Daniel Sullivan

English

Research Papers in Economics

ESSAYS ON ISSUES THE FEDERAL RESERVE BANK MARCH 1997
OF CHICAGO NUMBER 115
Chicago Fed Letter
Trends in real wage growth
In popular discussions of economic
policy it is often claimed that real wage
levels in the U.S. are stagnant or even
falling. This Chicago Fed Letter reviews
the statistical basis for such claims and
explains why they are misleading. Other
commentary has claimed that average
real wages are rising, but not as fast as
productivity, a phenomenon argued to
have left U.S. workers with a smaller
share of the national economic pie.
This article shows that there has been
a divergence between some common
measures of productivity and real wages.
However, the divergence has little to
do with shifts in the distribution of
income between labor and capital.
Instead it mainly reflects something
more mundane—changes in the rela-
tive prices of consumer and noncon-
sumer goods. Moreover, arguably
more appropriate measures of real
wages continue to closely track pro-
ductivity gains.1
Alternative real wage measures
The level of the average real wage,
which is the amount of goods and ser-
vices that can be bought with an hour
of work, is one of the key determinants
of the nation’s living standard. When
real wages rise, workers can consume
more goods and services for the same
amount of work time. Alternatively,
they can consume the same goods
and services, but work fewer hours
and have more leisure time. Standard
statistical measures of the real wage
are derived by deflating a measure of
nominal wages by a measure of con-
sumer prices. Thus, the growth rate
of the real wage is equal to the growth
rate of nominal wages minus the growth
rate of consumer prices. Because there
are a number of measures of nominal
wages as well as a number of measures
of consumer prices, there are many
possible measures of the real wage.
One measure of the real
wage that has received
substantial attention is
the real hourly earnings
series shown in figure 1.
It is obtained by deflat-
ing the average hour
earnings figure that the
Bureau of Labor Statis-
tics (BLS) obtains every
month from its Current
Employment Survey (CES)
of establishments by the
BLS’s Consumer Price
Index for Urban Con-
sumers (CPIU). The
CPIU, which is also
released monthly, is the
most widely followed
measure of consumer
prices.2
If the pattern depicted in figure 1
accurately reflected trends in real
wages, then living standards for U.S.
workers may indeed have fallen. As
the figure shows, real hourly earnings
peaked in 1972 and are currently about
16% below their historical high. They
are, moreover, not appreciably higher
than in 1964. Not surprisingly, com-
mentators arguing that the U.S. econ-
omy has fundamental problems often
point to the real hourly earnings series
for support.
There are, however, major method-
ological problems with using the aver-
age hourly earnings series to gauge
long-term trends in wage rates. First,
they cover only wage and salary com-
pensation. Fringe benefits and contri-
butions for social insurance programs,
important parts of workers’ total com-
pensation, are left out. Because these
components of compensation have
been increasing more rapidly than
wages and salaries over most of the
period covered by figure 1, average
hourly earnings understate compen-
sation growth. The earnings data
are also limited to production and
nonsupervisory workers. The nearly
20% of workers excluded from the av-
erage are more likely to be highly
skilled and highly paid. Because such
workers have experienced more rapid
wage growth since the early 1970s,
their exclusion imparts another down-
ward bias to the measured rate of av-
erage wage growth.3 Finally, though it
covers a large fraction of employment,
the CES is subject to substantial biases
in sample selection; for example, it
excludes workers at newly opened
establishments.
The historical CPIU data series used
to deflate average hourly earnings
also has serious methodological prob-
lems. In particular, BLS methodology
substantially overstated housing cost
inflation in the high interest rate envi-
ronment of the late 1970s and early
1980s. This methodology was corrected
in 1983. However, the historical data
for earlier periods were not revised.
The BLS did, though, release a series,
the CPIU-X1, that applies current
methodology to the period before
1983. These data suggest that from
1967 to 1983, the CPIU overstated
80
100
120
140
160
1964 ’68 ’72 ’76 ’80 ’84 ’88 ’92 ’96
index, 1964:Q1=100
Real hourly
earnings
Real hourly
compensation
1. Alternative real wage measures
Note: Shaded areas indicate recessions.
