# Ensuring a Sound Macroeconomic Foundation December 15, 2022 • Publications By [Jeffrey Miron](https://www.cato.org/people/jeffrey-miron) and Pedro Aldighieri ![EtAW - Macro image](/sites/cato.org/files/styles/aside_3x/public/2022-11/macroecon-hero-cropped.png?itok=ewqS8-0h) #### [Empowering the New American Worker](https://www.cato.org/empowering-new-american-worker) 19-part series ##### Introduction 1. ##### [Introduction](/publications/introduction) By [Scott Lincicome](https://www.cato.org/people/scott-lincicome) ##### Ensuring a Sound Macroeconomic Foundation 1. ##### [Ensuring a Sound Macroeconomic Foundation](/publications/ensuring-sound-macroeconomic-foundation) By [Jeffrey Miron](https://www.cato.org/people/jeffrey-miron) and Pedro Aldighieri ##### Facilitating Personal Improvement 1. ##### [Private Sector Labor Regulation](/publications/facilitating-personal-improvement-private-sector-labor-regulation) By [Ryan Bourne](https://www.cato.org/people/ryan-bourne) and Brad Subramaniam 2. ##### [Higher Education](/publications/facilitating-personal-improvement-higher-education) By [Neal McCluskey](https://www.cato.org/people/neal-mccluskey) 3. ##### [Occupational Licensing](/publications/facilitating-personal-improvement-occupational-licensing) By [Chris Edwards](https://www.cato.org/people/chris-edwards) 4. ##### [Independent Work](/publications/facilitating-personal-improvement-independent-contracting-gig-work) By [Scott Lincicome](https://www.cato.org/people/scott-lincicome) and Ilana Blumsack 5. ##### [Entrepreneurship and Home Businesses](/publications/facilitating-personal-improvement-entrepreneurship-home-based-businesses) By [Chris Edwards](https://www.cato.org/people/chris-edwards) 6. ##### [Criminal Justice](/publications/facilitating-personal-improvement-criminal-justice) By [Scott Lincicome](https://www.cato.org/people/scott-lincicome) and Ilana Blumsack ##### Enabling Mobility and Independence 1. ##### [Transportation](/publications/transportation) By [Colin Grabow](https://www.cato.org/people/colin-grabow) 2. ##### [Remote Work](/publications/remote-work) By [Scott Lincicome](https://www.cato.org/people/scott-lincicome) and Ilana Blumsack 3. ##### [Employee Benefits](/publications/employee-benefits) By [Vanessa Brown Calder](https://www.cato.org/people/vanessa-calder) 4. ##### [Welfare Reform](/publications/welfare-reform) By [Michael D. Tanner](https://www.cato.org/people/michael-d-tanner) ##### Improving Living Standards 1. ##### [Childcare](/publications/childcare) By [Ryan Bourne](https://www.cato.org/people/ryan-bourne) 2. ##### [K‑12 Education](/publications/k-12-education) By [Neal McCluskey](https://www.cato.org/people/neal-mccluskey) 3. ##### [Health Care](/publications/healthcare) By [Michael F. Cannon](https://www.cato.org/people/michael-f-cannon) and [Jeffrey A. Singer](https://www.cato.org/people/jeffrey-singer) 4. ##### [Housing Affordability](/publications/housing-affordability) By [Vanessa Brown Calder](https://www.cato.org/people/vanessa-calder) 5. ##### [Homeownership](/publications/homeownership) By [Norbert J. Michel](https://www.cato.org/people/norbert-michel) 6. ##### [Essential Goods](/publications/essential-goods) By [Gabriella Beaumont-Smith](https://www.cato.org/people/gabriella-beaumont-smith) ##### Conclusion 1. ##### [Conclusion](/publications/conclusion) By [Scott Lincicome](https://www.cato.org/people/scott-lincicome) [ Return to Series Home ](https://www.cato.org/empowering-new-american-worker) [ Download PDF ](https://www.cato.org/sites/cato.org/files/2022-12/empowering-the-new-american-worker-macroeconomic-future.pdf) ## The Issue #### Economic growth generates broad-based prosperity for all American workers Since the late 18th century, the world has experienced massive economic growth.[1](#_ednref1) Despite dire predictions that explosive population growth would impoverish the human species, real gross domestic product per capita (RGDPpc) has skyrocketed alongside population, albeit unevenly. Before that, living standards were mostly stagnant worldwide.