Real wages and the terms of trade: Productivity growth is little help if you're making stuff no-one wants to buy

To resume from where we left off last time, if you deflate nominal US nonfarm business sector compensation by the NFB deflator, you get a real compensation series that tracks productivity pretty well. But if you deflate it by the CPI, real buying power has lagged well behind productivity since the mid-70's:

Although the standard textbook story of how productivity drives real wages isn't challenged by that graph, the textbook definition of the real wage doesn't necessarily translate into real buying power. Less than half of the productivity gains since 1973 have shown up as increased buying power for workers.

The ratio of producer prices to consumer prices isn't a statistic we see discussed very often, but I'm pretty sure that the expression "labour terms of trade" is the proper way to describe it. (I've seen references in some of the development economics literature that define this ratio in that way). The labour terms of trade describe the rate at which production goods can be exchanged for consumer goods.

Since 1973, consumer prices have risen faster than producer prices - why? An obvious place to start is to look at the relative price of imports: imports are included in the CPI, but not in output deflators. Here is a graph of (the log of) the labour terms of trade - here defined as the ratio of the GDP deflator to the CPI - and the terms of trade (the ratio of the export and import deflators):

It would appear that variations in the terms of trade can explain much of the deviation between productivity growth and the real buying power of wages. (It should be noted that the two series have different vertical scales; since imports are still only a small fraction of US GDP, the passthrough is less than one-to-one.)

The most striking feature of this graph is the decline in both series immediately following the oil shock of the 1970s. But although the terms of trade levelled off sometime in the late 1980's, the labour terms of trade continued to decline until about 2000.

If the labour terms of trade have indeed levelled off, then future productivity gains will show up as increases in buying power. But since it's hard to see how an eventual reduction in the US current account deficit can occur without a decrease in the terms of trade, the US labour terms of trade may yet have further to fall.

Comments

[Soma]

Hello,

The article seems informative. But I wish to know the source for the graph presented here.

Can u let me know the source. It would be more helpful.

Thanks.