Sources: U.S. Department of Labor, Bureau of Labor Statistics, Current
Employment Survey and “Consumer Price Index,” Internet at http://
stats.bls.gov, various years; U.S. Department of Commerce, Bureau of
Economic Analysis, National Income and Product Accounts, Internet at
http://www.stats-usa.gov, various years.overall inflation by a cumulative 9%.
Moreover, many analysts have suggested
that even current CPIU methodology
substantially overstates inflation. For
instance, the Boskin Commission report
issued last year concluded that current
methodology overstates increases in
the cost of living by 1.1% per year.4 If
this finding is correct, then the down-
ward bias in real wage growth due to
inadequacies in the CPIU over the
period covered by figure 1 is even
greater than 9%.
The real hourly compensation series
shown in figure 1 largely avoids the
methodological problems with real
hourly earnings. This series replaces
average hourly earnings and the CPIU
with more appropriate measures of
nominal wages and prices. The nominal
wage measure underlying real hourly
compensation is derived from total
business sector compensation figures
from the National Income and Product
Accounts (NIPA) and the BLS’s series
on hours worked by all persons in the
business sector. The total compensa-
tion data are not limited to production
and nonsupervisory workers and they
cover wages and salaries paid to private
workers as well as the cost of fringe
benefits and contributions for social
insurance. They are also based on
much more complete data than the
CES. The deflator for the real hourly
compensation series shown in figure 1
is the CPIU-X1 which, as noted above,
eliminates upward bias in the CPIU by
applying current
methodology to the
period before 1983.5
Clearly, these method-
ological corrections
make a large differ-
ence to the measured
trend in average real
wages. Average real
wages now appear to
be 18% higher than in
1972, not 16% lower.
They are 53% higher
than in 1964, not the
same. Moreover, if the
findings of the Boskin
Commission on the
overstatement of infla-
tion by the current
CPIU methodology
are correct, then real
hourly compensation
has grown even faster than shown in
figure 1—approximately 57% since
1972 and 120% since 1964.
Given the great technological advanc-
es and investment in new physical cap-
ital over the last 25 years, the trend in
real hourly compensation is much more
in line with neoclassical economic ex-
pectations and should serve to dispel
some of the most radical critiques of
the economy’s performance. However,
the data do suggest that growth in av-
erage real wages has slowed significant-
ly since the 1960s and 1970s. For
instance, real hourly compensation
grew only 3.5% in the first 19 quarters
of the current expansion, compared
with 4.5% in the comparable period
of the 1980s expansion and 7.0% dur-
ing the 1975–79 expansion.
Real wages and productivity
Most economists would expect slowing
real wage growth to be attributable to a
corresponding slowing in productivity
growth. Some, however, have chal-
lenged that view with data such as that
shown in figure 2, which plots the real
hourly compensation measure dis-
cussed above along with the BLS’s stan-
dard measure of business sector labor
productivity. The pattern is striking.
Average real wages closely track pro-
ductivity growth until about 1982.
Then the two series diverge, as growth
in labor productivity outpaces growth
in real wages by about 0.7% per year.
The data in figure 2 should not, how-
ever, be interpreted as a shift in the
balance of power between capital and
labor. As figure 3 shows, labor’s share
of business sector income has fluctuat-
ed significantly since 1982, but the
long-term trend has been relatively
flat. Rather than a shift in the distribu-
tion of income, the divergence shown
in figure 2 reflects changes in the rela-
tive prices of consumer and noncon-
sumer goods.
How do relative price changes affect
the relationship between real wage
and productivity measures? Average
labor productivity is the ratio of real
business sector output to a corre-
sponding measure of hours worked.
Real output in this calculation is ob-
tained by deflating the nominal value
of business sector output by the im-
plicit price deflator for the business
sector. This is similar to the construc-
tion of real hourly compensation. The
major differences between real hourly
compensation and business sector
productivity are that 1) real hourly
compensation starts from the nominal
value of wages and benefits paid to
workers while the labor productivity
measure starts from the nominal value
of output, and 2) real hourly compen-
sation uses the CPIU to deflate prices,
while the labor productivity measure
uses the implicit price deflator for
business sector output. Because the la-
bor share data shown in figure 3 have
little trend, the difference between
nominal compensation and nominal
output cannot explain much of the di-
vergence shown in figure 2. Rather, it
is mainly the difference in the two
price deflators that has caused the
standard measures of real wages and
productivity to diverge.