[2](#_ednref2) Economists call this unprecedented phenomenon—shown in Figure 1—the “hockey stick” of human prosperity. ![Figure 1: GDP per capita, 1 to 2018, measured in constant (2011) U.S. dollars](https://infogram-thumbs-1024.s3-eu-west-1.amazonaws.com/3985eb72-79e9-4ad8-bab4-02d589cfc6bf.jpg) But what does economic growth mean, and why should a “pro-worker” agenda focus on it? Real GDP measures the inflation-adjusted value of final goods and services produced in a given period. Since many things that people (and thus, workers) need and care about have a monetary value—food, clothing, health care, housing, travel, concert tickets, etc.—RGDPpc is a good proxy for standards of living. Fundamentally, RGDPpc growth measures how much more stuff we produce per person. Problems with GDP measurement are well-known. GDP ignores illegal or non-monetary transactions, like selling drugs or cooking dinner at home. Government services have no market prices, so they are tallied by their costs, which might be higher or lower than society’s willingness to pay for them. Adjusting for the ever-changing quality of goods and services is hard; sometimes a product gets more expensive, but also much better—in some cases, a product can get better *and* cheaper. A different limitation is that GDP rarely accounts for production of “bads,” such as pollution or greenhouse gas emissions; in principle these should be subtracted from GDP, but measuring and valuing them is challenging. And GDP does not account for changes in leisure time, which also affect material well-being. In the 19th century, the average American laborer worked around 70 hours a week.[3](#_ednref3) Currently, American workers toil less than half that amount—for a total of 1,791 hours a year, or 34.4 hours weekly.[4](#_ednref4) [ #NewWorker ](https://x.com/hashtag/NewWorker) Nevertheless, RGDPpc is a useful measure. It is widely available, and approximate estimates go far back in time, allowing for comparisons across countries and over centuries. It also correlates with many nonmaterial things we care deeply about, such as life expectancy, education, child mortality, happiness, and more.[5](#_ednref5) Finally, RGDPpc gains have coincided with incredible increases in material well-being. Economists bypass problems with measures of standard of living across long time frames by looking at the real cost—often in labor-hours—of producing a constant-quality good. Nordhaus (1996), for example, looked at the cost of lighting (measured in lumens) across the centuries and finds that, roughly, “an hour’s work today will buy 300,000 times as much illumination as could be bought in early Babylonia.”[6](#_ednref6) Similarly, Nordhaus found that the cost of computations, like adding or subtracting, has fallen by a factor of 73 trillion (7.3 x 1013) relative to manual calculations, from 1850 through 2006.[7](#_ednref7) This and other work suggest that trying to gauge costs by looking at adjusted prices usually understates, by orders of magnitude, how much the real costs of goods have fallen—and thus how real standards of living have increased—over the last two centuries of skyrocketing RGDPpc growth. Establishing that economic growth reliably indicates better living standards and that RGDPpc has soared, however, is not enough to show that the average *worker* has benefited. RGDPpc says nothing about the distribution of incomes between or within countries; economic growth might accrue mainly to the richest, even as RGDPpc grows. Fortunately, this is not the case. Empirically, growth is good for the poor: incomes in the bottom quintile rise proportionally with average incomes. Furthermore, global inequality has been falling in the last several decades.[8](#_ednref8) As shown in Figure 2, U.S. hourly manufacturing wage growth has far outpaced food price growth throughout the 20th century. We can therefore safely assume that a rising RGDPpc tide will indeed lift all boats. ![Figure 2: Manufacturing wages versus food prices in the United States, 1901–2003](https://infogram-thumbs-1024.s3-eu-west-1.amazonaws.com/676d5343-bcce-4079-b5b9-f28283783daf.jpg) ## The Policy Solution #### Productivity, not Redistribution, Is Key We have seen that the world has witnessed incredible economic growth, and workers have undeniably benefited from it. What are the proximate causes of this unprecedented prosperity? Economic historians mainly