The Wage Standard: What's Wrong in the Labor Market and How to Fix It

The figure shows the difference in wage growth between the top and bottom deciles from 2000 to 2019. Larger numbers mean the top decile's pay grew faster than the bottom decile's. In America, top-decile wage growth outpaced bottom-decile growth by around 11 percentage points—consistent with the pattern of rising inequality that we documented in the first pages of this chapter. Yet in the G7 countries overall (Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States), wage growth for the bottom decile lagged the top decile by only 1 percentage point. And across all OECD countries with complete data, the bottom outgrew the top by 5 percentage points. America not only started out more unequal—with a top-to-bottom decile wage ratio of 4.5 in 2000 compared to 3.3 for the G7 average—but it has also become more unequal over time.

Did it have to unfold this way? Or was there a time when the fruits of economic growth were more equally shared with workers in this country?

To better understand the rise in wage inequality and the gap between productivity and the wages of most workers, we need to look further back. The arc of this story traces back to the early twentieth century, where a series of political and economic upheavals led to a tentative balance between labor and capital.

BEFORE THE DIVERGENCE

The household survey behind figure 1.1 began collecting hourly earnings data only in the 1970s, which complicates comparisons with earlier decades. Fortunately, other sources help us extend wage trends further back—especially for workers around the middle of the pay scale—and compare them to overall productivity growth.

One key source is the government's monthly establishment survey, which collects data from businesses on the wages of non-managerial employees (about 80 percent of the private workforce). From 1973 to 2019, these average wages closely tracked the median wage, allowing us to use them as a stand-in for earlier years. Before 1964, the only data on non-managerial wages came from manufacturing, but those wages rose at about the same pace as in other sectors around that time. Combining these sources lets us trace average non-managerial wages back to 1948.

This longer timeline reveals a stark contrast between two periods. From 1948 to 1979, wages and productivity rose more or less in tandem: After inflation, non-managerial wages rose by about 1.8 percent annually, not too far off from productivity's 2.5 percent growth. In contrast, between 1980 and 2019, non-managerial wages grew at roughly 0.5 percent per year, lagging far behind productivity growth of about 1.4 percent. Wage growth was around 73 percent of productivity growth in the earlier period, while it was only 37 percent in the latter.

But could workers simply be getting more of their total compensation through nonwage benefits like health insurance or retirement plans? As it turns out, this changes things only marginally. Figure 1.3 (not shown) also tracks "compensation," which includes these benefits. Before 1980, total compensation actually kept pace with productivity even more closely than wages alone. But after 1980, it began to lag almost as much as wages. The upshot is clear: Whether measured by wages alone or by wages plus benefits, typical American workers have not kept pace with the economy's growing prosperity since the 1980s. As a result, America has grown more unequal: From 1951 to 1980, annual earnings for the bottom 90 percent and the top 1 percent rose more similarly, but since 1980 the gap has widened sharply.

FINDING THE CULPRITS

When I was in graduate school, my PhD adviser Richard Freeman liked to say that empirical economists are like detectives at a crime scene. First, we document the scene as precisely as possible; then we track down suspects, weigh the evidence, and figure out who's responsible. In our case, the "crime scene" is the growing gap between overall economic prosperity and what ordinary Americans bring home in their paychecks. So we have to ask: Why did this happen, and was it inevitable?

As with most major shifts in the economy, more than one factor underpins this Great Divergence. We can start with the usual suspects. Many economists point to technological change that has hollowed out routine jobs, especially in manufacturing. Work by Daron Acemoglu and David Autor shows how automation and shifts in skill demand lowered pay for non-college-educated workers. Educational shortcomings, highlighted by Lawrence Katz and Claudia Goldin, have also played a role: America's higher-education system hasn't produced enough college graduates compared to some peer nations, adding to challenges. And job losses from trade matter, too. China's entry into the World Trade Organization in 2000 and the earlier North American Free Trade Agreement (NAFTA) both hit regions heavily exposed to import competition, eroding many traditional, stable, well-paying jobs.

Technology and globalization help explain how we got here—but they aren't destiny. Too often, we're told that inequality in market incomes is inevitable and that the best we can do is "compensate the losers" with government transfers. Yet, as we've already seen, other countries faced similar pressures from technology and trade without experiencing the same surge in wage inequality. Even Canada—our next-door neighbor with many similar economic structures—saw far less divergence between the top and the bottom. Market forces are important, but they are not irresistible.