In a recent video with over a million views, former labor secretary Robert Rice gives a
three minute description of the truth about the economy. One of his key points is that,
adjusting for inflation, most people's wages have barely increased since 1980. Based on
this claim, Rice argues several other controversial points about how the U.S. economy is in bad
shape. But I think this claim about average wages demands closer scrutiny. If true, such
wage stagnation would indeed be a serious indictment of the U.S. economy over the past
three decades. Fortunately, Rice's claim is based on a statistic too faulty to take
at face value. If you care about this issue, you need to
consider also one, how inflation is calculated, two, the benefits other than wages that workers
receive, and three, the distinction between statistics and flesh and blood individuals.
Let's look first at inflation. Adjusting for inflation, especially over long periods
of time, is as much an art as it is science. Economists have developed several different
methods for calculating inflation, each of which is considered legitimate, but which
yield different results. It's true that the calculated average hourly wage, adjusted
for inflation using the Consumer Price Index or CPI, hasn't risen much over the past
30 years. That's the basis of Rice's claim. But what about the other methods for adjusting
for inflation, methods no less respected than the CPI? As recent research from the Minneapolis
Fed shows, using an index called the Personal Consumption Expenditure Deflator results in
average hourly earnings rising by 10 percent between 1976 and 2006 rather than falling
by 4 percent when adjusted with the CPI. Another widely respected inflation adjustor, the GDP
Deflator, finds that real average hourly earnings rose even more over those years, by 18 percent.
Those are just two of the other indices an economist could use. So I caution anyone against
basing a firm conclusion on a statistic from a single index.
One reason for the ambiguity in adjusting for inflation is that it's really difficult
to account for improvements in the quality of goods and services. For example, a television
in 2012 is a vastly superior product to one that you could buy in 1976. There's simply
no scientifically agreed upon way to account for such quality changes when adjusting for
inflation. My second point: fringe benefits that come
with jobs, such as health insurance. While reasonable people can disagree about how best
to measure inflation, no reasonable person disagrees that to accurately calculate a worker's
total compensation, all forms of compensation must be included, wages and salaries as well
as benefits. Because fringe benefits have become a larger share of workers' pay over
the past 30 years, looking only at wages and salaries gives a false picture of the progress
of worker compensation. For example, for the years 1976 through 2006, I estimate that the
inclusion of benefits in worker pay results in average hourly wages rising by as much
as 26 percent, depending upon the method used to calculate inflation.
My third point is the most important. Robert Rice confuses statistical categories with
real people. When Rice says that since 1980, most people's wages have barely increased,
he gives the impression that most people have enjoyed nearly no economic gains over the
past three decades. What he means is simply that the average wage adjusted for inflation
with the CPI hasn't gone up, but statistical results such as averages or medians can give
a very misleading picture about what's happened to individuals included in those groups. Here's
an example: Let's say that you annually keep track of
the average height of your three kids. This year, their average height is, say, four feet
two inches. Next year, you have a fourth child and you calculate the average height again.
The addition of that infant will lower your kid's average height even though each of
your first three kids have grown in height during the year. Clearly you wouldn't conclude
from the lower average height of your children that your children are shrinking in size.
That would be absurd. But the same reasoning applies to average wages.
The individuals behind the statistics have changed a lot since 1980. To name a few such
changes: workers like me have gained more skills and now earn higher pay. Others have
retired and others, very significantly, have joined the workforce for the first time. Especially
noteworthy is the increasing rate at which women and immigrants have entered the workforce.
These workers generally earn a lower than average pay, which pulls the statistic down,
but not necessarily the actual pay of actual people.
Rice concludes by saying that a strong economy needs a strong middle class. He's got that
right. But the path to a strong middle class is not, as he suggests, higher taxes on the
wealthy. Instead it's the path that made the U.S. economy great in the first place:
the hard work and great entrepreneurial ideas of individual people all acting in a free
market.