Wages were squeezed in the "good" years

Between 1948 and 1981, compensation of employees fell from 25% of corporate business spending to 20%, while interest cost increased from 1% to 7%. Consumption was constrained, and production with it. Finance grew and blossomed.

I'm using corporate tax deductions as an estimate of corporate spending. I'm looking at employee compensation as a percent of corporate spending, to see how wage cost has changed since 1948. The most recent data I find at the IRS is for 2020.

A lot of "interesting" stuff has happened in our economy since 2020, but it won't show up on my graph for a couple years yet. Most people, I think, are interested in the recent events. I'm interested, too, but I don't dwell on the recent crap, because it is crap. If we pick a date (2008, say, the date of the financial crisis) we can say everything that happened since then is crap. Okay, not crap, but results. The economy went bad in 2008 and everything since that time is results: attempts to fix the problem after policymakers were caught by surprise.

I don't focus on results. I focus on causes. If you don't understand the causes, you don't get good results. I care about the causes of the 2008 crisis, the causes of the 1965-1984 inflation, the causes of the productivity slowdown of the 1970s that lasted 20 years. I care about the causes of the so-called "new economy" of the latter 1990s, which was really just a brief remission in the productivity slowdown. I care about all of it. I find that stuff fascinating.

I care about causes: why things were good, and how things went bad. You have to know how things went bad, or you can't fix them. And you have to look at times when the economy was good so you can see how things went bad.

That is the stuff that interests me. So I'm looking at employee compensation, the annual total paid by corporate business, as a percent of corporate business tax deductions. (I don't have the spending data, so I'm using the deductions as an estimate of spending.) Employee compensation started in 1948 at 25% of corporate deductions. By 1974 it was down around 20%. So our paychecks, those of us who worked for corporate business, our paychecks did not keep up with corporate spending. Our paychecks fell behind by five percentage points.

A lot of people got a lot of raises between 1948 and 1974, but all those raises together didn't keep up with corporate spending. To keep up, every $20 we earned in 1974 should have been $25. Every $100 should have been $125. Every thousand should have been $1250. But it was not, because our paychecks didn't keep up with corporate spending.

I dunno what they spent the money on. They spent it on many different things. I don't care about all that. I have a focus. I think the problem with our economy is debt. Now, before you say yeah, that damn federal debt... -- before you say that, let me say this: We've been trying to slow the growth of federal debt for half a century now, with no success. We've reached the point where Congress is getting crotchety about it. They're putting up stiff resistance to government spending. 

They're doing what Milton Friedman said. Friedman said

The problem is not one of knowing what to do.... The problem is to have the political will to take the necessary measures.

That's in chapter 8 of Money Mischief, page 213 in my paperback. Of course, Friedman was talking about inflation. But whatever we want to change about government will only change if we have the political will to make it change. At least, that's what Martin Gross was saying in A Call for Revolution.

And those crotchety congressmen, they do have the will to change things. That's why they're in the news all the time. And it's why they seem so crotchety.

Ironically, Friedman in the same chapter said government borrowing DOES NOT cause inflation:

Higher government spending will not lead to more rapid monetary growth and inflation if the additional spending is financed either by taxes or by borrowing from the public.

So there is a flaw in the solution that focuses on cutting government spending and government debt. To my eye, this flaw extends to the complaints of our crotchety congressmen. Their solution won't work. It hasn't worked in 50 years. Will it work now that they've developed an attitude? I don't think so. The fifty years of failure is not due to a lack of political will. The failure is because the solution we've been trying for fifty years is the wrong solution. The crotchety guys have the wrong solution. If you don't understand the causes, you can't get good results.

As I see it, when we say we want better economic growth, we mean growth of the private sector, not growth of government. That shouldn't have to be said, but it doesn't hurt to say it. The private sector is the economy. And by the way, it is private-sector debt that does harm to the private-sector economy. Business loans are repaid out of the prices businesses charge for their products, so an increase in business debt will push prices up. And household debt service, more and more, eats into consumer income, reducing our purchasing power. Between higher prices and lower purchasing power, business and consumer debt is destroying our economy. Private-sector debt is destroying our economy.