point to the Industrial Revolution, but we are interested in how that period resulted in growth and income gains. In short, the answer lies in productivity, with technological change (new machines and tools, for example) and division of labor as its main drivers. Nobel laureate Paul Krugman famously said that “productivity isn’t everything, but, in the long run, it is almost everything.” Productivity is the ability to produce more output with a given set of inputs. Exceptionally productive workers produce more per period than their counterparts, usually due to a combination of superior ability, experience, or effort. Economists often use the terms “productivity” or “technology” interchangeably to explain the output variation between firms and across time that is not accounted for by measurable inputs, such as labor-hours and physical capital (e.g., industrial robots). Labor productivity is more narrowly defined as the real output produced by an hour of work. Growth in RGDPpc can *always* be traced back to labor productivity, since sustained economic growth cannot merely arise from adding more hours of labor per capita—one can only work so many hours a day. Several factors can drive labor productivity. First, higher productivity comes from capital accumulation. More tools, machines, and facilities increase worker hourly output. Second, the division of labor and specialization further drive labor productivity. Specialization allows workers to learn their tasks faster, to become better at them, and to save time that would otherwise be spent changing between different tasks. Likewise, education and training increase labor productivity. Third, technological, scientific, and institutional progress improve the quality of capital, give birth to new management techniques, and allow for new modes of organization. The increasing productivity of labor also explains why we should expect that at least part of the benefits from economic growth accrue to workers. From an employer’s standpoint, the value of a worker comes from how much revenue that worker’s extra labor-hours can produce. If labor productivity increases, the worker becomes more valuable to the employer. Of course, employers want to keep wages to a minimum, but they also want to maximize their profits. If they keep their workers’ wages below their labor productivity, other employers can profitably poach those employees by offering higher wages. As firms compete for workers, we expect hourly wages to equal the productivity of adding an extra labor-hour in a competitive market. When markets are not perfectly competitive, wages may stay below the competitive level. Yet the same principle applies: as labor productivity increases, the demand for labor goes up since workers can produce more valuable stuff, thus driving real wages up. Even a monopolist must compete with other industries, potential entrants, or with individuals’ leisure time. For this reason, evidence shows that productivity and pay are linked, even though the correlation between compensation and labor productivity varies across time and countries.[9](#_ednref9) As long as labor productivity continues to increase, so will real wages over time. In the long run, by contrast, there are hard limits to what government redistribution can achieve for wages and workers. As shown in Figure 1, the United States had a RGDPpc in 1800 of $2,545 (measured in 2011 dollars; this would be equal to $3,210 in 2021). If there had been no productivity growth since 1800, everyone would get an annual check for $3,210 under a perfectly egalitarian government— assuming (incorrectly) that the government could perfectly redistribute resources with no negative impact on GDP. Yet current U.S. guidelines set the poverty threshold for a single-person household at $12,880. In other words, the whole American population would be considered poor today under perfect equality by 1800s standards of living.[10](#_ednref10) By contrast, that $3,210 would place an individual below the sixth percentile of the U.S. market income distribution in 2021.