MEMORANDUM TO PRESIDENT OBAMA, SECRETARY CLINTON AND OTHER 2016 PRESIDENTIAL ASPIRANTS
SUBJECT: Seize the Future by Linking Wages to Productivity Growth
RECOMMENDATION: The Democrats should adopt a new national economic doctrine that American enterprises link wages to productivity growth, just as their competitors do in Australia and across northern Europe.
DISCUSSION: As exemplified by their lawmakers’ positions on issues like raising the minimum wage, advocating for higher wages has become the third-rail in Republican Party politics. That has placed the burden on the Democratic Party for devising policies to address wage stagnation, the leapfrogging of American wages by other rich democracies and the resulting international wage gap.
Since 1979, American wages adjusted for inflation have stagnated. A relative handful of elite earners have done well, especially in finance and the professions. And some skilled workers (about 5 percent of the labor force) in booming sectors such as IT have also beat inflation over this span. But most Americans have been fortunate if earnings even kept pace with the cost of living. The evidence comes from Bureau of Labor Statistics data documenting that median weekly earnings of full-time workers (all private industries and occupations) rose from $232 in 1979 (1st quarter) to $ 802 in 2015 (1st quarter). That is a huge increase, but after adjusting for inflation, the actual increase was a tiny 2 % or $16 per week.[i]
Wage stagnation is the culprit responsible for income disparities widening by 23 percent over this span. It is the culprit responsible for the middle class shrinking by 17 percent in recent years, one-in-six falling out.[ii] It is why some 42 percent of U.S. workers now earn below $15 per hour.[iii] And it is the culprit responsible for only 21 percent of Americans in 2014 believing that their children will live better, a record low in polling. It stood at 54 percent just before the election of President Reagan launched the era of inequality. [iv] Until then, families had fared well as the postwar boom created history’s greatest middle class; men and women could control their own economic futures in an opportunity society where striving produced a secure and rewarding life.
Wages in Peer Nations Have Leapfrogged U.S. Wages
The outcome for workers in other rich democracies has been dramatically better. Real earnings have risen steadily enough for decades that manufacturing wages in thirteen other rich democracies have overtaken to now surpass U.S. wages. [v] Wages in Germany, for instance, which were 3 percent lower in 2001, were 28 percent higher by 2012. [vi] And this wage gap grows wider each year. In Australia and northern Europe, real wages have grown to be more than $10 an hour higher than in the U.S. And these figures are encompassing, including direct pay, social insurance fees and labor-related taxes. The U.S. has become a low-wage nation. As befitting higher wage nations, the quality of life abroad for most families is better, with secure retirements, longer vacations and necessities such as quality, affordable public education, college and health care more broadly available. That is because the gains from growth are broadcast widely across society, causing income disparities to be far smaller than in the U.S. For example, the income of the top decile of Australians rose 60% from 1990-2010, while income of lower-paid workers rose 40%.[vii]
The Secret to Steadily Rising Wages in Peer Nations: Wages Linked to Productivity
Wages in Australia and northern Europe are linked to productivity growth. Various techniques are utilized to achieve this proven, decades-old connection, usually involving government agencies or labor unions. The consequence is that about one-half of the increase in productivity each year goes to wages. It works like this:
For most employees in these nations, wages increase by the sum of cost-of-living last year plus about one-half of the growth in productivity last year. If inflation was 2.5 percent last year and productivity grew 2 percent, for example, wages the following year will tend to rise an average of 3.5 percent, i. e. 2.5 + (.5 x 2).
This Australian wage system means about one-half of the gains from economic growth each year go to workers or labor, with the other half supporting investment, job training, R&D, profits and the like. In America by contrast, virtually none of such gains from growth flow to labor. Because wage increases abroad are linked to productivity, inflation is not a danger and, as Australia and Germany exemplify, neither R&D nor investment is harmed. Indeed, because wages are linked to productivity, international competitiveness is not impaired. In fact, it may be improved. Linking wages to productivity incentivizes workforce upskilling. Consequently, Australia and every nation in northern Europe now have more skilled labor forces than the United States. As recently as 1998, it wasn’t that way, but skill levels in nations like Austria, Denmark and France have since risen above U.S. levels.[viii]
Where would U.S. wages be now had this system also been utilized in the U.S. since 1979?
