Tuesday, November 07, 2006

Your paycheck and inflation...

I am beginning to lean toward the idea of a gathering inflation storm. Or at least increased upwards pressure on prices. While I have always been a hawk on inflation, the idea of keeping our money sound may not be the be-all-and-end-all for prosperity in the US, or the globe.

One apparent reason is laying the blame for inflation largely at the feet of labor costs. No component of the price indexes watched by the Fed is more closely monitored than labor costs. When they begin to rise, the Fed usually acts to slow the economy.

The trouble is real wage growth - getting a raise, for example - is described as an increased labor cost, not a worker income boost. The governments not-so-subtle point of view bias is in favor of business owners - not business workers. This is the unwritten message of the "ownership society". While it sounds admirable and works for me, the quiet truth is if allowed to come to full fruition, passive returns from owning "things" (houses are a good example) will be how most wealth is accumulated, not by working.

The result is for most Americans, our government is trying really hard to make sure you don't get ahead. To be sure, this is not done deliberately (I think) but dispassionately to protect the value of money.

To begin with, I'm not sure this emphasis on labor costs is warranted. I'm not alone.
No matter what standard econometric models might suggest, the empirical cyclical evidence indicates that labor cost inflation is not a consistent predictor of cyclical upturns in inflation. In fact, a fair amount of asymmetry exists in the cyclical behavior of the growth rates of the ECI, AHE, and ULC when compared with inflation cycles. All three series lead consumer price inflation at peaks, and lag it at troughs. [More]
One problem is when you have some factors you can measure easily and accurately, and some you can't (like the effect of immigrant labor) you zero in on those you can see.

One thing that is certain, is this focus on control of labor costs has coincided with stagnant wage growth for the vast majority of Americans.
Wages have been flat or declining on average for 5 years now. As the Financial Times story points out, we have had 5 years of economic growth, but the amount the median American worker earns every week has fallen by 3.2 per cent, adjusted for inflation, since the start of the recovery in November 2001. For the first time ever, the real wages of American workers have declined through more than four years of strong growth. Calculations by NDN show that the average American earned $480 a week when President Bush came to office. Controlling for rising prices, the average American still earns exactly $480 today. So while the American economy has been growing, the incomes of most Americans have been standing still. [More]


I think this is the reason that good unemployment numbers don't generate the political enthusiasm that Republicans especially expect. No matter what the economy's overall performance is like, life at the individual level for most has not been all that exciting.

There is much more to this issue of course, and I will be trying to wrap my mind around it in the January issue of Top Producer, but for now contemplate this:

If rapid wage growth is inflationary, why isn't rapid profit growth? In other words, why is the return to capital a good thing and the return to labor a negative influence? Aren't more dollars chasing limited goods and services equal regardless of their source?

I'll be working on that one...

14 comments:

Anonymous said...

The difference in inflation resulting from rapid wage growth and rapid profit is due to the difference in goods and services being produced. Rapid wage growth may not be the result of increased productivity. Rapid profit growth results from more goods being produced from a given amount of capital. Therefore more dollars are not chasing a limited amount of goods and services but rather an expanded quantity of goods and services.

brian said...

John,
Are you entering the Lou Dobbs/Keith Olberman/Alan Guebert bowl? Where did this come from? I know that there is a backlash, that the pendulum is swinging away from conservatism, faith, and their nexus in the person of GW Bush. But please, " the gov't is working very hard to see that most Americans don't get ahead." ?? Maybe Huey Long, or even William Jennings Bryan is the better example of where you're headed.
Look, I have followed the fed pretty closely for a lot of years and I have never seen evidence that the sine qua non of monetary policy is to keep wages down**. Where is yours? I followed the links in your blog and came to an academic paper stating that wage levels are poor predictors of the business cycle, and to a liberal interest group whose agenda clearly has biased their presentation of the data.
The real story of the fed is how easy money is and for how long it's been that way. The recent raises in interest rates have in no way slowed down the growth in money supply or the availability of credit. And yes, you could argue that an inflation storm could result from this, though there are a multiplicity of other significant factors in the mix. No matter how you look at it, though, monetary policy has not been driven by a desire to prop up the dollar or defend our currency - the world markets are doing just fine with that on their own, thank you.
There are all kind of pitfalls in looking at statistical measures of the economy, and I'm afraid you may have taken a spill. The paper you linked to spoke of the lags in wage growth versus the economy. 2001 would have been the wage peak of the last growth cycle, which ended in March of 2000. The ensuing slowdown was spiked downward on 9/11, and economic growth has really just gotten its legs in the past year or two. The bottom line is that when you measure cyclical activity over half its wavelength, you get a distorted picture. The other issue is that you must include the value of benefits in income - their growth makes a huge difference.
Globalization is affecting Americans' relative economic position - we have more competition than we did in the halcyon days of yore. We also are no longer protected from attack by our oceans, but that's another story. The world has changed. Lou says we can use protectionism to prosper, Keith says we can just play nice and no one will bother us. Both are wrong. Many of the rest of us have an uneasy feeling that only the uber-connected or uber-talented can compete in this arena, so why not head for a modified, limited retreat? Why not just redistribute what we have - we can live off of that for a long time. But the line we are retreating from will follow us.
To complete the metaphorical theme in this post, maybe you not losing it, but are moving along the lines of the old progressives, a la Teddy Roosevelt. I have mixed feelings, as you might guess, about TR, but he is certainly an estimable and admirable figure. TR would have thought KO was a clown, and maybe Lou also, but he would have understood the implicit resonance of Lou's creed. Somebody does need to look out for the little guy. Keep up the good work.

