All Commentary
Tuesday, March 1, 1960

Wages, Productivity, and Prices

Dr. Wallis is Special Assistant to the Presi­dent of the United States and Executive Vice-chairman of the Cabinet Committee on Price Stability for Economic Growth, on leave as Dean of the Graduate School of Business, University of Chicago. This article is from his remarks of November 19, 1959, before the National Industrial Conference Board at Chicago.

The long and rapid rise in pro­ductivity in the United States has occurred not because people work harder—in fact, our grandfathers almost all worked longer hours at heavier tasks than we do—but be­cause people work more effectively. The increase in the effectiveness with which people work results in considerable part from increases in education, in skills, in health, and in general well-being. The rising quality of the labor force, in short, is an important source of productivity increases.

A related source of productivity increases is new knowledge, some produced by research in industrial, university, and government labo­ratories but much developed in an informal way on all kinds of jobs where ingenious people make in­numerable small or large improvements in their methods of doing things.

Productivity increases also as more and better capital equipment is used. One man with a steam shovel can move more earth than many men using only hand tools. Even without improvement in the quality of equipment, an increase in the amount used can bring a rise in output per man-hour. In general, however, as we accumulate capital, we incorporate in it the findings of research, so that we have not only more but better capi­tal equipment. But capital includes more than just tools and ma­chinery. For example, the im­provement of roads, harbors, communication networks, water supplies, and sanitary facilities can all contribute to rising produc­tivity.

Just as the tools with which people work are important to their productivity, so too are the natural resources at their disposal. Ask a farmer about the importance of good land or a miner about the importance of the richness of the seam he works. The discovery and development of more and richer natural resources results in in­creased productivity.

Increased productivity also re­sults from more effective organi­zation of the nation’s human and material resources, so that each input is used where it can produce the most value. The organizing job is performed mostly by man­agement, and improved methods of management increase the rate of growth in productivity. An im­portant contribution of managers is in seeking and developing new products and new methods, and especially in risking the funds necessary to try innovations that often prove costly failures. The responses people make on their own initiative to differences in wages and prices also result in labor, capital, and natural re­sources moving toward their most effective uses.

As manpower shifts from, or avoids, low-productivity jobs where pay must be low, and moves to higher-productivity jobs where pay is higher, productivity in­creases for the economy as a whole, even though productivity in each industry separately may re­main unchanged. Similarly, the efforts of owners of capital and natural resources to get a high re­turn lead them to employ their property where the demand for it is greatest. Competition for the buyer’s dollar and the incentives offered in a free economy by wages, prices, and profits play a vital role in directing our efforts and stimulating efficiency, as well as in rewarding them.

Increases in productivity arise, then, from the efforts of people in all walks of life. They are not at­tributable to any single group. Even a group whose measured productivity happens to be rising cannot necessarily claim special credit, for its rises may be due primarily to increases in the quan­tity and quality of the people, capital, natural resources, man­agement, and technology with which it works. Labor, capital, natural resources, management, and technology jointly produce our output, and an increase in the quantity or quality of any one of them will increase the output per unit of input of the others.

Productivity and Earnings in One Industry

The various measures of pro­ductivity all give us some insight into the process by which our standard of living rises, and they therefore have some bearing on the average gains that workers can expect to obtain through in­creases in average earnings or de­creases in average consumer prices. In evaluating specific wages and salaries, however, there is no similar rule or formula of broad applicability.

One important barrier to any general rule is that productivity and its growth, however measured, vary tremendously from industry to industry.

There are many reasons why productivity increases more rap­idly in some industries than in others. New industries typically present many opportunities for improvement, since as they grow, economies are realized from mass-production or simply from new ideas. New technology and new resources affect some industries more than others. Arrangements by governments, labor, or manage­ment stimulate productivity gains in some industries but retard them in other industries. Many direct-service industries are by nature difficult to change; for example, productivity cannot be expected to rise as rapidly in barbershops as in automobile factories.

If wages were tied to output per man-hour, industry by indus­try, the result would be both un­fair and impractical. Wages would go up rapidly in some industries, stay about the same in others, and even decline in a few.

Since many occupations and types of jobs are found in virtually all industries, people doing the same work would receive different pay. In fact, many plants produce in several industries, so wages might differ for the same work in the same plant. Industries with constant or only slowly rising wages would have more and more trouble persuading people to work for them, while people would be on waiting lists to work in the high-wage industries.

Also, tying wages to output per man-hour in each industry would reduce the incentive to industry to introduce the innovations which raise productivity in the first place, and would discourage ex­pansion in the successful indus­tries by preventing exceptional productivity from being fully re­flected in reduced costs and prices.

