U.S. Productivity Becomes an Hourly Problem of Pay

With imports flooding in and American jobs disappearing overseas, productivity--a subject even economists find dull--has jumped front and center. Higher levels of productivity, we are told, can offset the Third World’s labor cost advantage.

It would be nice if that were true. Unfortunately, productivity growth in the newly industrializing countries is so rapid that we would be hard-pressed to match their growth rates, much less to surpass them. Korea, a country whose economic prowess frightens even the Japanese, saw worker productivity increase an average of nearly 5% per year from 1973 to 1983. Our productivity growth averaged 0.3% in the same period. America hasn’t seen 4% productivity growth since 1964.

This is only to be expected. Athletes make the biggest gains in the early stages of training; a country in the early stages of industrialization can expect bigger increases in worker productivity. An untrained work force just growing accustomed to industrial work will move rapidly up the productivity curve. Mature economies, like ours, have a harder time making gains.

There is more bad news. When companies decide where to build a new factory, they are not interested in labor productivity itself but in the “dollar productivity” of labor. They are not interested in the output per hour, but in the output per dollar of labor cost. Because Third World wages are so abysmally low, the dollar productivity of labor there is much higher than here.

To return to Korea, in 1983 manufacturing workers cost employers about $1.29 an hour, and produced about $4.20 worth of goods. For every dollar spent on labor, the Korean manufacturer can expect about $3 worth of output. In America, employees cost $12.26 an hour, and produced goods worth roughly $23. Here, every dollar of labor cost yields less than $2.

This differential means that even if we managed to match Korea’s rate of productivity growth, we would still lose ground to Korean manufacturing.

Suppose that output per worker per hour increases 5% in both countries while wages remain constant. In Korea, $1.29 worth of labor time would yield $4.41 of goods, and in America $12.26 would generate $24.15. This looks like good news. Output there rose only $.21, while here we gained $1.15.

But if we consider dollar productivity, things look different. With the 5% increase, $1 of labor cost in Korea would produce $3.42 worth of goods, up $.17. In America, that same $1 gives us $1.97, up only $.07. With equal productivity growth, America actually loses ground to Korea.

In order to keep from losing competitive ground to Korea, American productivity must grow much faster. We would need over 8% productivity growth--27 times our 1973-83 average--to match Korea’s growth. We have to run almost 30 times faster to keep from falling further behind.

It is extremely unlikely--virtually impossible--that American productivity could grow at this rate over time. We have not seen such rates in 40 years. Assuming, as seems likely, that productivity will continue to increase in Korea and the other newly industrializing countries, and that the dollar will not stabilize much below its current depressed level, there are only two ways to stop the flight of jobs without protectionism. Wages in other countries can rise until the dollar productivity of labor is more or less equal around the world, or wages can fall here.

In terms of the United States and Korea, this would have meant in 1983 either that labor costs in Korea should rise toward about $2.20 an hour, or that American wages should drop toward $5.50. For every cent that Korean wages do not rise to reach equilibrium, American wages would have to fall more than seven cents. There is no doubt that Americans would prefer rising Korean paychecks to falling American ones; there is also no doubt about which outcome would be better for both countries.

It should be remembered that exchange rate fluctuations can make significant differences in worker compensation costs. If a given currency falls 10% against the dollar in a given year, the dollar cost of compensation may be reported with a variance of 10%, depending on what reporting period the statisticians use. Perhaps more important to remember, there are significant incentives to distort labor statistics. There is a systematic tendency for statistics to look better than reality. The lowest-wage employers are those least likely to make full and accurate reports.

Even so, if American purchasing power falls significantly, the world will go into a depression that would make the 1930s look like a day at the beach. The American consumer keeps the world economy going; anything that undercuts U.S. buying power brings world recession closer. If Korean and other Third World wages rose, the economy would boom. These workers would want to spend their new income and new factories would have to be built to meet their needs--creating more jobs which would create more demand for new products and so on.

Competition is good. Let people raise their living standards by becoming more productive, but without some form of international parity for wages related to productivity, there can be no competition. American industry and American workers do not need protection so much as we need a level playing field. To find that level playing field has to be the main object of American trade negotiators.