on and became a major structure of our society
but this is changing
increasingly workers are being asked to divert some of their “wages” to pay for their “health insurance benefit”
increasingly workers are being offered employement arrangements in which there is no “health insurance” benefit
this is a major shift in the structure of work arrangements
economists distort reality when they represent the “health insurance benefit” as being in the class of objects called “wages” or “compensation”
should we be concerned if average wages are declining and more and more workers are paying part of their wages to support their health insurance benefit” or are not getting a “health insurance benefit” at all?
yes
What do you say we just put the facts on the table.