Productivity growth increases wages

If the stock market had any measure of human rationality behind it, it would be responding better than it has thus far to the recent news that productivity in our economy during the last quarter was the best in 20 years. If there is anything better for the economy than productivity growth, I don’t know what it is.

Of course the market depends on lots of variables, not just productivity growth news, and there are certainly some things dampening the market right now. However, if productivity continues to grow a number of these variables should turn around and start contributing to heightened stock values. Recent corporate and individual tax cuts have played a significant role in this productivity growth with business responding to these stimuli by implementing new technologies-the root of much of the productivity rise.

Before we focus on productivity and wage increase we should quickly mention all the good that comes from productivity growth: A retarding of inflation, greater business profits, higher wages (and divided payments), and, therefore, greater demand for products, low interest rates, stronger business investment, more jobs, improvement in the balance of trade with less need for tariffs, stronger value of the dollar, opportunity for business to penetrate new markets as well as better compete in established markets, improved stock values, long-term increases in private retirement and social security paychecks, stimulation of additional rounds of productivity as mobile labor amplifies any techno-based growth by shifting from lower productivity companies to those enjoying the growth, and overall, a gain in our standard of living.

There are other benefits as well, but let’s focus on how productivity increase causes wages to increase, because this is one of the least understood and appreciated outcomes of advances in productivity – especially of techno-based advances. In fact, many people think that productivity up means employment decline and wage growth restriction. Indeed, a French economist/sociologist once wrote, “continual productivity growth in the world would one day lead to vast decline in the need for labor.” Of course, this hypothesis has long since been invalidated.

There are at least four ways productivity growth causes wages to increase. First, many employees participate in pay incentive programs, which tie individual income to organizational productivity improvements. Employees share in improved company profits resulting from these gains. Some of these programs provide employees with the major share of any improved profitability. Other programs reward employees significantly for the productivity increase, itself, even if resultant profit growth is minuscule due to offsetting factors.

Second, improved productivity means the marginal return (marginal revenue product for you economics purists) from a unit of labor increases relative to the marginal cost of labor, and this signals that a company will maximize profit at a higher level of labor input. That is, the company will wish to employ more labor to further build its profit picture. To attract this additional labor will require any productivity-improved companies to entice labor away from other companies. To lure this labor necessitates a bidding up of wages. Those other companies will respond to avoid losing excessive amounts of labor by bidding up their wages, too, to retain.

Third, since higher productivity means the marginal returns from labor increase relative to the marginal cost of labor, it will behoove companies to increase pay incentives for their present work forces in order to stimulate more production and thus get to the new, higher profit maximizing output volumes caused by the productivity increase. Technology-rooted productivity gains “drive” human performance gains. It pays companies to invest more in employee motivation (as well as training) to elicit still higher output – output beyond that achieved with the initial technology advance.

Fourth, employee “real” wage increases because higher productivity means more products available without higher prices and with more money available to buy it. This is why we say you enjoy a higher standard of living when there is productivity improvement. Greenspan has little reason to raise interest rates with regular productivity rise keeping the lid on prices. If the government wishes to put more money in the hands of its citizenry and strengthens the economy there is little else that makes more “policy sense” than providing incentive to America’s productive organizations to invest in the means for productivity increase.

General tax incentive helps but policy that directly funds, or targets tax cuts for, programs adopted by business that affect the determinants of productivity could be as valuable if not more so. Training programs, technology implementation experiment programs, work simplification programs, and employee incentive programs would be examples of programs as deserving of government funding as anything else.

Dr. Phil Grant is a management consultant and chair of the department of business administration at Husson College.