Commentary

Mythology Of Wages Vs Profits

This article originally appeared in the Washington Times on November 11, 2004.
In those desperate last days before the election, liberal advocacy groups even managed to sneak political propaganda into routine business news, of all places. In an article ostensibly reporting facts about economic growth, Washington Post writer Jonathan Weisman managed to insert the following tidbit:

“The liberal Center for Budget and Policy Priorities noted that the share of the economy going to wages and salaries has slipped from 49.5 percent when Bush came to office to 45.4 percent in the third quarter of 2004, even as corporate profits have risen as a share of the gross domestic product over that time, from 7.8 percent to 10.1 percent.”

The unsubtle suggestion was that the downtrodden working class has been systematically exploited by greedy capitalists since “Bush came to office.” But these statistics, like many others in the partisan press, were incredibly amateurish.

If you add together the income shares supposedly going to wages (45.4 percent) and profits (10.1 percent), nearly half the economy seems to be missing. A big reason is that GDP includes more than $1.5 trillion of estimated depreciation — wear and tear on everything from factories to cars. Depreciation is larger than corporate profits, but it is not income in any sense. That is why serious calculations compare shares of profits and pay to national income, not GDP.

The fact is that compensation of employees was 64.1 percent of national income in the third quarter and corporate profits were 11.5 percent. One reason labor’s share looks so much larger than Weisman’s reported figure is that depreciation is removed from the denominator. Another is that employee benefits are added to wage to arrive at total compensation.

Hourly non-farm compensation was up 3.7 percent over the year ending in the third quarter, as was the similar employment cost index. But that 3.7 percent blends together a 6.9 percent rise in benefits with a 2.5 percent rise in wages. It is obvious why that liberal group spoke only of wages, ignoring benefits. But it is less obvious how or why a financial journalist was so easily conned.

The Federal Reserve Bank of St. Louis took a longer perspective in the August issue of its “National Economic Trends.” Michael Pakko used a graph to show that, “labor’s share of income has averaged 70.5 percent (of national income) over the past 50 years and has remained within a narrow range of that average.” His 70.5 percent norm is slightly higher than my third quarter figure because Pakko properly attributes part of proprietors’ income to labor (shopkeepers do not work for nothing).

Confusing wages with overall compensation was a cheap political trick during the campaign. But that confusion still remains extremely important when it comes to the alleged burden of employee health insurance premiums on business.

Economic theory predicts that if the cost of employee benefits grows more rapidly, then the growth of wages and salaries will slow down, leaving total compensation unaffected. Yet many businessmen claim the rising cost of employees’ health insurance premiums is squeezing their profits, making it unprofitable to hire.

If that were generally true, then faster increases in the cost of benefits would show up as faster increases in the cost of total compensation. But total compensation rose by only 3.7 percent over the past year, after rising by a similar 3.8 percent to 4.1 percent in the previous three years. The cost of benefits has indeed been growing more rapidly, but the growth of wages has been correspondingly slower, leaving the total increase in employee compensation unchanged.

Back in early 2000, by contrast, both the stock market and the job market were “too hot not to cool down.”

Total compensation rose 7 percent in 2000. Despite a strong rise in productivity, unit labor costs rose by 3.9 percent, while prices businesses received rose only 1.8 percent. Profit margins were therefore squeezed, and layoffs became essential for most firms that survived.

Government data on corporate profits include many privately held firms and farms but exclude giant U.S. branches of foreign corporations. Earnings per share for the S&P 500 corporations are more revealing — they collapsed from 13.7 cents at the end of the third quarter of 2000 to only 4.8 cents by mid-2001. When profits fall that fast, many companies are losing money. We call that a recession. If the profit share had not improved since 2001, we would still be in a recession. One reason the share of income going to profits rose is that the share going to net interest expense fell when interest rates fell, and that was good news for workers, too.

To sum up, there has been no decline in labor’s share of national income once benefits are counted as income. The share going to corporate profits is cyclically volatile — declining sharply in recessions, after interest rates and labor costs peak. Employees’ share of (declining) national income looks high in recessions because profits are bad, not because pay is good. Rising health care premiums in the past few years have not increased U.S. labor costs, because collecting more of your pay in the form of benefits necessarily means getting less in cash.

If you want to know what is going on, it helps to get the facts right. But if you just want to deceive yourself or others, some leftist groups and compliant reporters often seem ready, willing and able to get the facts all wrong.

Alan Reynolds is a senior fellow with the Cato Institute and a nationally syndicated columnist.