Study: Why Productivity Goes Up But Wages Don’t

A new study by the Taub Center for Social Policy Studies in Israel explains why, at the end of 2015, real wages in the business sector were similar to those in 2001, whereas during the same period, labor productivity per worker rose by 15%. The research shows that the weakening of the link between productivity and wages was caused by the rapid increase in consumer prices relative to the price of produced goods, following years of similar growth.

The separation of the two indices in the last decade was caused to a large extent by the swift increase in housing and food prices during this time. While these two items are a considerable share of the consumer basket for the typical Israeli household, they only marginally reflect the change in the prices of goods and services produced in the market. The rapid increase in the consumer price index relative to the GDP price index led to an erosion in the value of a worker’s output, contributing to the weakening of the relationship between real wages and labor productivity.

The main study findings:

• Gross real wages in the business sector in 2015 were similar to wages in 2001, even though productivity rose by about 15% in the same period – which would typically have been reflected in wages.
• In contrast to the oft-heard claim, the erosion of wages was not caused by a weakening of the bargaining power of workers. In fact, workers’ share in the GDP has remained relatively stable over the past few decades.
• In the last decade, inflation has been concentrated to a greater extent in the prices of food and housing, and barely reflects the change in prices of goods and services produced in the market. Food and housing are responsible for about 75% of the increase in the consumer price index in the past decade, although their share in the average household consumer basket is only 42% and no more than 11% in the business GDP price index. The concentration of inflation in these items contributed to the weakening of the relationship between real wages and labor productivity.
• Some steps that would address this issue include efforts to reduce the prices of food and housing by way of eliminating import and entrance barriers in the food sector and increasing competition, as well as through increasing the supply of housing.

In the last 15 years, gross real wages in the business sector, which represents the purchasing power of workers, has remained almost static. In contrast, labor productivity (which reflects output per worker) increased by about 15%. Many researchers have looked at why the rise in productivity has not translated into a rise in real wages, as expected. Among the reasons given is the claim that the fruits of economic growth do not trickle down to the worker level due to a weakening of the bargaining power of workers. A new study by Gilad Brand, a researcher at the Taub Center, refutes this claim.

The explanation offered by the Taub Center research is that, to a large extent, a change in the mix of factors contributing to inflation led to a decrease in the growth rate of real wages. The study shows that inflation in the last decade was concentrated in those areas that impact households more than producers, a development that contributed to a weakening of the relationship between real wages and productivity. While a comparison of labor productivity per worker and average wages in nominal terms shows that an increase of 1% in productivity translated to an increase of 1% in worker wages (that is, the expected relationship between wages and productivity remained), gross real wages did not rise during this period due to the rise in consumer prices.

According to the paper’s author, Taub Center Researcher Gilad Brand, “During this period, the typical household consumer basket became more expensive at a faster rate than the average price of goods and services produced in the market. This discrepancy caused an erosion in the value of the marginal output of the worker relative to his/her consumer basket. In other words, the nominal salaries of workers have increased in accordance with rising labor productivity. However, this does not mean that workers, as consumers, are getting more bang for their buck, since consumer prices have offset the increase in productivity.”

The main contributors to the increase in the average household consumer basket during this period were food and housing, which were responsible for about 75% of the rise in the consumer price index in the last decade, even though they compose only 42% of the average household consumer basket. The weight of these two items in the business GDP price index is much lower and stands at no more than 11%, such that the household consumption basket became more expensive more quickly than the average of goods and services produced in the market. As a result, productivity growth did not translate into increased purchasing power for the workers.

The significance of the Taub Center research findings is that although the rise in productivity brought about a corresponding rise in wages, due to the vastly greater increase in the consumer basket relative to production prices, the value of the wages to the worker did not improve. Since the stagnation in wages is due to a great extent to the increase in the prices of food and housing, one of the ways to address this issue is for policy makers to concentrate their efforts in these two areas. In the area of food, various steps can be taken, including direct subsidies in the agriculture sector, eliminating trade barriers, and increasing competition. In the area of housing, steps that concentrate on increasing the supply of housing should be considered.

The Taub Center for Social Policy Studies in Israel, headed by Prof. Avi Weiss, is an independent, non-partisan institution for socioeconomic research based in Yerushalayim. The Center provides decision makers, as well as the public in general, with a big picture perspective on economic and social areas. The Center’s interdisciplinary Policy Programs – comprising leading academic and policy making experts – as well as the Center’s professional staff conduct research and provide policy recommendations in the key socioeconomic issues confronting the State.