There is a widespread belief in America that productivity
is rising but workers are not receiving the fruits of their labor.
Citing government data that wages have lagged far behind increases
in worker productivity in recent years, many politicians and
journalists contend that America is becoming less economically
mobile. This mistaken belief is the result of two
First, it is incorrect to focus on workers' cash income
instead of their total compensation. Total compensation
includes such increasingly important components of workers' pay as
health benefits, contributions to retirement plans, and paid
vacations. These and other employer-provided benefits are not cash
income, but they do contribute to workers' well-being.
Second, those claiming reduced mobility often use the
wrong measure of inflation to calculate inflation-adjusted pay. By
using the consumer price index (CPI) instead of the implicit price
deflator (IPD), these calculations overstate inflation and
understate wage growth. The result of this mistake is that wage
growth will almost always appear to lag far behind
productivity growth, even when workers are making gains.
When compensation is used instead of income and the correct
inflation measure is used to calculate inflation-adjusted
compensation, the data show that total compensation has actually
increased in tandem with worker productivity. Contrary to the
critics' arguments, the data on compensation do not indicate
any reduction in economic mobility.
Commonly used data appear to support the claim that workers'
earnings have not grown as fast as their productivity, suggesting
that many workers are being left behind as the economy moves ahead.
Chart 1 shows the growth in productivity and
inflation-adjusted median family income since 1987. In this
chart, income was adjusted for inflation using the CPI.
The chart shows that, using these measures, productivity has
grown much faster than family income since 1987. While the median
family income rose by 10 percent between 1987 and 2005,
productivity increased 49 percent. This has led many to conclude
that workers are losing ground. However, this particular choice of
data masks the true picture.
More Than Just Cash
Economic theory suggests that as workers become more productive,
firms must pay them more or risk losing them to competitors who
offer more money. Chart 1 seems to contradict that theory.
Economic theory, however, does not specify what form worker
compensation will take: It need not be cash.
The definition of income used in Chart 1 and in most reports of
family and household income comes from the U.S. Census Bureau. It
includes wage and salary income, bonuses, commissions, tips, and
most other forms of cash income, but it does not include
This income measure omits all of the other benefits that
employers provide, such as paid time off, health insurance, and
retirement contributions. These benefits contribute to workers'
wealth and well-being and should be included in any measure of
financial well-being. The measure of pay that includes these
benefits, along with wage and salary income, is total
Income, Compensation, and Earnings
Reporters and pundits often use the terms "income,"
"compensation," and "earnings" interchangeably without
appreciating the differences between them. Though closely related,
these terms are separate and distinct measures of financial
well-being, and using them interchangeably can create
misimpressions that present a distorted picture of workers'
Income consists of most forms of cash income to workers.
This measure includes wages, salaries, tips, commissions, and
bonuses, as well as interest payments and dividends. It also
includes pension payments, Social Security income, and any
government welfare benefits paid in cash. It does not include
fringe benefits and other non-cash payments.
Total compensation consists of both cash payments and
non-cash benefits that workers receive from their jobs. As with
income, this measure includes wages and salaries, but it also
includes non-cash compensation, such as health insurance, employer
contributions to employee retirement plans, and paid vacation days.
In addition, it excludes income from non-work sources such as
interest from bank accounts and Social Security income.
Earningsis the sum of
wage or salary income and net income from self-employment. This
measure represents cash income earned by working: the amount of
income received regularly before deductions for personal
income taxes, Social Security, union dues, Medicare deductions,
etc. It does not include unearned income such as
pension payments or government benefits, nor does it include
non-cash benefits such as paid time off.
A Rising Portion of Compensation
Benefits have risen much faster than wages in recent years, both
in absolute terms and as a share of total compensation. Benefits
represent a very real cost to employers and provide equally real
gains to employees. Leaving them out of the picture ignores this
Table 1 shows the percent increase between 2001 and 2006 in
employer spending on several benefits that are important to
workers: paid time off work, health coverage, and retirement
account and pension contributions. Contrary to the popular
impression that only health care spending has increased, spending
in all of these categories increased at double-digit rates.
All of these benefits cost money. Each dollar an employer
contributes to a 401(k) plan is a dollar that it does not pay as
wages. Chart 2 shows the proportion of total compensation that
workers receive as non-cash benefits. Since 2000, employers have
increased the proportion of workers' compensation that is paid out
in benefits and so decreased the proportion that workers
receive as cash.
