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The Real “Truth About the Economy:” Have Wages Stagnated?

Prof. Don Boudreaux responds to “The Truth About the Economy,” a recent video featuring former Labor Secretary Robert Reich (http://lrnlbty.co/z0ACuH). In the video, one of Reich’s key points is that most people’s wages have barely increased since 1980. However, when Reich’s numbers are examined in greater detail, his claim does not hold up. If you care about this issue, there are three things to consider:

  1. How inflation is calculated
  2. Benefits workers receive other than wages
  3. The distinction between statistics and individuals
Adjusting for inflation, especially over long periods of time, is as much an art as it is a science. In an attempt to measure inflation, economists have developed several indexes. All of these indexes are considered legitimate, but all of them yield different results. In “The Truth About the Economy” video, Robert Reich uses the consumer price index (CPI) to calculate the average hourly wage, and he finds that wages haven’t risen much over the past 30 years. However, when using other methods of adjusting for inflation, which are no less respected, the average hourly wage rate rises as much at 18% over the same 30 year period.
Index differences aside, everyone agrees that all forms of compensation must be considered to accurately calculate worker’s compensation. This includes not only wages and salaries, but also benefits like health insurance, retirement benefits, vacation days, sick pay, and more. It’s worth noting that fringe benefits have become a larger share of income over the past 30 years. According to Don Boudreaux’s calculations, which include fringe benefits, average hourly wages have increased up to 26% over the past 30 years.
Lastly, and most importantly, Robert Reich confuses statistical categories with real people. When Reich says that, since 1980, most people’s wages have barely increased, he gives the impression that most people have enjoyed no economic gains over the past three decades. What he means is that, adjusting for inflation, average wages have not increased. The real flesh and blood people within these statistical categories have actually experienced increased compensation. Some workers are gaining skills, others are retiring, and others are joining the workforce for the first time. Especially noteworthy is the increasing rate at which women and immigrants have entered the workforce in the past 30 years.
To Boudreaux, Reich is right to claim that a strong economy needs a strong middle class. However, taxing the rich, as Reich suggests, is not the path to a strong middle class. The path to a strong economy and a strong middle class requires the hard work and great entrepreneurial ideas of individual people acting in a free market.

The Real "Truth About the Economy:" Have Wages Stagnated?

In a recent video with over a million views, former labor secretary Robert Rice gives a three minute description of the truth about the economy. One of his key points is that, adjusting for inflation, most people’s wages have barely increased since 1980. Based on this claim, Rice argues several other controversial points about how the U.S. economy is in bad shape. But I think this claim about average wages demands closer scrutiny. If true, such wage stagnation would indeed be a serious indictment of the U.S. economy over the past three decades. Fortunately, Rice’s claim is based on a statistic too faulty to take at face value.

If you care about this issue, you need to consider also one, how inflation is calculated, two, the benefits other than wages that workers receive, and three, the distinction between statistics and flesh and blood individuals. Let’s look first at inflation. Adjusting for inflation, especially over long periods of time, is as much an art as it is science. Economists have developed several different methods for calculating inflation, each of which is considered legitimate, but which yield different results. It’s true that the calculated average hourly wage, adjusted for inflation using the Consumer Price Index or CPI, hasn’t risen much over the past 30 years. That’s the basis of Rice’s claim.

But what about the other methods for adjusting for inflation, methods no less respected than the CPI? As recent research from the Minneapolis Fed shows, using an index called the Personal Consumption Expenditure Deflator results in average hourly earnings rising by 10 percent between 1976 and 2006 rather than falling by 4 percent when adjusted with the CPI. Another widely respected inflation adjustor, the GDP Deflator, finds that real average hourly earnings rose even more over those years, by 18 percent. Those are just two of the other indices an economist could use. So I caution anyone against basing a firm conclusion on a statistic from a single index.

One reason for the ambiguity in adjusting for inflation is that it’s really difficult to account for improvements in the quality of goods and services. For example, a television in 2012 is a vastly superior product to one that you could buy in 1976. There’s simply no scientifically agreed upon way to account for such quality changes when adjusting for inflation.

My second point: fringe benefits that come with jobs, such as health insurance. While reasonable people can disagree about how best to measure inflation, no reasonable person disagrees that to accurately calculate a worker’s total compensation, all forms of compensation must be included, wages and salaries as well as benefits. Because fringe benefits have become a larger share of workers’ pay over the past 30 years, looking only at wages and salaries gives a false picture of the progress of worker compensation. For example, for the years 1976 through 2006, I estimate that the inclusion of benefits in worker pay results in average hourly wages rising by as much as 26 percent, depending upon the method used to calculate inflation.

My third point is the most important. Robert Rice confuses statistical categories with real people. When Rice says that since 1980, most people’s wages have barely increased, he gives the impression that most people have enjoyed nearly no economic gains over the past three decades. What he means is simply that the average wage adjusted for inflation with the CPI hasn’t gone up, but statistical results such as averages or medians can give a very misleading picture about what’s happened to individuals included in those groups. Here’s an example:

Let’s say that you annually keep track of the average height of your three kids. This year, their average height is, say, four feet two inches. Next year, you have a fourth child and you calculate the average height again. The addition of that infant will lower your kid’s average height even though each of your first three kids have grown in height during the year. Clearly you wouldn’t conclude from the lower average height of your children that your children are shrinking in size. That would be absurd. But the same reasoning applies to average wages.

The individuals behind the statistics have changed a lot since 1980. To name a few such changes: workers like me have gained more skills and now earn higher pay. Others have retired and others, very significantly, have joined the workforce for the first time. Especially noteworthy is the increasing rate at which women and immigrants have entered the workforce. These workers generally earn a lower than average pay, which pulls the statistic down, but not necessarily the actual pay of actual people.

Rice concludes by saying that a strong economy needs a strong middle class. He’s got that right. But the path to a strong middle class is not, as he suggests, higher taxes on the wealthy. Instead it’s the path that made the U.S. economy great in the first place: the hard work and great entrepreneurial ideas of individual people all acting in a free market.

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