Between 1979 and 2014, labor productivity increased 66 % in the nonfarm business sector, the largest combined U.S. economic sector, according to BLS.[ix] If one-half of the 66 % gain in productivity since 1979 had gone to wages as it does in peer nations, then the increase in real wages would have been 33 % instead of 2 % over that span. And the median weekly earnings of full-time workers in 2015 would have been $ 1,045 ($786 x 1.33) or $243 per week more than at present for the median wage earner.
Looking ahead, American wages will continue stagnating except for brief periods of economic boom. Is the Democratic Party satisfied with such trickle-down, or is it willing to rewrite history with seasoned structural reforms from abroad that have proven capable of yielding broadly based prosperity.
[i] BLS - http://www.bls.gov/webapps/legacy/cpswktab1.htm . At that BLS website site, retrieve current and constant median wage data for all over 16 years of age. Then on new page, request statistics for the period 1979 – 2015.
[ii] Richard Reeves, “Classless America, Still?” Brookings Institution, Aug. 27, 2014.
[iii] Harold Meyerson, “What Clinton Must Do,” Washington Post, April 16, 2015.
[iv] Dana Milbank, “American Optimism is Dying,” Washington Post, Aug. 12, 2014.
[v] BLS, Manufacturing data tables, 1996-2012 (XLS), table 1.2., http://www.bls.gov/fls/#compensation.
[vi] BLS, Manufacturing 1996-2012 (XLS), table 1.1., http://www.bls.gov/fls/#compensation.
[vii] Clancy Yeates, “Advance Australia Fair? Maybe Not,” Sydney Morning Herald, Jan. 27, 2014.
[viii] Education at a Glance, OECD, 2008, Table A1.6, http://www.oecd.org/education/skills-beyond-school/41284038.pdf .
[ix] BLS - http://www.bls.gov/lpc/prodybar.htm .
A generational effort is required to restore growth in U.S. wages.
Despite the sincerity of their sentiments, Democrats will fall flat in efforts to provide a structural solution to wage stagnation in the United States until they undertake a generation-long effort at educating voters.
That effort should be framed around closing the international wage gap – i.e., the growing disparity between prevailing wages in the United States and its peer economies. Wages are a toxic topic for Republicans, but the opportunity is there for the taking by Democrats. It offers a partisan advantage. As a campaign issue, the international wage gap would dramatize a Democratic economic agenda that systemically links wages to economy-wide productivity growth. It would pose a compelling contrast to tired or even fallicious supply-wide Republican policies.
What is the international wage gap?
U.S. Bureau of Labor Statistics data document that manufacturing wages in 13 other rich democracies in 2012 exceeded U.S. wages, many by $10 an hour or more, adjusted for exchange rates. Here are the data (hourly employer compensation costs including wages, government fees):
United States: $35.67
This gap has arisen because a hefty portion of rising productivity in these peer nations is added to wages each year, producing steady if unspectacular income growth that exceeds inflation. That is not the U.S. system and these results display the consequence.
Closing or even stabilizing this wage gap will not be an easy policy position, to be sure. Such a move will meet fierce resistance by U.S. high earners receiving most of today’s gains from growth. Their allies among Republican lawmakers will also be opposed and will continue to use arcane U.S. Senate rules to block any major Democratic efforts, even if Democrats re-capture the chamber.
Moreover, the instrumental role of private money in U.S. politics ensures vigorous Republican opposition. And they may be joined by some number of Democrats even if that party adopts the position widely. That role is documented by U.S. policy outcomes that chronically reflect an income bias, as Martin Gilens and Benjamin Page recently concluded.
However, there could be support from surprising quarters, if Democrats carefully prepare legislation to narrow the international wage gap. For example, one strategy would be to promote and provide incentives for the Codetermination model of corporate governance as practiced in northern Europe. I have made this argument previously in The Globalist.
Such a strategy, actually imposed in West Germany by the U.S. and British occupation, features employee representatives on corporate boards and involving them more in decision-making. Not only has this been proven — not surprisingly — to lead to higher wages, but it has also paid off well for many German and other northern European firms, relative to their quarterly-profit-oriented U.S. peers.