Looking only at cash income ignores the real gains that workers
have seen in the form of rising benefits. Chart 3 shows
productivity growth and total compensation growth since 1987. The
gap between productivity and pay, though still large, is
significantly narrower than in Chart 1. While productivity has
risen 53 percent, workers' total compensation has risen 28
Measuring Inflation Accurately
Any serious look at changes in workers' pay over time must
compensate for the effects of inflation. The government
measures inflation in many ways, and it is important to use the
appropriate measures. Most attempts to compare income or
compensation with productivity, including Charts 1 and 3, adjust
pay for inflation using the consumer price index (CPI). This is a
serious mistake for two reasons.
First, the CPI is based on changes in the prices of goods
that Americans consume, while productivity is based on changes in
the prices of goods that American workers produce. These are not
identical, so using one measure to adjust compensation and
another to adjust productivity is like mixing apples and
Second, the methodology used to calculate the CPI differs
from the methodology used to adjust productivity data for
inflation, and the CPI's methodology reports higher inflation
estimates. Therefore, the standard income-productivity comparison
will artificially suggest that inflation-adjusted productivity is
increasing more rapidly than inflation-adjusted compensation.
Comparing Apples to Oranges
The government measures productivity using the value of the
output that American workers produce. To calculate real
changes in output, the Bureau of Labor Statistics adjusts for
inflation using the implicit price deflator, a price index based on
changes in the prices of the produced goods. The CPI is based on
the prices of goods that Americans consume, not the goods they
Though the categories of goods produced and goods consumed do
overlap, they are not identical. Americans produce many goods
and services for export, and they import other goods rarely
produced by U.S. workers. This difference matters because, for the
purposes of comparing wages to productivity, the CPI will
overstate inflation when the prices of consumer goods rise faster
than the goods Americans produce. Adjusting inflation with a
productivity-based price index instead of the CPI allows an
apples-to-apples comparison of pay and productivity.
Consumer Price Index vs. Implicit
As an example of how the consumer price index differs from the
implicit price deflator, consider that America exports professional
business services (e.g., accounting, advertising, and management
consulting) to foreign companies and imports oil. The prices
of these services have been fairly stable, while the price of oil
has risen. If all else is held constant, adjusting wages using the
CPI would suggest that real wages are falling because the
price of the good that U.S. workers consume--oil--has risen; but
IPD-adjusted real wages would be constant because the prices of the
goods that workers produce--business services-- have not
The IPD adjustment is more appropriate because productivity
has not changed. Thus, a drop in CPI-adjusted wages because the
rising cost of oil boosts the CPI would not mean that workers are
being denied the value of what they have produced: Their employers
are not somehow earning more and paying less because of the higher
price of oil. In this example, the employers' business services
have not become more valuable, so worker productivity has not
increased. Thus, the employers are not withholding the fruits of
productivity gains from their workers, even though CPI-adjusted
measures of pay would misleadingly suggest otherwise.
Inferior Methodology and Inherent
The IPD measures inflation more accurately than the CPI. The CPI
measures inflation by surveying how the price of a basket of goods
that consumers purchase changes over time; it does not reflect
changes in consumption patterns that occur after the basket was
selected. Economists widely agree that this causes the CPI to
overstate the true level of inflation.
As an illustration, consider that the current CPI basket was
used to measure consumption in 2001 and 2002. Cell phone use has
increased sharply since then, while the price of cell phones has
fallen, leaving consumers much better off. The CPI does not account
for much of this, however, because relatively fewer consumers
bought cell phones five years ago than do today.
A chained price index, by contrast, takes into account changing
consumption patterns from year to year and is a more accurate
measure of inflation. Chained price indices also usually report
lower inflation rates than are reported by the consumer price
index. The IPD used for calculating productivity growth is a
chained index and reports noticeably lower inflation rates than
does the CPI.
Chart 4 shows year-on-year percent changes in both the implicit
price deflator and the consumer price index. The CPI is
consistently higher than the implicit price deflator. Between 1987
and 2006, the CPI increased by an average of 0.7 percentage point a
year more than the IPD. While the CPI increased 74 percent over
this time, the IPD increased just 53 percent.
If wages are adjusted for inflation using a measure that
overstates inflation and productivity is adjusted using a more
accurate chained index, compensation will appear to grow more
slowly than productivity, even if compensation and productivity
grow at the same rate. This is because the less accurate CPI
records higher inflation rates than the IPD, making compensation
appear smaller once it is adjusted for inflation.