The price deflator for business sector
output reflects the prices of all the
goods and services produced by the
business sector. This includes the pric-
es of the goods and services consum-
ers buy, which are measured by the
CPIU, and the prices of investment
goods and government purchases,
which are not. Since 1982, consumer
prices as measured by the CPIU have
risen 0.6% more per year than those
of all business sector outputs as mea-
sured by the implicit deflator for the
business sector. Cumulatively, the
CPIU grew by over 8% more than the
100
120
140
160
180
1964 ’68 ’72 ’76 ’80 ’84 ’88 ’92 ’96
index, 1964:Q1=100
Real hourly
compensation
Output
per hour
2. Real wages and productivity
Note: Shaded areas indicate recessions.
Sources: U.S. Department of Labor, Bureau of Labor Statistics, Survey
of Current Business and Current Employment Survey, Internet at
http://stats.bls.gov, various years; U.S. Department of Commerce, Bureau
of Economic Analysis, National Income and Product Accounts, Internet
at http://www.stats-usa.gov, various years.Michael H. Moskow, President; William C. Hunter,
Senior Vice President and Director of Research;
Douglas Evanoff, Assistant Vice President, financial
studies; Charles Evans, Assistant Vice President,
macroeconomic policy research; Daniel Sullivan,
Assistant Vice President, microeconomic policy research;
William Testa, Assistant Vice President, regional
programs;  Anne Weaver, Manager, administration;
Helen O’D. Koshy, Editor.
Chicago Fed Letter is published monthly by the
Research Department of the Federal Reserve
Bank of Chicago.  The views expressed are
the authors’ and are not necessarily those of
the Federal Reserve Bank of Chicago or the
Federal Reserve System.  Articles may be
reprinted if the source is credited and the
Research Department is provided with copies
of the reprints.
Chicago Fed Letter is available without charge
from the Public Information Center, Federal
Reserve Bank of Chicago, P.O. Box 834,
Chicago, Illinois 60690-0834, tel. 312-322-5111
or fax 312-322-5515.  Chicago Fed Letter is also
available on the World Wide Web at http:/ /
www.frbchi.org.
ISSN 0895-0164
business sector deflator over this peri-
od. This difference is enough to ex-
plain almost all of the difference
between the growth in real wages and
productivity since 1982.
Some of the difference between the
CPIU-X1 and the implicit deflator for
the business sector may reflect meth-
odological deficiencies in the CPIU-
X1. For instance, the use of fixed
consumption weights in the CPIU-X1
tends to overstate inflation when con-
sumers substitute between goods as
relative prices change, a bias that is
much less significant in the chain-
weighted price deflator. However,
most of the difference between the
price indices is probably genuine; the
prices of the things consumers typically
buy have, on average,
increased more rapid-
ly than the prices of
the things they don’t
buy. For instance, spec-
tacular productivity
increases have caused
quality-adjusted prices
to fall for investment
goods, such as comput-
ers and machine tools,
while some items impor-
tant to consumers, such
as college educations,
have increased in price
especially rapidly.
Figure 4 shows more
directly that the differ-
ence in deflators ex-
plains the divergence
of wages and productivity by compar-
ing labor productivity to a real wage
measure obtained by deflating the
NIPA-derived nominal wage series by
the business sector price deflator. Be-
cause this measure, often referred to
as the real product wage (as opposed
to the real consumption wage discussed
previously), reflects the prices of all the
goods and services produced by the
business sector, it is not surprising that
it more closely tracks labor productivity.
Indeed, it is the real product wage that
profit maximization implies should be
proportional to productivity.
As figure 4 shows, once proper account
is taken of relative price change, there
has been no major change in the rela-
tionship between real wages and
productivity. Thus,
the key to explaining
the slowing real wage
growth that is still evi-
dent in figure 4 really
is understanding the
nation’s slowing pro-
ductivity growth.
—Daniel Sullivan
Assistant vice president
61
63
65
67
1964 ’68 ’72 ’76 ’80 ’84 ’88 ’92 ’96
percent
100
120
140
160
180
1964 ’68 ’72 ’76 ’80 ’84 ’88 ’92 ’96
index, 1964:Q1=100
Real hourly
compensation
Productivity
3. Labor’s share in the business sector
4. Real wages and productivity II
Note: Shaded areas indicate recessions.
