Productivity, Wages, and Asset Inflation
Dean Baker has a very interesting piece trying to make sense of why, with headline productivity so high since the mid-nineties, wages have not kept pace. Dean Baker begins…
Most economists view productivity growth as being the key to rising living standards through time. The basic story of productivity in the post-war era is that growth was rapid in the years from 1947-1973, but then slowed sharply over the years from 1973-1995. Productivity growth then ticked up again in 1995 and has been relatively rapid since 1995.
1995, huh. That was quite a year according to this article by Aaron Krowne. Aaron argues that in 1995, an obscure loosening of US bank reserve requirments, and an abandonment by the Greenspan Fed of a “virtual gold standard”, gave rise to an era of unprecedented growth in broad money. In my own mind, 1995 corresponds to about the beginning of the “asset economy”, when wealth accumulation from capital gains rather than wage or business income became an unusually important driver of the US economy. Hmmm.
I have an monetarist intuition about wages during this period. Suppose that under certain circumstances fast money supply expansion results in asset inflation rather than goods inflation. Goods prices remain stable, the economy seems to grow at a moderate clip, but asset prices grow far faster than GDP. Sellers of productive capital (tractors, factory equipment, etc.) as well as workers then have to compete with the financial sector for investable funds. As expectations of asset appreciation increase, more investors choose to purchase stocks, homes, hedge funds, oil, or gold than to build factories, open businesses, and hire workers. Of course stocks have to be backed by firms, and homes have to be built, but on the margin, investment dollars are diverted from direct deployment as productive capital to purchasing paper assets via financial intermediaries. The net effect is a reduction of the “velocity of money” in the real investment sector, reducing input prices while at the same time diminishing future capacity. Input prices include wages.
In an environment where capital is drawn to appreciating financial assets, workers and vendors of productive capital have to make price concessions relative to productivity in order to attract funding. Rocketing asset prices should be expected to reduce the bargaining power of workers, and to exert downward pressure on their wages.
UPDATE: Shamed by Greg Mankiw and some awful grammar, I’ve performed major surgery on this post, prettying things up and dropping a long digression from the main point. (I’ll insert the original version into the comments for posterity). 2006-10-08 03:11 am EET
By the way, Dean Baker’s piece offers a very different, but quite interesting explanation for the divergence between wages and productivity. He adjusts productivity growth by subtracting out growth in depreciation costs (which cannot go towards wages) and taking into account the diversion between consumer inflation (by which real wage grwoth is reckoned) and the GDP deflator (by which real productivity is measured). Since consumer inflation has been higher than broad GDP inflation, even wage earners who do see their wages of growing in proportion with GDP would see their “real” wage lagging, because they disproportionately buy goods that have gotten more expensive. Read the whole thing.
I think there is probably a lot of truth to the effect you outline above. It would also seem to lend support to “Ka-Poom” theory, whereby disinflation in the financial sector (as credit-driven bubbles burst) leads to a relative “cashing out” into the real economy, driving up prices there.
On the balance, of course, money will be lost, as there is essentially no floor on the valuation of financial assets, so cashing-out must be concomitant with a dramatic reduction in their aggregate nominal value.
Last one out is definitely a rotten egg: they’ll lose their financial asset-shirt, and be faced with a dramatically more expensive real-asset replacement.
P.S. – I’m also cooking up a “1995 revisited” post, the crux of which is that the Fed managed to invert the behavior of the bond market around 1995. I haven’t completely worked out the implications of this, but then again, that may be an argument for posting the commentary sooner than later, so thoughtful persons such as yourself can weigh in!
October 7th, 2006 at 6:53 pm PDT
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I think it’s hard to say whether disinflation in the financial sector results in inflation in the goods sector. It all depends on how the disinflation happens. If the disinflation is destructive of broad money, it needn’t be inflationary. Since (as your piece points out) much of the money growth of the past decade had to do with banks freely creating it as debt, the quantity of money can deflate with the financial sector, via loans either retired or defaulted. If the money growth had been mostly Fed printing, than an unwinding of the financial sector would certainly be goods-inflationary, unless the Fed sucked the money back with a contractionary policy. As it is, I’m not so sure.
Re the 1995 piece… I’ll look forward to the sequel!
October 7th, 2006 at 8:44 pm PDT
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Grr… On rereading this post, I had to cut it to pieces. The original version of the text is pasted below, on the off chance someone may have quoted what no longer exists.
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Dean Baker has a very interesting piece trying to make sense of why, with headline productivity so high since the mid-nineties, wages have not kept pace. Dean Baker begins…
1995, huh. That was quite a year according to this article by Aaron Krowne. Aaron argues that in 1995, an obscure loosening of US bank reserve requirments, and an abandonment by the Greenspan Fed of a “virtual gold standard”, gave rise to an era of unprecedented growth in broad money. In my own mind, 1995 corresponds to about the beginning of the “asset economy”, when wealth accumulation from capital gains rather than wage or business income became an unusually important driver of the US economy. Hmmm.
I have an monetarist intuition about this period. Suppose that, owing to a combination of central bank credibility and a low elasticity of aggregate demand for real goods and services, fast money supply expansion results in asset inflation rather than goods inflation. Goods prices remain stable, the economy seems to grow at a moderate clip, but asset prices grow far faster than GDP. Sellers of productive capital (tractors, factory equipment, etc.) as well as workers then have to compete with the financial sector for investable funds. As expectations of asset appreciation increase, more investors choose to purchase stocks, homes, hedge funds, oil, or gold than to build factories, open businesses, and hire workers. Of course stocks have to be backed by firms, and homes have to be built, but on the margin, investment dollars are diverted from directly production products to existing assets for financial intermediaries. The net effect is a reduction of the “velocity of money” in the real goods and services sector, reducing input prices while at the same time diminishing future capacity. Input prices include wages.
This process ought to be self-limiting, as when the future comes, diminished capacity should cause goods prices to increase, forcing asset price to decline as consumers redeem portfolio wealth for goods, and giving greater bargaining power to labor and sellers of productive capacity. But the future can be delayed, particularly while imports that substitute for domestically produced goods are available at stable prices and while asset prices continue to increase. Hypothetically, there is no limit to asset prices. Prices are like Tinkerbell, as long as asset holders believe in them, they can and even should continue to grow while the money supply expands. The only limiting factors are faith and foreigners’ willingness to sell goods at stable prices for a currency increasingly backed only by… foreigners willingness to sell goods for it. The domestic real economy continues to grow, but specializes in less speculative, shorter-lead-time projects, as risk-tolerant capital is disproportionately drawn into financial assets.
That’s a much discussed dynamic (especially by me). But this article is about wages. In an environment where capital is attracted to appreciating financial assets, workers and vendors of productive capital have to make price concessions relative to productivity in order to attract funding. Rocketing asset prices should be expected to reduce the bargaining power of workers, and to exert downward pressure on their wages.
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By the way, Dean Baker’s piece offers a very different, but quite interesting explanation for the divergence between wages and productivity. He adjusts productivity growth by subtracting out growth in depreciation costs (which cannot go towards wages) and taking into account the diversion between consumer inflation (by which real wage grwoth is reckoned) and the GDP deflator (by which real productivity is measured). Since consumer inflation has been higher than broad GDP inflation, even wage earners who do see their wages of growing in proportion with GDP would see their “real” wage lagging, because they disproportionately buy goods that have gotten more expensive. Read the whole thing.
October 7th, 2006 at 8:46 pm PDT
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