The Great Decoupling in Itself is Not the Problem

In two recent Wall Street Journal opinion pieces – “The U.S. Needs a New Social Contract” and “Closing the Productivity and Pay Gap” – William Galston presented an in-depth analysis on the widening gap between productivity and wages. He calls the divergence between these two metrics the “Great Decoupling” and believes it is a defining phenomenon of our era. A significant share of income has shifted from labor to capital. According to Glaston, “In 1947, labor received 67% of nonfarm business output. At the end of 1973, that figure still stood at 66%. In 2012 (the latest year for which data have been released), labor received only 58% of total output, the lowest by far in the entire postwar period.” Galston’s concern on this issue is tied closely to the inequality issue that has been a recent hot topic. While he presents compelling ways to fix this problem, Galston fails to recognize the root causes and shows a gross misunderstanding of economic principles.

The divergence in productivity and wages stems primarily from efficiency gains. As technology has improved, automation and computers have taken over many tasks once performed by hand and productivity has increased dramatically without the need for new workers. Galston fails to mention this point at all and it is very important. Technological progress drives long run growth in macroeconomic models and makes everyone better off. In the short-run technological advancements will shift income to owners of capital, but in the long run this should even out as new industries and jobs are created that did not exist previously. It is also important to think about this issue in absolute terms, rather than purely relative. While it is true that labor is receiving a smaller share of total income than it did through much of the post-war period, in absolute terms workers are better off than through most of that period.

A second issue that Galston fails to recognize is that in a competitive labor market the equilibrium wages should be equal to the marginal product of labor. If the marginal product of labor is higher than wages, firms could increase profits by hiring additional workers. Eventually the marginal product reaches a point where it is equal to the wage and it is not longer profitable for firms to hire additional employees. The point that Galston fails to realize is that, from a micro level, in order to increase wages we need to increase marginal product of labor.

The best way to increase marginal product of labor and therefore wages are to increase education so workers are able to utilize the advances in technology to increase their own productivity. Education reform should be a more pressing issue than it is in order to sustain economic growth. Many unskilled workers likely have a marginal product of labor that is below the current equilibrium wage level and so it does not make sense for firms to hire them. A focus on providing education to the unskilled workers could improve the plight of the poorest American’s, while unlocking productivity from a currently under-utilized labor source. Galston proposes some education reform in his piece and he is right about that – he just needs to realize that the “Great Decoupling” itself is not the problem, but rather a symptom of deeper trends in the economy.

One thought on “The Great Decoupling in Itself is Not the Problem

  1. meethoon

    I agree with you that the marginal product of labor will led to higher wage, and your solution is also plausible and convincing. At the same time, I believe unskilled workers are not necessary unskilled because they do not received or chance to learn, but there are more people who are just lazy to learn and equipped with proper skills. Thus, I would like to add that education reform should be only benefited toward who are willing to learn!

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