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Thursday, August 31, 2006

The problem with the "fabulous" economy 


Regular readers know that I am a big booster of the American economy, and in particular its fluid labor markets. I know from managerial decisions that I have made why the United States creates a lot of jobs and growth and why Europe does not. My abiding affection for the creative destruction of American capitalism does not, however, mean that I drink the Kool-Aid down to the very last drop.

Case in point, the economically optimistic post du jour. Messers. Reynolds and Hinderaker, two men with whom I agree eight or nine times as often as I disagree, both linked to Engram's worthy post, "Americans hate their fabulous economy." Engram does a great job of showing how strong our economy is in the aggregate and that its performance diverges from the collective perception of it as measured by public opinion polls. How to explain this divergence? According to Engram, it is because reporters who write on the economy don't provide enough data in useful charts. I doubt it.

The problem with Engram's post is that it does not respond to the primary lefty criticism of the "Bush" economy, which is that real wages for the average Joe -- people who are not in, say, the top decile -- have been flat to down. If we look at The New York Times as a suitable proxy for "lefty criticism" -- anybody got a problem with that? -- we see a typical story from Monday's edition, "Real Wages Fail to Match a Rise in Productivity." Money graphs:

The median hourly wage for American workers has declined 2 percent since 2003, after factoring in inflation. The drop has been especially notable, economists say, because productivity — the amount that an average worker produces in an hour and the basic wellspring of a nation’s living standards — has risen steadily over the same period.

As a result, wages and salaries now make up the lowest share of the nation’s gross domestic product since the government began recording the data in 1947, while corporate profits have climbed to their highest share since the 1960’s....

Until the last year, stagnating wages were somewhat offset by the rising value of benefits, especially health insurance, which caused overall compensation for most Americans to continue increasing. Since last summer, however, the value of workers’ benefits has also failed to keep pace with inflation, according to government data.

At the very top of the income spectrum, many workers have continued to receive raises that outpace inflation, and the gains have been large enough to keep average income and consumer spending rising.

Not being an economist, I am hard-pressed to pick apart the data in the linked article. If Engram or another economist can do so, I'd be very interested. I do understand the superficial retorts, however. Yes, family incomes have continued to rise -- slightly -- because people are working longer hours, and, yes, total compensation keeps going up because the "value" of health benefits keeps going up, but neither of those qualifications is going to make the average wage earner happier no matter how thoroughly charted in newspaper articles.

Now, I am not proposing that the federal government do anything about this. I tend to think that these things revert to the mean, and that American workers will capture a larger percentage of GDP in the future, probably the near future, than they did last year. But I don't think that champions of today's economy -- and I include myself among them -- should pretend that the average guy is garnering the benefits of economic growth at the same rate that he did during the Clinton years. While I do not doubt that the media is tougher on the economy today than it was during the Clinton years, real wage stagnation is a more likely explanation for the sour public mood than a vast mainstream media conspiracy.

MORE: Glenn linked back, and had this to say:
Hmm. Maybe. But two observations: One, the shift from satisfaction to dissatisfaction is awfully abrupt, and comes when Bush was elected. Wages can't stagnate that fast, but media coverage can shift tone that fast. Two, I keep hearing about real-wage stagnation, but everyone I know who has a business complains that they can't get enough decent help even when they raise pay, because people are always leaving for better jobs. That may be a local phenomenon or something, but I'd like to see something that accounts for worker mobility, too.

Well, "hmm, maybe." The abrupt shift from satisfaction to dissatisfaction may have tracked Bush's election, or it may have tracked the collapse of the stock market, particularly the NASDAQ, starting in March 2000, and the weakening of the economy starting in early 2001. See the chart below, which shows quarterly GDP real growth by two different measures:



Eyeballing the table, it is hard to deny that things got soft in a hurry after Bush's election. It may have been Clinton's "fault" to the extent that fault can fairly be found, but I'm not sure that the rapid souring of the national mood did not reflect genuine economic problems. The question is, why didn't the national mood recover along with the economy, and I persist in thinking that the stagnation of real wages is a big part of the explanation.

