The Pay Gap Is Real, But Not This Bad: Capitalism Is Raising Most Boats

Inequality is real and is a problem. The wealthiest people are benefiting disproportionately more than the average American worker from increases in national economic prosperity. But we don’t need to exaggerate this fact for the sake of stoking extra outrage. Doing so is not only dishonest, but it also makes people less likely to listen to people on the left who are talking about inequality. In this case, I am talking about a graph by the Economic Policy Institute (EPI) and versions of it that other people use to make an exaggerated claim about inequality.

EPI graph on the divergence of “productivity” and worker compensation.

The first issue is that what they’re labeling “productivity” is ambiguous in meaning, and is basically just another way of measuring national average income. This is fairly standard among economists, and it doesn’t necessarily indicate dishonesty, but it isn’t the best way to analyze the situation.

To derive productivity the EPI divides Net Domestic Product (GDP minus capital depreciation) by the number of hours worked. In other words, it is everyone’s pooled net income divided by everyone’s pooled hours worked. So, a more straightforward framing is that the graph is comparing the income of some workers–production workers–to everyone’s income. Labeling what is essentially average income as “productivity” is unnecessarily misleading, particularly for laypersons trying to interpret it. The divergence of production workers’ total compensation from average compensation would still be a problem, and dressing up average income as “productivity” is unnecessary to make that point.

Given that this way of measuring “productivity” is basically just measuring average income, the EPI’s choice to use two different deflators for productivity and worker compensation seems even less justified. This is where the EPI’s biggest error is.

To adjust for inflation of productivity they use the Net Domestic Product (NDP) deflator. However, to adjust for inflation with workers income they use the Consumer Price Index (CPI). This turns it into an apples to oranges comparison. Even then, let’s pretend for a moment that they’re justified in using two different deflators. Using the NDP for productivity may be reasonable, but using the CPI for workers compensation is not. There is a readily available superior option that the Federal Reserve uses, the personal consumption expenditures (PCE) price index. The Clevland Fed says the following:

The PCE price index has several advantages over the CPI that include its ability to capture the changing composition of spending that is more consistent with consumer behavior (including consumers’ substitution toward relatively cheaper items), as well as weights that are based on a more comprehensive measure of expenditure.

So why did the EPI use the CPI instead? They may have been doing what they thought was best, but it seems suspect since using the CPI unnecessarily massages the picture in a direction that’s convenient to an anti-corporation perspective. Using it makes it look like wages have improved much less than the PCE. Indeed, it is commonly believed by economists that the CPI overstates inflation by 20%, which the dark “CPI adjusted” line in the graph below adjusts for (Strain, 2019). These revised estimates are likely much closer to reality than compensation as portrayed by the EPI’s estimates.

Real Wages Using Different Inflation Indices (Sacerdote, 2017)

At least the EPI graphic is depicting total worker compensation. Some graphics attempt to make this exaggerated picture even more exaggerated by comparing only direct wage to productivity, which excludes other benefits (like healthcare) workers receive, which make up around 19% of their compensation on average (Strain, 2019).

Of course a much more honest and straightforward way of getting an accurate picture of the pay gap would be to dispense with the theatrics of “productivity” and just compare country-wide average compensation to production worker compensation and use the same inflation adjusting index for both. A noticeable gap would still be there, it would just be much less outrageous than the fear-mongers would be satisfied with.

We could also look at median income versus average. Median means that about half of the population makes more than you, and half of the population makes less. This is useful to get a reasonable view of the situation. Data from the Social Security Administration shows a disconnect, but a steady increase for both median and average from the period of 1991 through 2019.

Right-winger sources like the Foundation for Economic Freedom go too far in the opposite direction in their response to EPI. They correctly cite the problem with adjusting for inflation, but they get just about everything else wrong. They want to compare average wages to productivity to pretend as though there’s virtually no gap. But as we’ve discussed, average compensation and productivity is almost a tautology that is talking about the same thing. Average wage is absolutely not a good measure to rest your analysis on because ultra-high earners raise the overall average of everyone even though most people aren’t actually experiencing that raise. That is where the EPI is right. With the EPI, they use production non-supervisory workers (82% of all US workers). When 82% of US workers are be benefitting from an increased economy at half the rate of the top 1%, that is indicative of a problem. In that situation workers are still benefiting, but the argument they aren’t benefiting their fair share could reasonably be made.

Closing Thoughts

My biggest gripe about the EPI data/graph isn’t even about its bad methodology. The major problem I have is that it (and its derivative graphs) are used to push this false belief that the average worker in America today has not benefited at all from the US’s economic growth. Indeed, the common catch phrase frequently used on the political left is that “the poor are getting poorer,” that the common person is worse off now than this golden age in the past. This just flat out isn’t true. Yes, the rich are benefiting disproportionately more from our economic growth, and that is a problem we need to hold them accountable for. But the poor are still also better off now than they were twenty or thirty years ago. The poor and working class have seen a steady increase in prosperity decade after decade. Stansbury and Summers (2017) found that for every 1% increase in productivity, production/nonsupervisory worker compensation grew 0.4-0.7 percentage points. For median compensation it was 0.7-1.0 percentage points for every 1% increase in productivity. So even though it isn’t a perfect one-to-one ratio, all of us have noticeably benefited from the increase in productivity.

Often this narrative that the poor are getting poorer is used to say that capitalism has failed us and needs to be completely scrapped. In reality capitalism has elevated us to higher and higher prosperity. Don’t get me wrong, workers are often exploited and consumers are often duped, and this is why I support well-regulated capitalism. We knew that lead in gasoline was exceedingly dangerous for a long time, all the while corporate interests financed lies and obscurantism about it, preventing it from being outlawed. Something similar happened with tobacco and climate change as well. But despite these failures in our imperfect capitalistic system, the net effect has still been great prosperity for everyone. We need not throw out the baby with the bathwater.

The same day this article was originally published I stumbled on an example of leftists making these false claims about income, using it as proof of the failure of capitalism and the necessity to abolish it.

Many “socialists,” communists, anarchists, etc., accuse me of not being open-minded to a better system than capitalism. In reality I am highly open-minded, I just don’t buy their senseless utopian propositions about what to replace it with. When they come to me with a proposal that doesn’t require a nearly perfectly educated, just, and selfless population to work (which we absolutely don’t have), I’ll give them a listen.

Unfortunately, their proposed socialist and/or anarchist systems almost always approach things from how they wish people were, not how people actually are. Like with anarcho-capitalists on the political right, leftists reject empirically observed facts for the delusional belief that they have the fundamental principles of how everything works figured out. They ignore basic facts of psychology and turn their delusions into dogmatic political religions that they defend against all attacks, legitimate or illegitimate.

I’ll end here with an excerpt from The Open Society and its Enemies, by philosopher of science Karl Popper who clearly had political religions like Communism in mind:

They also believe that they have discovered laws of history which enable them to prophesy the course of historical events… This prophetic wisdom is harmful,… the metaphysics of history impede the application of the piecemeal methods of science to the problems of social reform…. There are some social philosophies which… preach the impotence of reason in social life… Why do all these social philosophies support the revolt against civilization? And what is the secret of their popularity? Why do they attract and seduce so many intellectuals? I am inclined to think that the reason is that they give expression to a deep-felt dissatisfaction with a world which does not, and cannot, live up to our moral ideals and to our dreams of perfection. The tendency of historicism (and of related views) to support the revolt against civilization may be due to the fact that historicism itself is, largely, a reaction against the strain of our civilization and its demand for personal responsibility.


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