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Economies are Long-Run Processes

Paul Krugman, among others, has warned that today’s economy is scarily different from economies in the past.  His reasoning, as explained in this June 16, 2006, column in the New York Times, is this:

In fact, the distinctive feature of the current economic expansion —
the reason most Americans are unhappy with the state of the economy, in
spite of good numbers for the gross domestic product and explosive
growth in corporate profits — is the disconnect between rising worker
productivity and stagnant wages.

I’ve never bought the implication that productivity is really disconnected from workers’ compensation.  Capital is too fluid and the American labor market too competitive for such a "disconnect" to be lasting.  The fact that such a "disconnect" shows up in economic reports reveals more about the shortcomings of inferring long-term trends from the happenings during arbitrary (and ususually short) time periods such as "month," "quarter," or "year."

Now today’s Boston Gbobe has this report, entitled "Pay outpaces productivity: inflation feared."  And here’s a letter that I sent to the Globe in response:

Dear Editor:

months we’ve been warned that the current economic recovery differs
ominously from past recoveries because worker pay now is rising more
slowly than worker productivity.  But in today’s paper we read that
"Growth in productivity – the key ingredient for rising living
standards – skidded to a standstill in the late summer while workers’
wages and benefits shot up at the fastest clip in more than two
decades" ("Pay outpaces productivity: inflation feared," Nov. 3).  In
other words, workers’ pay is catching up with their productivity, just
as economics predicts.

Economies are long-run processes; they
should be evaluated as such.  What happens in any arbitrary time period
– a month, a quarter, or even a year – typically is too filled with
short-run distortions and lags to present a reliable picture of an
economy’s long-run trajectory.

Donald J. Boudreaux

By the way, just as we have no real reason to fear that wages will not keep pace with worker productivity, we also — for a variety of reasons — have no reason to fear that rising wages will cause higher inflation.