I, like Glenn, also know a lot of people in business who complain that they cannot get enough "decent" help. In fact, I would be one of those people if I hung with Glenn. But there are two or three reasons why the shortage of good employees does not necessarily mean that the national mood about the economy is invalid, or somehow a creature of bad economic reporting. First, the sum of anecdotes is not data. Much as I would like to generalize from my own experience to the economy writ large, it is not particularly valid. I am also prepared to believe that the economies of Knoxville and Princeton are both quite a bit stronger than the national average, which may make good workers particularly scarce.

Second, the shortage of "decent" help is not easily remedied by paying more money. A lot of the time there are just not good people available at any reasonable price. Sure, you can lure a specific person away from a competitor by offering a huge pile of money, but that is a solution that works only in anecdotal cases. The ugly truth is that there is a huge mismatch in our labor force between the skills business needs and those that are available. The people without skills know that, and it both frustrates them and makes them unhappy. That leads to the third point: if you are basically unskilled labor, or have skills that are easy to pick up, it is very hard to increase your wages even when the wages of more educated employees are still going up. Yes, companies have been paying up for educated white collar workers, but they are not giving basic production employees wage gains much above the rate of inflation. Most companies target a corporate rate for their annual increase in compensation expense -- including health care benefits -- at no greater than the rate of inflation. If you hand solid real increases to your best employees to keep them motivated and shovel another big pile out the door to pay for health benefits, you make up for it by giving little or no increase to many other employees. Based on my admittedly anecdotal experience, I would guess that companies are differentiating among their employees much more aggressively now than they were even five years ago. A lot of employees get annual wage increases of less than 2% to "make up" for bigger increases to workers in high demand.

I have also received comments and emails with additional criticisms, all of which may be true around the margin but none of which strike me as dispositive. Some people have observed that "average" real wages may be stagnant because of a big influx in entry-level workers that would bring down the average without the circumstances of any individual employee worsening. Of course that is possible, but I oversee human resources at a pretty big company and have not read or seen evidence that the influx of entry-level workers in the last five years is manifestly greater than in 1995-2000. If there has been I stand corrected. Other people observe that the official inflation rate may be overstated by various measures, including that it does not adjust for the "Wal-Mart" effect on actual consumer prices, and that government statistics do not reflect the true purchasing power of the working class. See, e.g., Virginia Postrel's column in the current issue of Forbes. Far be it from me to deny any of this, but most of the gains Postrel cites have accrued over a period of decades. Yes, it is much better to be in the American working class today than in 1970. But that doesn't mean that it is better to be an average American wage earner today than in 1999, and that is the relevant period in Engram's post.

This is obviously a frustrating exchange, because I am a huge bull on the United States and its economy. I never want to talk down our economy, which I believe has been incredibly strong, especially considering the circumstances that have prevailed since 2001. However, I do believe that financial discipline inside American corporations, soaring healthcare costs, a growing tendency of employers to differentiate sharply among employees, and much higher gasoline prices (compared to 2000) have together wiped out wage growth for a great many people. One need not indict the Bush administration's "management" of the economy or even its tax policy to recognize that wage stagnation may account for a big part of the public's negative feelings about the economy.

BONUS: A commenter points to the latest news on this subject from the New York Times, which seems to support the idea that wages remain low as a percentage of GDP but will eventually revert to the mean:

Perhaps the biggest surprise in today’s report was a surge in wage-and-salary income during the first half of this year. Between the fourth quarter of last year and the second quarter of 2006, it grew at an annual rate of about 7 percent, after adjusting for inflation, up from an earlier estimate of 4 percent, according to MFR, a consulting firm in New York.

As a result, wages and salaries no longer make up their smallest share of the gross domestic product since World War II. They accounted for 46.1 percent of economic output in the second quarter, down from a high of 53.6 percent in 1970 but up from 45.4 percent last year.