Adding employees to corporate boards improves the performance of firms by featuring cooperation. And it is the key to boosting anemic U.S. R&D and woeful corporate under-investment to match firms in nations such as Germany. While activist shareholders andCEOs seeking immediate gain would object, a number of U.S. corporate shareholders might well accept Codetermination that enhances long-term enterprise growth.
Empowering employees with worksite reforms is a useful starting point, as Larry Summers and other experts have recently advocated on both sides of the Atlantic. However, ensuring that real U.S. wages rise steadily year after year will require more, especially linking wages and productivity growth. If a company does very well for itself, some percentage of those profits reasonably should be translated into higher wages for employees, rather than merely being as now plowed into stock buybacks, dividends and executive compensation packages.
A generational challenge
Making that case, however, will be a generational challenge for wage advocates, including Democratic lawmakers.
Why generational? The Reaganesque division of gains from growth since the 1980s has de facto been achieved by making war on wages. And that pattern has become institutionalized. American history has shown that once even a damaging economic arrangement has been established, it is extraordinarily difficult to uproot.
Examples include the U.S. Constitution’s embrace of the slave economy built during colonial times, the Jim Crow era lasting nearly a century after the Civil War, and the employer-centered health care system whose reform was first propose in the 1940s.
Indeed, history teaches that such entrenched arrangements are only uprooted by unique circumstances – including a Civil War or a rare filibuster-proof progressive majority in the Senate. Medicare, Head Start, Medicaid, Obamacare, ending Jim Crow and Franklin Roosevelt’s reforms like Social Security were fruits of such once-in-a-generation circumstance.
That history means the next legislative opportunity to adopt structural linkages between wages and productivity, which are common in other rich democracies, could well be many decades away in the United States. And wages will continue to stagnate in the interim except for temporary episodic boomlets that trickle down to higher wages.
Groundwork to realize this generational agenda
Even then, it is not merely enough to have a filibuster-proof margin in the Senate after a landslide election born of general crisis. If a sweeping set of reforms is desired, voters have to be educated, ready and waiting.
We cannot know when the next moment of great opportunity will strike, but the interim time can fruitfully be utilized to lay the groundwork. This means education, activism and incremental steps for linking wages to productivity. Economists and the various centers studying corporate governance should devise a base of research, data, and analyses of the various systems in other rich democracies linking wages to productivity. Task forces, forums, think tanks, academics, advocates and activists must engage to provide the kind of energy that has inspired and mobilized mass reform movements before, such as civil rights and the environment.
This process is underway to some degree. For instance, Democratic Party legislators in California and in Congress have proposed tax incentives for the private sector to link wages to productivity or to CEO pay.
A key role must be played by state and local government leaders, in line with the U.S. tradition of using states and cities as smaller “laboratories of democracy.” They can provide invaluable proof of concept – as they have done repeatedly in the past in setting the national pace for environmental reforms, minimum wages and the like.
In doing so, they will also expand the share of the workforce where wages are linked to national productivity performance, further easing the transition when the time comes for national legislation.
It will take a generation to thwart the war on wages. There is no more time to waist.
Stagnant wages have robbed the American middle class of opportunity. Since 1979, wages have barely kept up with inflation and for tens of millions of relatively unskilled Americans, earnings have actually declined.
This wage compression is why fewer Americans now believe they are middle class; remarkably, the share of Americans who self-identify as below-middle class has risen 60 percent since 2008 to near equivalence in size with those identifying as middle class. Horatio Alger has emigrated to Australia and northern Europe where wages and economic mobility are higher. The consequence is continuation of a trend that began in the 1980s where Americans need to pick their parents very, very carefully to have even reasonable odds of prospering as adults. Utilizing quintile income data, Julia Isaacs at Brookings and the Pew Mobility Project concluded that the only odds higher than a rich man’s son in the U.S. being rich himself three decades hence (40 percent) are the odds that a poor man’s son will be poor (42 percent).
President Obama's failure to offer substantive solutions will be his economic legacy.