** By the way, the holy grail of fed policy is for wages to grow in step with productivity growth. There is no reason to think this has changed, though your 2001 baseline, and lack of total worker compensation, gives you a measurement problem.

John Phipps said...

I tell ya, the woods are full of amateur economists like me...

Roger - higher profits can come from higher prices, not necessarily more goods being made. What really worries me is all these truisms I used to embrace and which seemed to logical on paper are somehow producing or at least failing to counter a system where the wealth is piling up in very few hands.

Brian: Nobody is more horrified to hear some of these things come out of my mouth than me, but I'm looking for some answers here.

Whether the Fed is deliberately keeping us down or not, the effect is the same. The concentration on wage growth is not my interpretation alone, several observers cited the recent wage reports as reasons for expecting interest rate increases.

I chose the real wage growth graph because it was about the first clear one I could come by - and if you do not question the numbers, should the link source matter? I cite stuff from all over the spectrum.

I'll try to find a longer period real earnings chart, but I seem to remember it's pretty flat as well.

But your comment about the uber-talented being the only ones getting ahead matches my concerns. I am less concerned about an ideology to explain it than an effective response.

BTW, I getting comments from USFR viewers for not being strongly against illegal immigration, so obviously I am an equal opportunity offender.

Oddly enough, I don't think we are swinging away from conservatism, but struggling to find it.

Bless your little heart with the TR reference.

"I would rather fail while daring greatly than be numbered among those gray and timid souls who neither suffer much nor enjoy much."

Anonymous said...

John,
I submit that merely raising prices to increase profits is not that easily done, otherwise we would all do it. Other factors to consider include competition, demand, elasticity of demand, supply, etc.
I am also concerned about the concentration of wealth, but as an amature economist coming out of the woods, I do not have a solution.

John Phipps said...

Roger: I meant no disparagement by the "amateur economist" remark. What I am finding difficult is the tools that worked for a economy based on producing stuff are less useful in an economy centered increasingly on services.

Item: The Chicago Tribune reported today (sorry, I can't hotlink in the comments section) that 5 investment firms were about to distribute $36 BILLION in bonuses to employees. (That is this year's corn crop and more)

How difficult is it for Goldman Sachs or Morgan Stanley to raise prices? Obviously not very, at least when the market is going up.

My point is the role of capital and labor are being redefined, and capital is winning. I do NOT aver capitalists are in the wrong, however, but that I need to figure how I fit into a world like this.

Anonymous said...

John,
I did not take offense at your "amateur economist" remark. I was just trying to be cute with my response. I think you have figured out very well how to fit into a world where you provide services (deliver information and entertainment) instead of, or in addition to, producing "stuff" (corn and soybeans).

brian said...

John,
Where to start. Two things - first, don't look at what "observers" say, look at what the the fed says and does. I simply categorically reject the idea that they view their role is to suppress wages. And the effect is most definitely not the same. If times are tough because the Indians and Chinese are now committed to being math and science mavens, and the Mexicans are exporting their work ethic across the border, that has vastly different implications than an express policy of the US gov't to keep the worker down. The latter is the kind of notion that Lenin used to topple the czar!
Second, your comment about labor and capital is, and I say this with affection, precisely and symmetrically wrong. Labor is winning, it is just not the kind of labor you are thinking of. It is the labor which can manage a 4 billion dollar company (CEO's, and other execs), labor which can manage huge amounts of investment dollars around the globe (Wall Street Bankers), media talent and moguls (Oprah and JP), lawyers, google founders, ballplayers, programmers, pharmacists, lobbyists, hog farmers, cable show hosts, etc., etc., etc. This may not be what you consider "labor", but capital?? Forget about it.
It's all about skills, as Napolean Dynamite would say.
Let me bring this close to home. I have a neighbor whose father had a few sows on pasture in the 70's, but no debt. This thirty-something neighbor recognized the changing hog industry and, using the family's farming base and one heck of a lot of non-manual labor, grew the farm since 1990 into 8,000 plus sows. His income in 2006 was comfortably in seven figures. He, and his kind, are "winning." Meanwhile, the kid with the big beltbuckle and the decal-detailed and oversize diesel pickup, who barely made it through high school and is now driving the feed delivery truck, is making about $20/hour(including benefits) and can't even think about supporting a family without marrying the post-high-educated teacher/nurse/office worker wife. He, and his kind, are not "winning."
For what it's worth, executive pay increases over the past 40 years has tracked very closely with the total dollar volume of business of companies. CEO's today earn the same share of their company's gross incomes as they did a generation ago.

brian said...