[11](#_ednref11) If we consider average yearly lifetime earnings, the percentile is likely to be even lower. Most people on the bottom of the income distribution are out of work, are inexperienced, or have suffered a negative income shock and will likely improve their earnings over time. Thus, over the very long run, government redistribution is mostly irrelevant to explain how standards of living change, except that redistribution might affect how productivity grows. To the extent that government redistribution reduces labor productivity and economic growth—for example, by discouraging human capital investments through taxes on labor income to fund the transfers—these adverse effects can compound over time to add to a massive cost, even for the poorest. Increasing labor productivity is therefore the key to improve standards of living for workers in the long term. The trillion-dollar question then becomes: How do we explain and maximize productivity growth and technological progress? The answers are still up for debate and are beyond the scope of this chapter. Several factors might play a role, such as institutions, geography, culture, and even luck.[12](#_ednref12) Nevertheless, decades of economic history and analysis show that free markets and property rights play a crucial role in increasing productivity and standards of living.[13](#_ednref13) Well-functioning markets are key to properly allocating labor and capital, putting scarce resources to good use.[14](#_ednref14) Free exchange allows individuals to further their own interests while providing valuable services and goods to others, and property rights help ensure that individuals will be rightfully compensated for doing so. As a result, market discipline forces firms and individuals to relentlessly increase labor productivity and standards of living, if only to maximize profits. In a free market, firms that are unable to put labor resources to good use will eventually go out of business. Policy-wise, this means that governments should strive to open markets to competition as much as possible—for example, by slashing trade barriers, dropping occupational licensing requirements, allowing for labor mobility (migration) within and between countries, lowering regulatory barriers to entry, and so on. Tax rates should be kept at relatively low and stable levels so as not to discourage investment, savings, and work. Governments must keep expenditure in check or risk runaway inflation. Finally, the rule of law and a predictable regulatory environment are crucial to foster long-term investments and to ensure that creditors can recoup their loans. Concretely, this translates to a fast, efficient, and predictable court system that is able to enforce laws and contracts. ## Conclusion Standards of living have grown tremendously during the past few centuries, even as world population has exploded. This is an unprecedented phenomenon in history: poverty had been the natural state of mankind until two centuries ago. These gains have accrued to the rich and poor alike. Poverty fell precipitously, and even global inequality has been falling in recent decades.[15](#_ednref15) This growth is a result of the ability of human labor to produce ever-increasing value, largely enabled by free markets and property rights. Understanding this phenomenon and its causes should be a crucial feature of contemporary literacy, lest we throw away the tenets, values, and institutions that saved and improved so many lives in our recent history. [![Empowering Book Cover](/sites/cato.org/files/styles/serial_cover_phone/public/2022-11/FireShot%20Capture%20186%20-%20%20-%20.png?itok=LIuU8TWS)](https://www.cato.org/sites/cato.org/files/2022-12/empowering-the-new-american-worker-macroeconomic-future.pdf) ### Download This Publication ##### Ensuring a Sound Macroeconomic Foundation [ Download PDF ](https://www.cato.org/sites/cato.org/files/2022-12/empowering-the-new-american-worker-macroeconomic-future.pdf) ##### About the Authors [![j-mironcropped.jpg](/sites/cato.org/files/styles/author_picture/public/2021-04/j-mironcropped.jpg?itok=dkHQXJBB)](/people/jeffrey-miron) ##### [Jeffrey Miron](/people/jeffrey-miron) Director, Graduate and Undergraduate Studies, Department of Economics at Harvard University [ ](https://x.com/jeffreyamiron) [ ](mailto:jmiron@cato.org) ![b-Soares-cropped.jpg](/sites/cato.org/files/styles/author_picture/public/2021-08/b-Soares-cropped.jpg?itok=YtiwiGJn) ##### Pedro