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Decoupling Revisited: Who is reaping the benefits of economic growth?

Economic growth is something that almost everyone agrees is important: it’s how we enlarge the pie so that incomes can rise. Still, it is theoretically possible for the economy to grow with the benefits only going to corporate profits or a few wage earners at the very top. When this happens it is called “decoupling” because wages and productivity stop rising in tandem. Recently, a number of people have been arguing that decoupling is indeed occurring.

However, it turns out that can be more difficult than you expect to determine whether decoupling is happening, and, if it is happening, what might be causing it. Simple graphs can be deceptive: What is meant by wage growth? Should mean or median wage be used? What subset of workers does it make sense to study? Should non-wage benefits be included? Additionally, there may be significant measurement issues associated with certain statistical series, particularly those involving inflation and measurements of value added because of their significant complexity.

Previous work from ITIF has shown that many of the claims of decoupling may be overstated due to the rise in benefits and several other factors. Now, a new paper by Joao Paulo Pessoa and John Van Reenen confirms our analysis. Pessoa and Van Reenen examine wage and compensation growth in the USA and the UK and find that the decoupling between US wages and US productivity can be explained through 3 factors: inequality (i.e., the gap between mean and median wages), growth in benefits, and issues with the measurement of inflation. Pessoa and Van Reenen find a larger gap from inequality than our ITIF paper, although in part this may be due to using newer data.

This means that economic growth is still benefiting everyone, but some people benefit more than others due to rising inequality. Moreover, a large chunk of our increasing incomes are getting soaked up by benefits—which are also unequally distributed.

What can we take away from all this? First of all, the differences from inflation measurement are a good reminder that measurement is complicated and we need to adequately fund our statistical agencies so that they can provide us with the most accurate statistics possible. In particular, the budget battles of the past few years and the sequester have hurt agency budgets significantly.

Second, the fact large portion of income that went to benefits is clearly related to increases in health care costs. This is why keeping healthcare costs down is so important—the jury is still out on whether Obamacare will help slow rising costs, but technology is another place we can look to for more efficient care.

Finally, income inequality in the United States is getting worse, even if it’s less than headline numbers might suggest, and it is not going away. The migration of unionized production jobs due to NAFTA and trade with East Asia combined with the rise of the financial sector is a major cause of the problem. However the problem is also that U.S. competitiveness is lacking: we must provide a competitive business environment that attracts investment and keeps on the cutting edge of new tradeable technologies. We need this because we still need economic growth. Faster growth makes labor scarce and gives workers more bargaining power; this tends to decrease inequality across the entire economy. Raising the minimum wage can also help reduce inequality and possibly spur productivity growth as well.

(photo credit: Matti Mattila)

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