Total compensation — including employee health benefits, which have risen in value in recent years — equaled 57.1 percent of the economy, down from 59.8 percent in 1970. Still, compensation makes up a larger share of the economy than it did throughout the 1950’s and early 60’s, as well as during parts of the mid-1990’s and the last couple of years

Again, I'm not facile enough with these numbers to pick them apart, but it does seem to me that if wages and salaries are just above their smallest share of GDP since World War II we should not be surprised if people who depend on wages and salaries are less than effusive about the direction of the economy.

18 Comments:

By Blogger Nemesis, at Thu Aug 31, 11:09:00 AM:

This needs to be looked into further but median hourly wage is the weakest and most misleading of indicators, which is why the NYT and others of that ilk like to cite it. I suspect a more comprehensive picture of worker compensation and consumer activity would show a rather different picture.  

By Anonymous Anonymous, at Thu Aug 31, 11:14:00 AM:

A agree with Nemesis. A down trend in the median simply means the market is flooded with large numbers of entry level workers. (Which is good. These are the otherwise idle in a "bad" economy and thus would not part of the calculation.) The fact that NYT does not cite mean wages belies the deception.  

By Blogger Nemesis, at Thu Aug 31, 11:37:00 AM:

Anon: I was just about to make that point. Without seeing the distribution of the data, saying the median went down means very little.

As you say, in an expanding economy with job growth the median can be expected to drop becuase of the number of entry level jobs created. A better indicator would be income mobility, which I don't see anything about that in the article.

It's also worth pointing out that imigration effects these numbers as well. A constant influx of imigrants gives the appearance a "permanent" class of poor workers, but from year to year, these are not all the same workers. As many succeed and move up, more come in behind them and so the median does not move. But track income in any specific group and the rise will be apparent.

I also find the comment about corp profits a bit of a red herring since people own corps and most are not "the rich." Many people have 401K's, own some stock, get dividends or other funds that benefit from increased profits. None of this is reflected on hourly wage numbers either. But is still wealth.  

By Anonymous Anonymous, at Thu Aug 31, 12:31:00 PM:

Just a little extra, but in my industry (pertroleum engineering) allot of the Baby Boomers flooded this industry with skilled high paid labor.

They are retiring. And will continue to do so for a while. in the offices I have worked and seen, the top level is 55yo median or better, with a spattering of younger folk like myself. I am used to being the youngest one in the office by a decade or better. At 32.

Recently the mid-late 20yo have been popping up. They get less pay, as we should, than a Senior Engineer, but I imagine it is the same through out alot of other industries. The experience will be graduating to retirement here soon, along with the high pay that goes with it.

That could be part of the swing we see. I don't mind. I get a raise everytime we lose to many people.

Josh  

By Blogger Enlighten, at Thu Aug 31, 01:03:00 PM:

From yesterday’s NYT article - Economy Grew Faster Than Expected:

“Perhaps the biggest surprise in today’s report was a surge in wage-and-salary income during the first half of this year. Between the fourth quarter of last year and the second quarter of 2006, it grew at an annual rate of about 7 percent, after adjusting for inflation, up from an earlier estimate of 4 percent, according to MFR, a consulting firm in New York.”

“Total compensation — including employee health benefits, which have risen in value in recent years — equaled 57.1 percent of the economy, down from 59.8 percent in 1970. Still, compensation makes up a larger share of the economy than it did throughout the 1950’s and early 60’s, as well as during parts of the mid-1990’s and the last couple of years.”  

By Blogger GreenmanTim, at Thu Aug 31, 01:37:00 PM:

It strikes me that personal debt, rather than personal spending, is a useful place to look as well when trying to understand the cricicism that household income is not keeping place with the cost of living for those below the 10th decile. All of us have it, and we start our adult lives with more of it than any previous generation. We save less and borrow more as a result.

I personally feel appropriately compensated as a managerial level conservation professional working in the non-profit sector, and the combined value of my salary and benefits looks positively robust on paper. Yet even with the fiscal discipline of not spending above my means and keeping personal credit card debt to a minimum, the morgage on my modest home, my share of the healthcare plan provided by my employer, and heat and fuel costs make us feel pretty stretched. The trade off between what my spouse could earn with her skills in our rural area and the cost of childcare for our two children were she to do so is a wash. We are driving two aged vehicles because - even though this is unsustainable in the medium term - the cost of maintaining them for the short term is less that the cost of adding car payments to our monthly budget. And we are solidly middle class and perhaps better off than many of our neighbors in our blue collar town.

