Friday, December 13, 2013

Medicare vs. Stagnant Wages: Cause & Effect By Rick Kelo

Medicare vs. Stagnant Wages: Cause & Effect
By Rick Kelo

There have been a great many articles written about how wages are flat.  I am going to show you exactly why wages have been flat since 1973 and show you a couple common fallacies & myths associated with this topic.
Myth 1:Let's start with the good news at least.  The good news is that it is a myth that overall wages are flat.  Actually overall wages are increasing.  Most loose populist articles fail to identify a very important disclaimer: they are only referring to the wages of a certain sub-set of the overall economy.  Overall wages have risen nearly every year, but not so for this particular sub-set of non-supervisory, production level workers.
This is a very important component for a society, but it is often conflated to imply that overall wages are stagnant which is untrue.
Myth 2:
This is one to remember as you read future articles on this topic.  I'm not going to elaborate on it here other than to point it out so you're aware of it.  Wage growth is generally graphed alongside productivity.  This is completely fallacious approach and, in my opinion, usually used to mislead.  Productivity does not determine wages at the macroeconomic level, which we will be examining here.  Perhaps for the individual worker it influences (not determines) wages, but at the macro level wages are set by a concept called the overall marginal productivity of labor and depend on many more factors than the general, non-marginal productivity number they're often graphed against.
The Back Story on Flat Wages:
Now to the specific topic of flat wages.  Below is a graph that is frequently thrown around.  Various versions now exist, but this is the original from Dr. Lawrence Mishel at the Economic Policy Institute.

It shows how wages for the labor sub-set of non-supervisory, production level employees became flat in 1973.  It is graphed against productivity to imply that workers are producing more but not being paid more.
Let me note that Dr. Mishel's graph is based on some "special" unpublished BLS data.  I fact check everything I include in my articles, and am opening with the disclaimer that the Mishel graph is not readily verifiable.  I contacted Mishel several times to request the data for his graph to no avail.  Regardless I consider it accurate.
Reinhart Rogoff reminded us this can sometimes be a dangerous assumption.  As I pointed out recently the CBO is occasioned to make announcements of fact based only on modeled projections and the BEA is occasioned to make major revisions to its GDP calculation methodology under dubious circumstances as well.  So, trust me, I value reading the fine print and I always encourage others to do so.  Despite that, for this article I am going to accept the Mishel wage graph prima facie.
The Facts on Wage Rates
As you can see wages for the non-supervisory, production sub-set break from the historic trend of growing in near tandem with productivity starting in 1973.  This was caused by a very major economic change that occurred in America that same year.
I'd have preferred to use the Mishel data since this graph is the most widely circulated.  Since I wasn't able to do that I, instead, obtained historic nominal wage data from Dr. Sam Williamson & Dr. Larry Officer, both professors of economics where I went to grad school in Chicago.  (As a quick FYI for the reader Williamson & Officer specialize in economic history and are involved in a very valuable project called Measuring Worth that makes high quality historical economic data widely available.)
That said, I took the Williamson/Officer nominal wage rates for non-supervisory, production level employees.  I then converted them to real wages using the BLS inflation calculator (SOURCE) for the period from 1949 - 2012.  The result was similar to the Mishel graph, however, it does not explain WHY wages for this sub-set have been flat.  
The Cause Of It AllWhat changed in 1973 that derailed the growth in wages?  Simple: America phased in a new payroll tax code-named Medicare.  The Medicare payroll tax was introduced in 1966 and slowly ramped up to full force in a series of 4 metered increases spread over 8 years from 1966-1973.  In 1973 the Medicare payroll tax rate underwent its far & away largest increase and jumped to 2%.  It eventually underwent 4 more rate increases until arriving at 2.9% in 1985 where it remains to this day.
Wages are still growing at the same rate they were before, but now Medicare is redirecting that growth into the hands of a government bureaucracy and out of the hands of the employee.  The hardest hit have been those at the bottom: the non-supervisory, production level workers.  
Look at wage growth and Medicare rates side by side:

The previous 2.92% wage growth is now being skimmed off the top by a 2.90% Medicare payroll tax.  Compare the changes by time period with wage growth above.  I have graphed them below.  The thick red & thick blue lines are the trendlines with equations included to draw your attention to their near identical inverse slopes.  If we mute out wage variations due to the business cycle and examine the two trendlines ceteris paribus they have a correlation coefficient of exactly -1.00.   As Medicare rates increase, real wage growth for production level, non-supervisory employees decreases.  

ConclusionWhen examined it becomes apparent the blame for stagnant wages is not a failing of private business or the free enterprise system as is usually the conclusion when this topic comes up.  The lack of real wage growth is a distortion caused exclusively by government action.  Americans love to vote themselves access to more and more government programs, unfortunately there's no free lunch. 

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