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Transcript of UNBROKEN: PRODUCTIVITY AND WORKER COMPENSATION IN ... This report may be cited as: Stephen Kirchner,

  • UNBROKEN: PRODUCTIVITY AND WORKER COMPENSATION IN AUSTRALIA AND THE UNITED STATES Stephen Kirchner March 2019

  • The United States Studies Centre at the University of Sydney is a university-based research centre, dedicated to the rigorous analysis of American foreign policy, economics, politics and culture. The Centre is a national resource, that builds Australia’s awareness of the dynamics shaping America — and critically — their implications for Australia.

    The Centre’s Trade and Investment Program examines trends, challenges and opportunities in the trade and investment relationship between Australia and the United States. It places the Australia-US economic relationship in the broader context of Australia’s relations with the rest of the world and promotes public policy recommendations conducive to the growth and integration of the Australian, US and world economies.

    United States Studies Centre Institute Building (H03) The University of Sydney NSW 2006 Australia

    Phone: +61 2 9351 7249 Email: us-studies@sydney.edu.au Twitter: @ussc Website: ussc.edu.au

    This report may be cited as: Stephen Kirchner, “Unbroken: Productivity and worker compensation in Australia and the United States,” United States Studies Centre at the University of Sydney, March 2019.

    Research conclusions are derived independently and authors represent their own view, not those of the United States Studies Centre. Reports published by the Centre are anonymously peer-reviewed by both internal and external experts.

    Cover, p3, p8, p10 photos: Getty Images

  • 1

    Table of contents

    Executive summary 02

    Introduction 03

    The Australian debate 05

    The US debate 07

    What does US research tell us about the productivity-compensation link? 08

    US studies 10

    Replicating Stansbury-Summers with Australian data 12

    Explaining the labour share of income 17

    Explaining nominal wages 22

    Conclusion 24

    Appendix 1: Model specification 25

    Endnotes 26

    About the author 28

  • UNITED STATES STUDIES CENTRE | TRADE AND INVESTMENT PROGRAM UNBROKEN: PRODUCTIVITY AND WORKER COMPENSATION IN AUSTRALIA AND THE UNITED STATES

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    Executive summary

    Subdued wages growth has been a feature of the Australian and US economies in recent years, posting the slowest growth on record on some measures. This has led some to question whether workers are sharing in the benefits of increased productivity and greater economic prosperity.

    The United States has seen a long-running debate over the supposed ‘decoupling’ of wages from productivity and its implications for the labour share of income and income inequality. There is an extensive US

    literature on ‘decoupling,’ with evidence presented both for and against this phenomenon.

    It is important to distinguish between the earnings of the average and the median (sometimes called ‘typical’) worker. Economy- wide productivity growth is mostly expected to raise average rather than median earnings.

    The literature supporting the ‘decoupling’ thesis based on median earnings

    confuses the productivity-compensation nexus with distributional issues. This confusion can lead policymakers to neglect policies focused on productivity growth and focus too much on redistribution.

    This report finds the link between productivity and compensation in Australia remains robust under existing institutional arrangements, although this does not preclude the possibility of further reforms that could boost productivity, worker compensation and improve the distribution of productivity gains.

    The long-run increase in the capital share in the United States, other G7 economies and Australia is largely driven by the housing component of the capital share. This in turn reflects the increased scarcity of housing driven by excessive regulation of land use and dwelling construction. Policymakers concerned about income inequality should focus on improving housing supply rather than workers’ bargaining power.

    This report also shows that the cyclical variation in the labour share is a consequence of the relatively greater volatility of the capital share and not changes in workers’ bargaining power.

    Monetary policy can also play a role in improving nominal wages growth by returning inflation to the central tendency of the Reserve Bank’s inflation target.

    This report finds the link between productivity and compensation in Australia remains robust under existing institutional arrangements, although this does not preclude the possibility of further reforms that could boost productivity, worker compensation and improve the distribution of productivity gains.

  • UNITED STATES STUDIES CENTRE | TRADE AND INVESTMENT PROGRAM UNBROKEN: PRODUCTIVITY AND WORKER COMPENSATION IN AUSTRALIA AND THE UNITED STATES

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    Introduction

    Subdued wages growth has been a feature of the Australian and US economies in recent years, posting the slowest growth on record on some measures. Real wages should be closely linked to productivity and nominal wages to productivity and inflation. Inflation and productivity growth have also slowed relative to previous decades and this accounts for some of the observed weakness in wages.

    But slow wages growth has still led some to question whether workers are sharing in the benefits of increased productivity and greater economic prosperity. If wages do not keep pace with productivity growth, then the labour share of income will decline over time relative to the capital share. A declining labour and rising capital share of income is also a stylised fact for many advanced economies in recent years.

    The view that the link between productivity and wages is broken has been the basis for a number of public policy recommendations, including suggestions Australia should return to some form of national wages policy or centralised wage fixing and that the Superannuation Guarantee contribution rate should be increased. The Reserve Bank has also blamed the undershooting of its inflation target on slow wages growth.

    The United States has seen a similar and longer running debate over the supposed ‘decoupling’ of wages from productivity and its implications for the labour share of income and income inequality. This debate has informed populist politics on both the left and the right. There is extensive US literature on ‘decoupling’, with evidence presented both for and against this phenomenon.

    The US debate points to a key distinction that needs to be made to avoid confusion about these issues and to draw the right policy conclusions. It is important to distinguish between the earnings of the average and the median (sometimes called ‘typical’) worker. Median measures of compensation are more representative of the typical worker in capturing the middle of the income distribution. Average wages growth may be higher than median wages growth if there is stronger growth at the top end of the earnings distribution relative to the middle of the distribution. The average/

    median ratio can be viewed as a measure of wage and income inequality.

    Economy-wide productivity growth is mostly expected to raise average rather than median earnings. The link between productivity and average compensation does not guarantee that productivity and income growth will be equally distributed. Much of the US literature on ‘decoupling’ between productivity and compensation references median rather than average earnings to argue that the ‘typical’ worker does not benefit from productivity growth.1 But this is the wrong measure to use when examining the productivity-compensation nexus.

    The literature supporting the ‘decoupling’ thesis based on median earnings confuses the productivity- compensation nexus with distributional issues, whereas these should be viewed as distinct, albeit related, questions. A robust compensation-productivity nexus does not preclude problems with the distribution of productivity gains and growing income inequality, as the US literature arguing against the ‘decoupling’ thesis readily acknowledges.2

    Both sides of the debate recognise that productivity growth is a necessary but not sufficient condition for improving wages growth for all workers. The danger in confusing the productivity-compensation nexus with distributional issues is that it can lead policymakers to

  • UNITED STATES STUDIES CENTRE | TRADE AND INVESTMENT PROGRAM UNBROKEN: PRODUCTIVITY AND WORKER COMPENSATION IN AUSTRALIA AND THE UNITED STATES

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    neglect policies focused on productivity growth and focus too much on redistribution. In particular, it may lead policymakers to move away from competitive wage determination on the basis that it is not delivering for workers. But as Australia’s historical experience with non-market approaches to wage setting before the early 1990s demonstrates, this is likely to lower productivity, as well as break the productivity- compensation nexus, to the detriment of growth in incomes.

    This report examines the relationship between productivity and compensation in Australia and the United States. In particular, it replicates work by former US Treasury Secretary Larry Summers and Anna Stansbury on the productivity and compensation link using Australian data. Consistent with Stansbury and

    Summers, I find that the link between productivity and compensation in Australia remains robust unde