No question, in other fields where I am qualified I could earn more than I do, but I do this work for other reasons. I will continue to do so as long as I can support my family this way, but if that were no longer possible, then the world loses a conservationist and gains an attorney or politician. I'd rather that were not the alternatives, and perhaps society should care about that too.

There are two ways to deal with debt and both are needed - personal responsibility for those debts that are excessive and unnecessary, and increasing real income to pay down those that are unavoidable. Either that, or start forgiving or otherwise reducing debts for housing and healthcare incurred by firefighters, police officers, teachers and -if society believes we are providing desireable public benefits worthy of encouragement - those in the non-profit sector, in areas where they are needed but otherwise priced out of the market. Where I live, we are losing all of these valued citizens to the high cost of living, to the detriment of our community and those who provide valuable services here.  

By Blogger TigerHawk, at Thu Aug 31, 02:08:00 PM:

Enlighten, I love you like a brother but I think your omission of the paragraph between the two quoted 'graphs was, shall we say, aggressive cutting.  

By Anonymous Nobrainer, at Thu Aug 31, 02:42:00 PM:

Cafe Hayek usually has good discussions why certain economic stats and indicators can be horribly misleading.  

By Blogger skipsailing, at Thu Aug 31, 04:53:00 PM:

As a finance geek in the healthcare industry I'd like to speak to the cost of healthcare benefits, since this has dramatic impact of total income.

there is no question that Medicare is going broke. And quickly. In addition Medicaid has become a budgetary nightmare for many states.

the government is responding in a variety of ways but two have real and immediate impact on our incomes.

first, medicaid reimbursement is ratcheting down. In Ohio we are witnessing a steady decline in per diem reimbursement for care, especially long term care.

next, medicare is engaged in a variety of complex re imbursement schemes all of which amount to sub rosa rationing.

These two factors result in a "cost shifting" dynamic. That is providers will seek to maintain their equilibrium by charging others more. Or simply providing less care.

A further drain on heathcare providers is uncompensated care. The cost of the illegal immigrant population is difficult to measure but I've worked at border hospitals and treating these uninsured people is a significant drain on healthcare providers.

the net result can be seen directly in the premiums we pay. Everybody's care must be paid for, one way or another.

Healthcare costs are rising in part because the government is paying less for the treatment of it's patients. We are in effect funding Medicare and Medicaid twice. Once through taxation and once through our own increased premiums.

The big buzz in our industry now is consumer drive care. MSA's and other tools designed to make the consumer the ultimate rationer are getting closer scrutiny. Moving away from the current "first dollar" benefit structure to a high deductable lower premium model may dramatically change the system. It would certainly change the nature of "income" derived from the heathcare benefits offered by employers.

finally, its important to understand the tax policy implications of this blend of income streams. Payroll taxes, personal income taxes and the value of untaxed benefits are all in this mix. Is it less expensive for an employer to pay for a good insurance plan, rather than provide a salary increase?  

By Blogger Screwy Hoolie, at Thu Aug 31, 05:28:00 PM:

Hawk,

I think people have a negativeview of the economy because they're not looking at the numbers you're looking at. They're looking at the cost of health care, colleges, gasoline, durable goods rise faster than their paychecks. They're seeing their neighbors, laid off from factory jobs, working at Subway. They're seeing mothers and fathers bringing in two incomes and continuing to struggle to make ends meet.

It's not about the fancy statistics. It's about individuals' realities.  

By Blogger Mycroft, at Thu Aug 31, 05:42:00 PM:

Speaking as a young grad student who very recently left the job market, there are two things which, even given an overall rise in average wages, might serve to make people unhappy.