The President’s minimalist response is a wage agenda featuring more education, minimum wage hikes and the like. Good ideas all, but meek. In truth, his prospects for broadly-based wage gains hinge entirely on hopes that labor markets will episodically tighten as they seem to be now – just more cyclical Republican trickle-down like in the late-1990s. That is why I have argued that historians regarding economics are certain to cast him as a James Buchanan figure rather than a Lincoln – a timid President kicking the wage issue down the road for a more visionary successor to solve.
A new agenda is needed that breaks the wage stagnation paradigm, a textured one that leans heavily on successful programs such as those in Australia and northern Europe. What is that agenda?
Democrats Need To Acknowledge Four Economic Realities
First, shareholder capitalism is responsible for deterioration in the composition of the American workforce. The uber free market ethos prevailing since Ronald Reagan has chilled hopes of using public policy to offset the wage compression effects of globalization, technology acceleration, financial sector liberalization, rent-senking by executive suites and the like. High value jobs are routinely exported, replaced by domestic ones paying less with paltry benefits, many featuring on-demand part-time or contract work.
Second, U.S. wage stagnation is an aberration among peer nations, with real wages in other rich democracies continuing to climb steadily. That is because U.S. wages are delinked from productivity growth. Not so abroad. The consequence, according to the U.S. Bureau of Labor Statistics, is that wages in more than a dozen other peer countries have leapfrogged American wages. Exchange-rate-adjusted American wages in manufacturing in 2012 were below $25/hour. That ranked 14th globally, well below Denmark, Switzerland, Australia, Germany and the like; these superior economies also feature quality, affordable university educations, health care plus retirement security. Moreover, unemployment in Germany is below the U.S. while labor force participation is higher. These data belie the argument that low American wages are the inevitable trade-off for handsome employment statistics.
Third, the U.S. corporate governance model incentivizes behaviors that Nobel laureate Edmund Phelps has labeled “short-termism,” with harmful consequences as explored by Harvard Business professors Clayton Christensen and Derek van Bever. Share prices and executive remuneration spike while R&D, investment, wages and labor force upskilling slump. Business equipment spending, for instance, since 2009 (5.2 percent of GDP) remains well below levels averaged since the 1960s (6.5 percent). And over a longer term, investment by nonfinancial firms in Australia and northern Europe has outpaced investment by American firms for nearly two decades. It is instructive that board oversight is far tighter at privately-held U.S. firms, forcing management to adopt longer time horizons: John Asker and Alexander Ljungqvist of NYU and Joan Farre-Mensa of Harvard found that publicly-held U.S. firms devote only 3.7 percent of assets to investment compared to 6.7 percent at privately-held firms.
The fourth reality is that the danger posed by secular stagnation has captured the imagination of economists worldwide. While the U.S. recovery is proceeding, economists such as Gauti Eggertsson and Neil Mehrotra in a study for the National Bureau of Economic Research document the longer term dangers to America of low growth from inadequate demand and production. Weak public and private investment is one problem. And other explanations include the effects of eroding wage shares and widening income disparities as argued in a briefing paper prepared by Sherpas for the November Brisbane G-20 meeting.
Eroding wage shares and widening income disparities are a particular problem because most rich democracies are wage-driven rather than profit driven in the terms utilized by Marc Lavoie and Engelbert Stockhammer in a study for the International Labour Office. They concluded that a 1 percentage point decline in the wage share of U.S. GDP reduces aggregate demand by .808 percentage points, the most severe marginal reaction of any rich democracy to rising disparities.
A Visionary Agenda To Raise Real Wages
These realities offer a target-rich environment for President Obama if eager to leave a visionary rather than a vacuous economic legacy. Moreover, they are promising foils for reforms capable of capturing middle class imaginations and votes, especially those of working class Americans. Two structural changes are needed to create an economy like those in Australia or northern Europe where wages are linked to productivity – changes that would enable most Americans to share in the gains from growth.
First, reform corporate governance. Short-termism is enabled by low-quality American board rooms. That means upgrading U.S. corporate governance as hinted by economists such as Robert Solow of M.I.T. must be a central plank of any wage agenda. Indeed, that reform is imperative in light of the centrality of public corporations as a state-sanctioned device to generate and sustain broadly-based prosperity. Corporate America is failing to widely broadcast the gains from productivity growth – and weak internal oversight coupled with a Randian rent-seeking syndrome among CEOs are the reasons. Governance remediation featuring Codetermination can draw on successful practices abroad, especially from Germany, the highest functioning capitalist economy on the globe.
