CASE STUDY

PRODUCTIVITY AND WAGES

One of the Ten Principles of Economics in Chapter I is that our standard of living depends on our ability to produce goods and services. We can now see how this principle works in the market for labor. In particular, our analysis of labor demand shows that wages equal productivity as measured by the value of the marginal. product of labor. Put simply, highly productive workers are highly paid, and less productive workers are less highly paid.

This lesson is key to understanding why workers today are better off than workers in previous generations. Table 2 presents some data on growth in productivity and growth in real wages (that is, wages adjusted for inflation). From 1959 to 2003, productivity as measured by output per hour of work grew about 2.1 percent per year. Real wages grew at 2.n percent-almost exactly the same rate. With a growth rate of 2 percent per year, productivity and real wages double about every 35 years.

TABLE 2 Productivity and Wage Growth in the United States

Source: Economic Report of the Preside”, 200S, Table 1-49. Growth in productivity is measured here as the annualized rate of change in output per hour in the non farm business sector, Growth in real wages is measured as the annualized change in compensation per hour in the non farm business sector divided by the implicit price deflator for that sector, These productivity data measure average productivity the
quantity of output divided by the quantity of labor=rarher than marginal  producrivrry, hut average and marginal productivity are thought to move closely together the productivity slowdown is not well understood, but the link between productivity and real wages is exactly as standard theory predicts. The slowdown in productivity growth from 2.9 to 1.4 percent per year coincided with a slowdown in real wage growth from 2.8 to 1.2 percent per year.

Productivity growth picked up again around 1995, and many observers hailed the arrival of the new economy. This productivity acceleration is most often attributed to the spread of computers and information technology. As theory predicts, growth in real wages picked up as well. From 1995 to 2003, both productivity and real wages grew by 3.0 percent per year.

The bottom line: Both theory and history confirm the close connection between productivity and real wages.