One other note. To follow your logic, my hog farmer above must have had no trouble in raising his prices. :)

John Phipps said...

Brian: You are arguing means, I am talking about ends. Two ends in particular:

1. Stagnant real wages: you offer excellent reason why this is so and how the Fed is not responsible. I am saying it is a problem and am looking for the multiple causes. I still believe keying inflation controls to labor costs contributes to this lack of growth.
2. Wealth and income concentration: CEO's make the same percentage of the gross income as previously, you assert. Why is that a fair measure and not the CEO-to-average worker wage ratio used more commonly? Why is it so much lower in Japan and the EU?

It may very well be that our wonderful economic system makes these developments inevitable, but others seem to be at least mitigating them.

Is there any level of maldistribution of income and wealth where you would support changes?

We've been here before and your reference to TR was insightful. The Gilded Age was marked by similar staggering inequalities. It too ended.

brian said...

John,
I do appreciate the give and take, and the civility of your comments. This is fun. I also give you credit for seeking answers.
On the fed, I just think it is dangerously wrong to say that our government is working against the little guy. Yes, the fed looks at labor costs when it is deciding policy. It also looks at energy costs, raw materials, commodities, etc. And, more importantly, it also looks at asset values, debt levels, housing prices, stock values, commercial real estate, etc., as it tries to gauge the threat of the economy overheating into inflation. All are economic indicators, and to single out one as overiding all others is to mislead. We used to believe that unemployment and inflation were a direct trade-off, but the fed abandoned that notion years ago.
My point on income inequality is not that it is not an important issue. I understand your concerns for the social implications of too much imbalance. I think the election results today are definitely part of the balancing mechanisms that play out in our country, and that can be a good thing.
I just was taken aback by your old marxist dichotomy of labor vs. capital. The people today who are in high income brackets are there not because they inherited money, or even because they own assets. Your interpretation of the ownership society confuses me. I urge you to consider that the returns in today's economy do not go to physical assets, but go to those with the most talent/ingenuity/motivation - human capital. It's just that the stakes are higher now, and the differences in people on the t/i/m index are multiplied more broadly in a global free enterprise, market driven economy. It's why all the pay ratios of high skills (execs, ballplayers, hog farm entrepreneurs) vs low skills (pick one) are increasing. Your metric of ceo vs worker pay is irrelevant to the market - it's all about each's ability to generate wealth and market returns. (Actually, exec pay is an interesting subject in itself, as most corporate pay works like what economists refer to as a tournament, with the high pay at the top serving as motivation for the entire corps of managers vying for upward mobility.)
Absolutely, too much inequality can be a problem. You may be pretty well off, but not feel like it because others are doing better. Voting in favor of protectionism, or social medicine, or immigration restrictions are all reflexes against this trend.
The bottom line is this: don't fall into the trap of believing that income inequality is a result of a rigged game. It is precisely the opposite. The freer the game, the more the meritocracy multiplies inequality. We definitely need to deal with this issue, but let's be real about it.

John Phipps said...

Brian: I hear echoes of Pangloss in you replies. You agree inequality is worrisome, but seem content to worry in this best of all possible worlds.

I do not begrudge the top their compensation, however, I do object to those who pull up the ladder after them.

Casual disregard for ensuring a mildly even income distribution is reassuring for all, since the guys at the bottom can plan and scheme to rise, and the guys at the top know that failure does not eject them permanently from paradise.

I have not mentioned protectionism, in fact I support libertarian approaches to our commerce. You seem to keep linking me to positions I have not espoused.

Income redistribution may be repugnant to lassez faire capitalists but without some form economies seem to gravitate to autocracy.

And I have come to believe there is a significant bias in the US for passive income and rent-seeking behavior The high income bracket doesn't receive mucho income from capital? Have a looky at capital gains tax receipts and how few pay them. Perhaps there is sweat on their intellectual brows but there is a reason for jokes about trust-funders as well.

One stated government goal is move as many of us as possible to this blessed state, via home ownership and mutual funds. I am less sanguine about all of us riding and few of us pushing.

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