Aldighieri Graduate Student in Economics, Pontifical Catholic University Show Endnotes Hide Endnotes ##### Notes [1](#_edn1). “World GDP over the Last Two Millennia,” Our World in Data. [2](#_edn2). “Malthusianism,” Wikipedia, June 11, 2022; Paul R. Ehrlich, *The Population Bomb* (Cutchogue, NY: Buccaneer Books, 2007); “The Global Population Hockey Stick,” Our World in Data, October 8, 2021; and Walter Scheidel, “Real Wages in Early Economies: Evidence for Living Standards from 1800 BCE to 1300 CE,” *Journal of the Economic and Social History of the Orient* 53, no. 3 (2010): 425–62. [3](#_edn3). Robert Whaples, “The Shortening of the American Work Week: An Economic and Historical Analysis of Its Context, Causes, and Consequences,” *Journal of Economic History* 51, no. 2 (June 1991): 454–57. [4](#_edn4). Organisation for Economic Co-operation and Development, “Hours Worked: Employment,” August 17, 2022. [5](#_edn5). “Life Expectancy vs GDP per Capita, PPP,” Gapminder; Markus Brückner and Mark Gradstein, “Income and Schooling,” VoxEU CEPR, April 4, 2013; “Child Mortality vs GDP per Capita, 2016,” Our World in Data, June 6, 2019; and Betsey Stevenson and Justin Wolfers, “Subjective Well-Being and Income: Is There Any Evidence of Satiation?,” Brookings Institution. [6](#_edn6). William D. Nordhaus, “Do Real-Output and Real-Wage Measures Capture Reality? The History of Lighting Suggests Not,” in Timothy F. Breshanan and Robert J. Gordon, eds., *The Economics of New Goods* (Chicago: University of Chicago Press, 1996), pp. 27–70; and “Lumen (Unit),” Wikipedia, June 24, 2022. [7](#_edn7). William D. Nordhaus, “Two Centuries of Productivity Growth in Computing,” *Journal of Economic History* 67, no. 1 (March 2007): 128–59. [8](#_edn8). David Dollar and Aart Kraay, “Growth Is Good for the Poor,” *Journal of Economic Growth* 7, no. 3 (September 2002): 195–225; and Max Roser, “Global Income Inequality,” Our World in Data, 2013. [9](#_edn9). Jacob Greenspon, Anna Stansbury, and Lawrence H. Summers, “Productivity and Pay: A Comparison of the US and Canada,” VoxEU CEPR, February 15, 2022; and Michael R. Strain, “The Link between Wages and Productivity Is Strong,” in Melissa S. Kearney and Amy Ganz, eds., *Expanding Economic Opportunity for More Americans* (Washington: Aspen Institute, February 2019), pp. 168–79. [10](#_edn10). “U.S. Federal Poverty Guidelines Used to Determine Financial Eligibility for Certain Federal Programs,” U.S. Department of Health and Human Services, Office of the Assistant Secretary for Planning and Evaluation, February 1, 2021. [11](#_edn11). PK, “Income Percentile Calculator for the United States,” *Don’t Quit Your Day Job* (DQDJY)(blog). [12](#_edn12). Jared Diamond, *Guns, Germs, and Steel: The Fates of Human Societies* (New York: W. W. Norton & Company, 1999); Luigi Guiso, Paola Sapienza, and Luigi Zingales, “Does Culture Affect Economic Outcomes?,” *Journal of Economic Perspectives* 20, no. 2 (Spring 2006): 23–48; Daron Acemoglu, Simon Johnson, and James A. Robinson, “The Colonial Origins of Comparative Development: An Empirical Investigation,” *American Economic Review* 91, no. 5 (December 2001): 1369–401; and Paul Krugman, “History versus Expectations,” *Quarterly Journal of Economics* 106, no. 2 (May 1991): 651–67. [3](#_edn13). Timothy Besley and Maitreesh Ghatak, “Property Rights and Economic Development,” Suntory and Toyota International Centres for Economics and Related Disciplines discussion paper EOPP/2009/6, London School of Economics and Political Science, 2009. [14](#_edn14). Philippe Aghion, Peter Howitt, and David Mayer-Foulkes, “The Effect of Financial Development on Convergence: Theory and Evidence,” *Quarterly Journal of Economics* 120, no. 1 (February 2005): 173–222; and Diego Restuccia and Richard Rogereson, “The Causes and Costs of Misallocation,” *Journal of Economic Perspectives* 31, no. 3 (Summer 2017): 151–74. [15](#_edn51). Max Roser, “Extreme Poverty: How Far Have We Come, How Far Do We Still Have to Go?,” Our World in Data, November 22, 2021. [ Download PDF ](https://www.cato.org/sites/cato.org/files/2022-12/empowering-the-new-american-worker-macroeconomic-future.pdf)