Strengthening corporate governance hinges on a recomposition of boards of directors of U.S. enterprises. Compelling evidence of the potential offered by such recomposition is provided by the potent performance of German enterprises such as VW or Daimler whose supervisory boards are split between shareholder and employee representatives. Indeed, the weight of analytical evidence is that shareholders would benefit from a strengthening of American supervisory boards in mimicry of German-style Codetermination, as documented by Larry Fauver and Michael Fuerst.
An immediate option involves pension funds whose trustees could play a pivotal role in strengthening governance. Funds such as Calpers could incentivize board recomposition through investment policies. And the Obama administration could facilitate that strategy by clarifying that board recomposition is a furtherance of trustees’ duty to invest solely in the interest of participants and beneficiaries.
Government can do more. It has a host of options involving penalties or incentives to induce board recomposition. And there are no legal impediments to establishing recomposition standards for firms licensed by states or even those incorporated elsewhere which nonetheless conduct considerable economic activity within a specific state. Thus, progressive state governments could and should become laboratories to explore a variety of those options. Indeed, states like California already have provided proof of concept: they have set the pace for some safety and environmental practices by the private sector subsequently adopted nationwide. And progressives in Congress could mimic German law by incentivizing all public corporations with more than 2,000 employees to recompose supervisory boards, with members drawn equally from shareholders and employees.
Second, institutionalize annual real wage increases. Governance reforms will help restore the link between productivity and wages. But Australia and the northern European economies have gone further by institutionalizing that linkage. Industry, region or national wage agreements struck by labor unions and employer organizations – monitored by the public sector – provide national templates for annual real wage increases. Encouragingly, tentative approaches are being explored in the U.S. to restore that linkage. The Democratic caucus in the House of Representatives, for instance, endorsed legislation in 2014 to raises taxes on CEO compensation unless firms raised wages. The proposal permitted firms to keep taxes low by increasing wages by the sum of inflation and nationwide productivity growth. Democrats in California have been similarly innovative. American CEOs earn well more than 300 times the median wage of employees. That is an unwarranted windfall because the ratio is far lower in every other democracy. For instance, it’s 64 times in Australia. Democrats in the California State Senate set out to reduce that ratio by rewarding firms with tax cuts who cap at 100-fold higher.
These and similar efforts to relink wages to productivity also hold promise for easing the longer term risks of secular stagnation. Economists ranging from Paul Krugman to Lawrence Summers argue for more fiscal stimulus and public infrastructure investment as one means of boosting wages and output. And Adair Turner in the pages of the Financial Times recently even argued for such stimulus to be supported by helicopter (printing) money. The problem is that such approaches will raise wages only indirectly. Surely a more efficient approach is to focus on reforms that directly raise real wages and to do so in a structured setting that also incentivizes investment, R&D and productivity. Other rich democracies have figured out how to blend these goals and America can benefit from their experience.
A Visionary Obama Economic Agenda Will Reframe the Wage Debate
The wage issue bears on the great philosophical question of how broadly should prosperity be enjoyed in a democracy. Capitalism can provide for widely enjoyed prosperity, a position advocated by the President. Today’s Republicans disagree, evidenced by resistance to ballot and legislative initiatives and to union efforts in spots such as Tennessee to raise real wages. And they may also resist upgrading corporate governance. The President has not been intimidated by partisan criticism in the past and should not be deterred from offering a visionary and expansive wage agenda. An additional concern is that the Democratic Party like the Republicans are reliant on campaign donations from large dollar donors, as noted recently by former labor secretary Robert Reich. That argues for a wage agenda which features incentives rather than coercion. The agenda outlined here are practical, proven steps to relink wages and productivity.
President Obama should use his bully pulpit to reframe the wage debate around this agenda and thereby establish a visionary legacy.