Equitable and Practical

Thus, if wages are not tied to the productivity of individual in­dustries, the outcome is likely to be more equitable and more prac­tical. The ordinary processes of wage determination and of choos­ing among jobs once rates of pay are established, tend to bring about roughly equal pay for equal work.

Not only would it be impractical to tie wages in each industry to productivity in that particular in­dustry, but it would also be im­practical to tie wages in each in­dustry to average productivity in the whole economy. This would ignore differences in the need for labor and in its availability. In an expanding area, industry, or oc­cupation, employers frequently raise wages more than the na­tional average increase in output per man-hour. These large wage increases serve the useful purpose of inducing labor to enter the area, industry, or occupation in question, and they help pay mov­ing or retraining costs. In a declining area, industry, or occu­pation, a chronic labor surplus may develop, and attempts to in­crease wages in line with the na­tional average increase in output per man-hour would reduce em­ployment opportunities and make it less likely that new industries would move into the areas of labor surplus.

These considerations and many others like them make it clear that it is difficult or impossible to pre­scribe general criteria for proper rates of wages and salaries. Those on the spot with knowledge of all the special circumstances must find the best solution for each case.

Productivity, Wages, and Prices in the Economy as a Whole

Even though the special circum­stances surrounding each particu­lar wage or salary may make it impossible to judge any one rate, certain judgments can be made about the general or average re­sult of all the separate rates. There is here an analogy with judging baseball players: the shortstop, for example, is not necessarily causing a game to be lost if he scores fewer runs than the oppos­ing shortstop; but the team as a whole certainly loses if it scores fewer runs than the opposing team as a whole. In wage negotiations as in baseball, even though we have no clear-cut criterion for evaluating any one contributor to the total result, we can apply cer­tain clear-cut criteria to the total result.

For the economy as a whole, productivity is related to wages in the following broad terms: If the average level of prices is to be reasonably stable, wages can rise only as much as productivity, ap­propriately measured, rises. (In­creases in the total share of national output going to wage and salary earners do modify this as­sertion; but such changes are so slow and the possibilities for fur­ther increases from the present 80 per cent are so limited that they can be overlooked in discussing short-run practical questions.)

Productivity, and changes in productivity, throw little light on what wages should be, or what changes in wages should occur, in any particular job, firm, industry, occupation, or region. Above average increases in productivity in any one industry, for example, may

… to some extent raise wages in the industry,

… to some extent increase em-
ployment in the industry,

… to some extent decrease em-
ployment in the industry,

… to some extent increase output in the industry,

… to some extent lower prices in the industry,

… to some extent raise wages in other industries which compete for similar workers,

… to some extent lower wages in other industries,

… to some extent raise prices in other industries,

… to some extent lower prices in other industries.

The extent to which each of these adjustments is appropriate in any instance depends on literally thousands of details and special circumstances, and can best be worked out by individuals who have freedom and opportunities to choose among jobs and among the goods and services they buy. Since the public interest may be little concerned with each separate ad­justment in each instance, and since the maintenance of free in­stitutions and free collective bar­gaining are paramount goals of public policy, attainment of the appropriate over-all result for the whole economy must be sought by controlling the environment in which wage and salary negotia­tions occur.

An Environment of Freedom

The key to a proper environment is to maintain a legal and institu­tional framework such that the self-interest of each party is either consistent with the public interest, or else is balanced and checked by opposing interests of other par­ties. If excessive wage and price increases would cause severe losses of employment, sales, and public good will, for example, one side or the other will resist them. Where excessive concentrations of power in the hands of labor or business produce too many results or an average result contrary to the pub­lic interest, remedies should be sought through eliminating the power to injure the public interest, rather than through direct control of unions, businesses, or collective bargaining.

Another important key to an environment which will hold wages and salary settlements in line with the public interest is sound management of money, budgets, and debt by govern­ments. When mismanagement creates pervasive inflationary pressures, little success can be achieved by those who attempt to hold down particular wages or prices, for neither party to trans­actions gains any advantage from preventing increases—and to the extent that they do succeed they may do as much harm as good, since “grey markets” appear under these conditions.

Productivity is the basis of prosperity. Increases in produc­tivity, on which depend the rapid improvements that characterize the American standard of living, spring from many different sources: more effective workers, more and better capital equipment, better natural resources, better management, new knowledge and technology, and a social organiza­tion which affords broad oppor­tunities, encourages competition, and provides incentives and re­wards to individuals for efficiency, thrift, and industry.