Source: U.S. Department of Labor, Bureau of Labor Statistics, Current
Employment Survey, Internet at http://stats.bls.gov, various years.
Notes: Real hourly compensation is deflated by the implicit price
deflator for the business sector. Shaded areas indicate recessions.
Sources: See figure 2.
1The points made in this
article are known to many
researchers. See, for exam-
ple, Barry Bosworth and
George L. Perry, “Produc-
tivity and real wages: Is
there a puzzle?” and the
discussion by Matthew D.
Shapiro in Brookings Papers
on Economic Activity, Vol. 1,
1994. However, they have not been completely
absorbed by the popular press. See, for exam-
ple, Allen R. Myerson, “In era of belt-tighten-
ing, modest gains for workers,” New York Times,
February 13, 1997, p. 1.
2To facilitate comparisons with other mea-
sures, the real hourly earnings series has been
scaled to 100 in 1964. The shaded areas in
this and subsequent figures represent reces-
sions as defined by the National Bureau of
Economic Research. The series the BLS refers
to as real hourly earnings is actually deflated
by the CPIW, the Consumer Price Index for
Urban Wage Earners, but that series and the
one shown in figure 1 are very similar.
3This article is concerned only with trends in
average real wages. Since the early 1970s there
has been a substantial increase in wage ine-
quality. See, for example, Kevin Murphy and
Finis Welch, “The structure of wages,” Quarter-
ly Journal of Economics, Vol. 107, No. 1, Febru-
ary 1992. As a result, the real wages of certain
groups of less-skilled workers may have fallen
even while average wages rose for the econo-
my as a whole.
4See “Toward a more accurate measure of
the cost of living,” Final report to the Senate
Finance Committee, Advisory Commission
to study the Consumer Price Index, Decem-
ber 1996.
5The BLS only produced the CPIU-X1 series
back to 1967. Growth rates in the standard
CPIU were used to extend the CPIU-X1 series
backward from 1967. Since interest rates were
relatively stable in this period, this should
create no problems.3.0
4.5
6.0
7.5
Motor vehicle production (millions, seasonally adj. annual rate)
Cars
Light trucks
Motor vehicle production
(millions, seasonally adj. annual rate)
Dec. Month ago Year ago
Cars 5.8 6.3 6.1
5.5 5.6 6.0 Light trucks
1993 1995 1996
Manufacturing output indexes
(1992=100)
Dec. Month ago Year ago
CFMMI 124.4 123.2 118.7
113.8 118.1 119.3 IP
Purchasing managers’ surveys:
net % reporting production growth
Jan. Month ago Year ago
MW 60.8 58.4 58.3
45.1 58.4 58.0 U.S.
1994
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Tracking Midwest manufacturing activity
Sources: The Chicago Fed Midwest Manufacturing
Index (CFMMI) is a composite index of 16 industries,
based on monthly hours worked and kilowatt hours.
IP represents the Federal Reserve Board’s Indus-
trial Production Index for the U.S. manufacturing
sector. Autos and light trucks are measured in an-
nualized units, using seasonal adjustments devel-
oped by the Board. The purchasing managers’
survey data for the Midwest are weighted averages
of the seasonally adjusted production components
from the Chicago, Detroit, and Milwaukee Purchas-
ing Managers’ Association surveys, with assistance
from Bishop Associates, Comerica, and the Uni-
versity of Wisconsin–Milwaukee.
Midwest manufacturing activity ended 1996 on a strong note and appeared to
carry some momentum into the new year.  Following a strong rebound in Novem-
ber, motor vehicle production in December was little changed from November’s
pace at a seasonally adjusted rate of 11.8 million units.  With support from the
auto sector, total manufacturing output in the region, as measured by the
CFMMI, rose 1.0% in December, its best showing since April of last year.
The new year appeared to be off to a good start, with the production compo-
nent of the composite index from purchasing managers’ surveys in the region
continuing to be above its national counterpart. Indeed, while the national pur-
chasing managers’ index indicated a very modest slowing in the sector’s pace of
expansion, the Midwest index suggested a slight acceleration.

Trends in real wage growth

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Trends in real wage growth

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Research Papers in Economics