For quite some years now we have talked about the Fourth Industrial Revolution and how it will create a new era of high growth and increased wealth. However, despite major leaps forward in computers, robots, wearable technology, wireless communication, and artificial intelligence, the effect has not materialised. Most of the Western world experiences low economic growth, stagnating productivity, low investment levels, and slow if any growth in wages for the great majority. This happens despite steady growth in employment in recent years. As the Nobel Prize winner in economy, Paul Krugman, has stated, it remains peculiar how we’re simultaneously worrying that robots will take all our jobs and bemoaning the stalling out of productivity growth. What is wrong?
Ryan Avent, senior editor at The Economist, believes he has an explanation: low wages reduce the incentive to invest in labour-saving technology, and this slows productivity growth.
Full or partial automation of jobs pushes people into unemployment and subsequent employment in lower paid jobs, and the threat of being replaced by a robot makes workers accept low wage growth or even pay cuts. Thus, companies can save on expenses and increase profits without having to increase productivity through innovation, automation, or other technological effectivity improvement: something that can be bothersome and expensive in the short term and thus reduce short-term profits. The problem, therefore, according to Avent, isn’t that the introduction of new technology to workplaces is happening too fast, but rather that it is happening too slow.
The paradox, then, is that the digital revolution has reduced the cost of labour, and the low cost of labour inhibits the further digital revolution and thus overall economic growth.
The question is if Avent is right.
If low wages reduce incentives to increase efficiency and thus inhibit productivity growth, earlier periods with low wages ought also to have resulted in low productivity growth, but is this the case?
The US-based Economic Policy Institute (EPI) has published historic figures for wages and productivity in the United States, and they paint an interesting picture. In the decades following the end of World War II, both productivity and worker wages increased rapidly and steadily. In the quarter century from 1948 to 1973, productivity rose a total of 96.7 percent, while worker wages rose almost as much, namely 91.3 percent (both adjusted for inflation). In 1973, however, we see a sudden and dramatic change. Since 1973, inflation-adjusted wages for American workers have hardly increased — only 12.3 percent total up to 2016 — while productivity rose 73.7 percent over the same period. Productivity growth after the break, however, is only half as great as before: 1.3 percent annually compared to 2.7 percent in the post-war decades, with productivity growth being lowest in the periods with the lowest wages. Thus, there may be some truth to Ryan Avent’s argument, even if it is hard to say what is cause and what is effect. Does productivity stagnate because low growth in wages reduce incentives to improve efficiency, or do wages stagnate because sufficient growth in productivity isn’t achieved?
No matter what is cause and effect, it is remarkable that even though productivity growth is down after 1973, it is still significantly higher than the growth in worker compensation. This means that company income increases faster than the company’s wage expenses, and thus the company’s owners and CEOs can increase their income without creating radical improvements through innovation or large-scale automation. EPI statistics do in fact show that where the CEO of a major company in 1973 on average earned 23.7 times as much as an average worker, by 2016 this ratio had increased to 275.6 times. Thus, the owners and managers of companies can profit from low productivity growth if the growth in worker compensation is even lower.
What happened in 1973?
The question then is what happened in 1973 to create the overserved break in the curves, where overall productivity growth was cut in half and worker wages almost ground to a halt.
1973 is the year of the first big oil crisis, where oil prices (and hence energy prices) more than tripled in a single year, with another doubling in 1979, until prices in the early 1980s again fell to something near the original level. In spite of these crises and the subsequent brief recessions, the United States experienced rising economic growth during the 1970s, with a growth in 1978 greater than any year since the early 1950s. In return, economic growth declined in the early 1980s, when oil prices also dropped to a stable, low level. Despite the wild economic swings in the economy as such, productivity growth was quite steady during the 1970s and 1980s, while real wages slowly declined. Thus, the oil crises and their aftermaths can’t be seen in the development of productivity and worker compensation, except perhaps as the starting gun for disconnecting the relationship between the two.
The 1970s were also very much characterised by stagflation, where most western economies experienced high inflation at the same time as high unemployment and low economic growth. Even though many economists point to the oil crisis in 1973 as the beginning of stagflation, the United States and especially the UK were plagued by high inflation and unemployment already in the late 1960s: now economists point to Nixon’s 1971 economic interventions, which among other things included increased import tariffs and a 90 days freeze of prices and wages, as contributing to creating the stagflation crisis. The stagflation crisis ended in the early 1980s, when oil prices, inflation, and unemployment began to drop; but as with the end of the oil crisis, the end of the stagflation crisis can’t be read in the development of productivity and worker compensation.
In the absence of better explanations, it does make sense to point to the oil crisis, which hit at a time when Western economies were already suffering from beginning stagflation, as the initiator for disconnecting wage growth from productivity growth, but what is the explanation for the continued disconnect after the end of the oil and stagnation crises? It is tempting to point to Ronald Reagan’s economic policies from 1981, which were characterised by top-bracket tax breaks, freezing minimum wages, and laissez-faire financial policies. On the other side of the Atlantic, British premier Margaret Thatcher introduced similar measures. These policies ensured that companies and their owners earned more without having to innovate and thus reduced inducements to invest in efficiency improvements through new technology.
Decade by decade since the 1960s, growth in the Western world has declined as the gap between productivity and wages has increased, and even though the West currently experiences renewed growth after the financial crisis, the question is if this will last. Historically, economic growth has always been high in the aftermath to recessions, but growth has also always declined again once the losses have been recouped and have then stabilised, often at a lower level than before the crisis hit. For this reason, high growth figures for a few years should not lead one to think that the growth will just keep going at full steam. Low growth in productivity and wages is a warning sign that, if we are to believe Ryan Avent, indicates that we in the West are too slow at implementing new technology.
Companies may increase their profits by keeping employee wages down compared to the prices of their products and services, but that doesn’t create sustainable economic growth. On the other hand, innovation, automation, and other technological efficiency improvements, despite short-term expenses, lead to real, long-term productivity growth and thus long-term economic growth, which in turn leads to new investments that may create new jobs. It therefore makes political sense to create incentives for companies to invest in innovation and new technology and avoid measures that makes it possible for companies to retain or increase their profits without investments, such as freezing worker wages or giving tax breaks to companies and their owners.