The Secret of Why Productivity Has Outstripped Wages for Seven Decades

The crisis of the working American stems mainly from political decisions that benefit large companies and limit competition. It’s not just the result of technology, education, globalization or the Chinese

A worker at a New York brewery.
Bloomberg

An enigma baffling American economists for years has been solved, with a little help from outside. In a study published in January, professors Efraim Benmelech, Nittai Bergman and Hyunseob Kim explain why over the 68 years from 1948 to 2016 the productivity of the average American employee increased 242% while wages rose only 115%. The original data appeared in a breakthrough study by the economist Lawrence Mishel in 2015.

In contrast to Mishel, a labor-market economist considered progressive, the Israeli-born Benmelech and Bergman are financial economists without a clear ideological or political profile, certainly not in the United States. Both were born in Israel but got their doctorates at the University of Chicago and Harvard respectively. Benmelech today is at Northwestern’s Kellogg School of Management and Bergman is at the MIT Sloan School of Management.

Why didn’t the increase in productivity reach the employees? Why did it stop with the shareholders? Until now, there were three explanations: globalization, especially competition by China; technology and automation; and the collapse of organized labor.

When Bergman, Benmelech and Kim embarked on their work, they began with the issue of organized labor. But the more they delved, the more they thought they were onto something that would explain that yawning gap between productivity increases and wage increases: economic concentration. More and more American economists and journalists have begun to challenge a decades-old consensus that America’s markets are competitive.

In 2015, Prof. Roni Michaely of Cornell, who with Gustavo Grullon and Yelena Larkin wrote a paper claiming that concentration in the American marketplace had increased significantly since 1997. Then in a series of articles, The Economist also showed that market concentration in America had been increasing and competition had been diminishing.

In a dissertation, Simcha Barkai (Disclosure: I have worked with him)  double-checked the data and showed a clear correlation between the increase in concentration and decrease in the share going to employees. He debunked the argument that the decrease in salaries was due to automation and robotics, showing that in years when concentration increased, corporate investment in machinery and equipment decreased.

Noncompetition in many ways

Benmelech et al. followed that line and using official U.S. data, calculated the level of concentration in each American county; they then looked at wages from 1977 to 2009.

In areas where concentration in certain industries increased, wages eroded. The more concentration increased, as plants closed down or merged, the more wages eroded. The sensitivity of wages to rising concentration was observed throughout the period they studied but intensified in the late 1990s and early 2000s.

Their explanation was simple. China, technology and automation all contributed to wage erosion, but the main metric was this: It’s not the competitiveness of American workers that has eroded, but their power to negotiate. The more concentration in a given area, the more employers can keep a lid on wages.

Workers carry a truck-engine cooling-module component at the MAHLE Behr Charleston auto part facility, South Carolina, March 20, 2018.
Bloomberg

Employment terms can suffer, for example, when only two or three companies are engaged in the same business; it’s easier for employers to enter into cartels and agree not to compete over workers.

Sometimes the exploitation of employees is open. U.S. studies have shown that one in every five employees has to sign a noncompetition agreement. The amazing thing is that noncompetition agreements are ostensibly designed to prevent talent from defecting to the competition, but most employees signed onto the things are rank-and-file people and the agreement is glaringly designed to weaken the worker.

Such agreements have been found in fast-food chains like Burger King and Baskin-Robbins. What secret information does a worker there possess? How to flip burgers on a grill or butterscotch ice cream onto a cone? Yes, competition with the Chinese worker has hurt American wages. But Benmelech et al. argue that this isn’t the main metric: American wages also eroded before the China effect.

Supporting the argument that weakened negotiating power is behind the pay erosion, Benmelech et al. found that where companies have more organized workers, the negative effect of concentration is muted, sometimes significantly so.

To what degree can economic concentration really explain what has happened to the United States over the past 30 years? Apparently to a very significant degree. In the industries they checked, Benmelech and his colleagues estimate that the increase in concentration reduces wages by between 1% and 2% annually. That can lead to the 30% decrease in wages over the period, a figure that keeps coming up in reports on the decline of the American middle class since the 1970s.

Not just Trumpism

I believe the Benmelech paper joins a long list of studies proving that the crisis of the American middle class, of the working American, mainly stems from government policy, from political decisions. It’s not just the result of technology, education, globalization or the Chinese.

It might be over-egging the pudding to declare that economic concentration brought Donald Trump to the White House. The rise of racist, authoritarian leaders apparently originates not just in economics, but also in culture and identity, including a backlash against liberal reforms. But there’s no question that economic concentration and the vast power held by the few partly explains the processes that got the misogynist, racist reality TV star and real estate investor into the White House.

American antitrust authorities allowed mergers that increased concentration, weakened unions and enabled the development of an expensive, predatory and corrupt health system. All were political decisions made in Congress and the Senate under Republican and Democratic leaders, most of whom openly grub for bribes and money from giant companies and rich donors.

No American would settle for a few lousy cigars or champagne and some obsequious coverage in the media. In the United States, politicians make their fortunes while in office, or afterward; some 40% become lobbyists after leaving politics. Washington, like Wall Street, believes in cash. Millions, preferably billions.

Benmelech, Barkai and Michaely aren’t the only ones to challenge the conventional wisdom about the middle-class crisis and worsening inequality. A recent study including economists from Spain reached similar conclusions. The prominence of Israelis and other non-Americans in the research on concentration may not be coincidence; it may be easier to see things from the outside.

One of the most important researchers in this respect is Lucian Arye Bebchuk, a professor at Harvard Law School. Fifteen years ago he published a book with Harvard Law colleague Jesse Fried, “Pay without Performance: The Unfulfilled Promise of Executive Compensation,” explaining why the correlation between executive pay on Wall Street and performance is so weak. It’s mainly because directors are captives of management, and the market for managers isn’t really a market, it’s more like a rigged game.

Bebchuk also advised Israel’s economic concentration committee, explaining why the country’s corporate pyramids needed to be torn down and corporate governance needed strengthening. This is practically the consensus nowadays, but back in 2011, when the committee met, academics generally clung to the fence or if anything advised the tycoons and banks.

There’s also Prof. Anat Admati of Stanford, who has been landing blows on Wall Street’s bankers for seven years, exposing the truth behind their empty rhetoric. In recent years she has abandoned financial models and has been studying the politics behind the economy and captive regulators, as well as academics who serve the rich – taboo subjects to many observers.