1) There's not that much employer/employee loyalty anymore. A lot of my friends change companies every two or three years, and feel that there's nothing wrong with that. Employers reciprocate with high wages up front, but there's not much of a premium for seniority at a company past the first two or three years. If this phenomenon extends across the job market as a whole (and not just to technically inclined college-educated 20-somethings), this may mean that people in steady jobs no longer see their situation *improving* from year to year relative to, say, entry-level employees. If part of feeling like your life is getting better is doing better *relative* to others as time passes, people might be feeling like they're standing still.

2) The recent bout of inflation hit my checkbook like a thunderbolt. I don't *care* if they tell me the inflation rate is only 3%. I don't know what basket they're using to measure consumer prices, but my personal "basket," which consists mostly of food, books, utility bills, gas, cheap furniture, and car repair bills, has increased a good deal more than that in the past year. I don't know about big-ticket items like computers, houses, cars, and the like, but my personal impression is that low-cost necessities have increased significantly in price -- and they're the things that everybody has to buy. Of course, personal experience need not translate to data, but that's why I feel like I'm in a less comfortable spot now than I was a year ago, and my graduate student stipend is indexed to inflation.  

By Blogger TigerHawk, at Thu Aug 31, 06:01:00 PM:

Screwy,

I think you are guilty of the same offense that conservative optimists are, only in reverse. The plural of anecdotes is not data. Granted, there is always somebody who has had a tough time, the question is whether there are in fact more of those people today than in the period 1995-2000. Most of the data suggest that there are not, whatever the experiece of Screwy Hoolie, TigerHawk or Glenn Reynolds. However, some of the data hint at flat wages for certain people.

Mycroft, I think your second point is more valid than your first. In the last year especially, all the focus on "core" inflation has to some degree misled people about the extent of the real cost increases ordinary people suffer through.

The first point varies quite a bit, I think, from employer to employer. Certain jobs and careers lend themselves to a lot of mobility, but others do not. Speaking as an employer, in my judgment "loyalty" consists of candor. I have no objection if an employee looks for another job, but I would appreciate a conversation before the employee takes another job. That gives me a chance to compete. Similarly, if an employee asks me whether he or she has a future at my company, or where it might take them, I believe that a "loyal" employer is the one that answers honestly. Sometimes honesty requires saying "you are in a dead end here, and while we value you and hope you stick around, it is difficult to see promoting you." Candor, I think, is all that either can expect.  

By Blogger Westhawk, at Thu Aug 31, 07:31:00 PM:

Real disposable personal income per capita is the best overall measure of personal income status in the U.S. economy.

This measure includes wages, but also adds in employee benefits, other sources of income (rents, interest, self-employment, etc.), and also includes government benefit program payments to individuals.

Then, it subtracts out tax payments (making it "disposable"), adjusts out inflation (making it "real"), and divides it by the U.S. population (making it "per capita").

It is "the bottom line."

TigerHawk wants to compare 1995-2000 with 2001 to today (latest data is for 2006, second quarter).

Real disposable personal income per capita:

1994Q4: $22,106

2000Q4: $25,599

2006Q2: $27,789

1995-2000 compound annual growth rate: 2.48% per year

2001-2006Q2 compound annual growth rate: 1.50% per year

Comments:

1995-2000 started as a "mid-cycle pause" in the business cycle and ended very near the peak of an all-time boom.

2001-2006Q2 started near the beginning of a mild recession and ends at what will likely be another mid-cycle pause. This would imply that there is more income expansion yet to occur in this business cycle.

The later period's income growth rate is slower, but we suspect some readers are surprised that the growth rate is even positive (needless to say, the latest reading on real disposable personal income per capita is an all-time high).

This statistic obviously doesn't say anything about distribution or skew. We surmise that income distribution skew was no better, and probably worse, in 2000.

(See line 37 of this table from the Bureau of Economic Analysis for further study.)

As for the level of "churn" or turnover in the U.S. labot market, academic studies (which we can't find at the moment) have revealed that the job turnover rate hasn't changed materially over the past several decades. The Bureau of Labor Statistics collects these data at its JOLTS website.