Weak American investment and weak wages are the consequence of weak corporate governance, with solutions to be found in Australia and northern Europe. Here are the facts:
First, real U.S. wages have gone flat since 1980 despite continued productivity gains, while in Australia and northern Europe they’ve mostly kept pace with productivity. Today, wages and comprehensive employer costs for labor are about $10/hour higher in Australia and northern Europe than in the United States. In manufacturing, German wages are $20/hour higher according to Bureau of Labor Statistics data from 2012 (latest year).
Second, investment by nonfinancial firms in Australia and northern Europe has outrun investment by American firms for decades, as documented by Eurostat economists Denis Leythienne and Tatjana Smokova in 2009.
Third, U.S. managers apply unreasonably high discount rates when evaluating future investments, truncating their investment time horizons compared to managers in these other rich democracies. James Poterba at MIT (and President of NBER) and Lawrence Summers, as early as 1995, documented that German managers devote a considerably higher share of R&D budgets to the long term than U.S. managers. Moreover, the Americans would forego “a very positive net present value project” merely to smooth out earnings per share data, as reported later in an NBER study by John R. Graham, Campbell R. Harvey and Shiva Rajgopal.
Fourth, Australia and every nation in northern Europe now has more skilled labor forces than the United States. As recently as 1998, it wasn’t that way, but skill levels in nations like Austria, Denmark and France have since leapfrogged the U.S. level, where firms eschew human capital investments. Employee loyalty now comes in two-week segments until the next paycheck, with longer term upskilling and the concept of employee commitment to the firm hollowed out. Firm management in these other rich democracies have done a superior job of investing anew, changing product mixes, upskilling workforces and offshoring few domestic jobs.
What are we to make of this?
Globalization is fingered as the culprit by many who’ve written on U.S. wage stagnation, but it’s a rather baffling explanation in light of the considerably greater integration of these higher wage nations like Austria, Denmark or Germany in cross-border trade. A few, including former labor secretary Robert Reich and James Galbraith are closer to the mark, pinpointing a variety of structural factors, like offshoring, Randian executive suites, weaker labor unions and deregulation.They and others such as Nobel laureate Edmund Phelps, call this agency problem “short-termism.” It’s a focus by stock-optioned American management on near-term performance, being parsimonious with corporate outlays for R&D, wages, investment and the like in order to spike quarterly earnings.
Foolish mergers are another element of the syndrome as examined by Jeffrey Harrison at the University of Richmond and Derek Olin of Texas Tech. This syndrome partly explains why net investment by U.S. firms is 4 percent of GDP now while profits account for 12 percent of GDP, when they both equaled about 9 percent in the late 1980s. That’s also why John Asker and Alexander Ljungqvist of NYU and Joan Farre-Mensa of Harvard found that publicly held U.S. firms devote only 3.7 percent of assets to investment compared to 6.7 percent at privately owned firms. And it’s why productivity per hour worked in northern Europe has grown one-third faster than in the United States since 1979 to the point that equivalence exists on the factory floor now in the United States, France and the Low Countries. These nations are as productive as the United States and pay notably higher wages.
The culprit is quarterly capitalism. What kind of managers would run U.S. companies like that, crimping longer term prospects? Well, managers like those eighteenth century expat East India Company officials lamented by Adam Smith in The Wealth of Nations. Then as now, changing their management incentive structure is the answer. And that means drawing on corporate governance techniques of firms in those peer democracies who figured out how to avoid short-termism. The architecture of American corporate governance should learn from the successful codetermination structure of northern Europe, which is, to a large extent, responsible for Germany being the world’s highest performing economy. Shareholders will applaud codetermination because it means greater returns, as Larry Fauver at the University of Tennessee and Michael Fuerst at th University of Miami concluded in 2006. And a healthy byproduct of codetermination is greater investment and higher wages, with firms supporting the Australian wage determination structure linking wages to rising productivity.
There are several reasons to look askance at northern Europe, struggling to generate growth and reform the architecture of its monetary union. But those valid macro-economic concerns should not deflect from the long-term success of their sturdy internal processes in broadcasting rising real incomes widely year after year.
What a contrast to the grim outcomes and prognosis for U.S. family economics, featuring further income disparities, stagnant wages and weak productivity, GDP and job growth as far as the eye can see.
It is time for Americans to do what they do very well: draw on the best and brightest from across the globe for a solution to its poorly crafted corporate governance structure.