This is very important in the debate over earnings. As an
example, suppose that total compensation doubled over the past
20 years before adjusting for inflation. Also suppose that the CPI
reported that the price level had doubled over those two decades
and that a chained index reported that price levels increased just
50 percent. Adjusting total compensation for inflation using the
CPI would indicate that inflation-adjusted pay had not changed at
all over the 20 years, but adjusting total compensation for
inflation using the chained index would indicate that
inflation-adjusted compensation had increased by one-third,
leaving workers much better off. In this way, an artificially high
measure of inflation overcompensates for price increases and
makes inflation-adjusted compensation appear lower than it actually
Other Important Factors
Comparing median wages to average productivity does not
necessarily reveal whether workers' pay is rising in step with
their productivity, because the Bureau of Labor Statistics does not
calculate median productivity growth, only average
productivity levels. If productivity growth were
concentrated among one group of workers, such as college
graduates, those workers' wages would rise. This would cause
average wages to rise, but median wages would move little if
non-graduates' productivity did not also improve. In this way,
comparing average productivity to median wages gives the misleading
impression that workers are not receiving the fruits of
increased productivity when in fact those workers who have
become more productive are earning higher wages.
Recent research suggests that this may be happening. A
substantial portion of the increased inequality in America in
recent years can be explained by the fact that the use of
performance-based pay has increased. Especially productive workers
are getting raises that match their productivity. This
increases average compensation but has little effect on median
In addition, demographic shifts can skew median family income
figures. Divorce rates have risen since the early 1970s. A
two-income family with the husband earning $50,000 and the wife
working part-time and earning $25,000 has a total family income of
$75,000. After a divorce, government statistics would report
the couple as two separate families, one with an income of
$50,000 and a second with an income of $25,000. A rise in divorce
rates or a drop in marriage rates tends to lower median family
income, even if wages and salaries remain unchanged.
The Complete Picture: Compensation Has
Grown with Productivity
Using the more accurate implicit price deflator to calculate
productivity growth and compensation growth reveals that
compensation has grown in line with productivity, not lagged,
during the past 20 years. Chart 5 shows productivity and
compensation growth over the past 20 years, using the IPD to
adjust compensation for inflation.
As the chart shows, using the right measure of inflation and
looking at total compensation--not just cash income--almost
eliminates the difference between compensation growth and
productivity growth. Productivity has grown 53 percent since
1987, while real compensation has grown 46 percent. At several
points during the late 1990s, compensation growth even exceeded
It is true that productivity has risen somewhat faster than
compensation since 2003, but this also happened in the early 1990s
and is not an unusual long-term pattern. Wages caught up to
productivity in the late 1990s, when low unemployment forced
employers to compete for increasingly productive workers. There is
every reason to expect a similar outcome in the near future.
Workers are not missing out on the fruits of their rising
productivity. Compensation appears to have fallen relative to
productivity only when analysts, journalists, and politicians use
the wrong price index to adjust it for inflation and overlook the
difference between cash income and total compensation.
Using the implicit price deflator--the same measure that
the government uses to adjust productivity figures for
inflation--shows that there is no large gap between compensation
growth and productivity growth. It is time for policymakers
and others to retire erroneous and misleading measures that
suggest that American workers are falling behind and instead
present the data and their conclusions honestly and
James Sherk is
Bradley Fellow in Labor Policy in the Center for Data Analysis
at The Heritage Foundation.
is the most recent year for which the Census Bureau reports median
family income data.
Because compensation data come from surveys of
firm payrolls, not individual employees, only the average
compensation for the entire economy (or within a specific industry)
can be calculated; it is not possible to calculate the total
compensation paid to the median worker.
e.g., Robert J. Gordon, "The Boskin Commission Report: A
Retrospective One Decade Later," National Bureau of Economic
Research Working Paper No. W12311, June 2006, at http://ssrn.com/abstract=910843.
Department of Labor, Bureau of Labor Statistics, "Consumer Price
Indexes: Frequently Asked Questions," May 10, 2007, at www.bls.gov/cpi/cpifaq.htm.
Thomas Lemieux, W. Bentley MacLeod, and Daniel
Parent, "Performance Pay and Wage Inequality," National Bureau of
Economic Research Working Paper No. 13128, May 2007, at