If there is anxiety about the labor market compared to the 1998-2000 "happy period", we attribute it to 1) being a bit earlier in the business cycle, and 2) MSM distemper.

Westhawk  

By Blogger Lone Star, at Thu Aug 31, 09:16:00 PM:

It is simple supply and demand. The area I live in experienced a lot of layoffs over the last few years, meaning that workers were in oversupply, thus prices go down. Now things are booming and workers are in short supply and wages are going up. I myself just recieved a suprise raise (the biggest I have ever received at this company in fact) because of the fact that we are losing so many employees now.
It is also natural that wages lag behind in an economic recovery. Business has to improve enough that companies start hiring for increased production, before the surplus of workers becomes a shortage of workers.  

By Anonymous Purple Avenger, at Fri Sep 01, 01:33:00 AM:

have not read or seen evidence that the influx of entry-level workers in the last five years is manifestly greater than in 1995-2000

The illegals aren't going to work for big corporations, because they can't product proof of citizenchip or anything else. They're working for small companies willing to overlook discrepancies...and they're virtually all "entry level" jobs.

Don't confuse median with mean, they're quite different statistically. Dump a few million illegals in the system and the mean can quite suddenly shift to the left even though the mean may not be affected much.

Fascile shifting between the two to confuse is a common method of lying using statistics.  

By Blogger Lanky_Bastard, at Fri Sep 01, 02:09:00 AM:

Vintage post Tiger. Well done. Put it on the fridge or something.

I'll add that some very surprising things have been outsourced in the last few years. Not just manufacturing and engineering, but I know a consulting agency who hired 3 Medical Doctorates in India because it was WAY cheaper than one here. (yes, i know, data/ancedote: i just thought it was interesting and maybe worth sharing)

mycroft: It takes a special kind of person to leave a cushy job to return to grad school. It's taken me five long years of bohemian living to realize I should have bagged out after 12 months with a masters.  

By Blogger GreenmanTim, at Fri Sep 01, 07:52:00 AM:

A proposition: Anecdotal evidence carries more weight in forming "conventional wisdom" and public sentiment than hard, logistical analysis, testable propositions and objective review of verifiable results. Test this against any of your favorite straw men and see whether it holds.

When I used to work in conservation in Africa (anecdote alert), local people were convinced their lives were at risk from neighboring elephants even those there had only been three elephant caused human fatalities in the previous decade. Everyone knew about them, though, and felt powerless to deal with the real problem, which was how to be a subsistance farmer on lanmd you did not own but were compelled to share with elephants.

I believe that understanding how an individual or a group feels about something requires qualitiative, rather than quantitative measures precisely because feelings are not governed by dispassionate, rational analysis but by other, often subjective experiences.

Needless to say, it is probably a losing proposition to expect someone to feel differently once presented with statistical evidence to the contrary. We form judgements and expectations based on other factors than logic, such as shared experience and expectations, and these are powerful motivators for our behavior. They can also, needless to say, be manipulated by the media, and - dare I say it - the blogosphere, which is powered by anecdote.  

By Blogger Cardinalpark, at Fri Sep 01, 01:55:00 PM:

i have been enjoying my end of summer vacation and figured i'd sit out commenting, but this one got my attention. FWIW, I don't think people think in terms of real wages.
they just don't. only economists do.

People think in nominal terms.
and in nominal terms, wages have risen at seemingly slow rates because inflation has been very low.

Throw into that mix the fact that people's marked to market equity portfolios have generally gone nowhere for years, and are probably down from their high watermark, and you get a general sense of economic disappointment. And while increases in housing prices have more than compensated poeple for their poor equity performance, you don't get a financial statement every month which marks your house to market with any certainty. Throw on top of that the fact that we are daily tormented with evidence of a housing bubble, on the heels of a stock market bubble, and people get rightly nervous.

So I think the bubble hangover is with us for some time to come and may impact a full generation of economic participants very much like the 40s reflected a marked hangover from the 30s bust. Throw in a war, and people feel pretty cautious.

And cautious they should be.

But this real wage argument I think falls short. It too scientific a way to get at people's animal spirits...  

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