Federal debt? Most of the time, they don't even pay it off. They just roll it over. In "Does the National Debt Matter?" David Andolfatto of the St. Louis Fed said:

Yes, debt has to be repaid when it comes due. But maturing debt can be replaced with newly issued debt. Rolling over the debt in this manner means that it need never be “paid back.”

According to The Atlantic, rolling debt over has been the strategy for a long time:

Unlike after World War I, the US never really tried to pay down much of the debt it incurred during World War II. Still the debt shrank in significance as the US economy grew.

Our massive debt from World War Two -- even that debt, so long ago -- we never really tried to pay it down. But as The Atlantic points out, that massive federal debt did not hinder economic growth. (By the way, private-sector debt was relatively low in those good years after WWII. Private-sector debt back then wasn't a problem for the economy. Today it is.)

The Atlantic says the government doesn't even try to pay down the federal debt. Time magazine, December 31, 1965, said that economists

no longer think that deficit spending is immoral. Nor, in perhaps the greatest change of all, do they believe that Government will ever fully pay off its debt, any more than General Motors or IBM find it advisable to pay off their long-term obligations; instead of demanding payment, creditors would rather continue collecting interest.

Yes, Time's article was about Keynes, the much despised, much loved economist. He was an awesome writer, an awesome thinker. And by the way, it wasn't Keynes's idea to accumulate government debt forever. That idea was from economists of the 1960s -- two decades after the death of Keynes -- who proudly but mistakenly called themselves "Keynesian".

Love Keynes or hate him, it is still evidently true today that creditors would rather collect the interest, as in 1965. And it is still evidently true that the federal government doesn't really try to pay down its debt. That's why the federal debt is so big: We don't pay it down; we just roll it over and pay off the interest.

Speaking of paying the interest on the federal debt, the Peterson Foundation makes an interesting observation:

Even without accounting for interest payments, federal spending has frequently outpaced revenues — causing the government to run primary deficits. Over the past 50 years, annual federal revenues have equaled or exceeded non-interest expenditures only 12 times. 

Only 12 years in 50, according to Peterson, was federal revenue sufficient to pay the annual federal spending other than interest. In the other 38 years, the federal government had to borrow to pay for non-interest expenditures, and borrow more to pay the whole of the interest expense. And even in the 12 years, or most of the 12, it is almost certain the government had to borrow to pay at least some of the interest expense.

In only 12 years out of 50 -- less than a quarter of the time -- did any taxpayer dollars go to pay interest on the federal debt. The federal government doesn't pay down its debt, and three quarters of the time it borrows the money it needs to make the interest payment. Three quarters of the time, taxpayers don't foot the bill at all. 

Federal debt is not the problem. Private-sector debt is the problem. Cutting government spending will not solve the problem. Reducing government debt will not solve the problem.

Hey, I don't like the way the federal government handles its debt. But I don't complain about the federal debt. I see the debt as a consequence -- a consequence of something in our economy that has gone very wrong, something other than federal spending. It is true, no doubt, that if the government spends more money than it brings in it creates a deficit and adds to the debt. But that's not economics. That is arithmetic. Arithmetic is not the cause of deficits. Arithmetic is not the cause of debt. If you want to understand the cause, you have to go to the economics.

The cost of debt is the problem. But the federal debt is mostly just rolled over, not repaid, so this debt is a low-cost item. And the interest on the federal debt is mostly paid by borrowing the money to pay it, which adds to the low-cost federal debt. The cost of debt is a problem, but the cost of federal debt is not. 

Private-sector debt is the problem. The cost of private-sector debt hits the private sector directly and with full force. The solution is to reduce private-sector debt. Reduce private-sector debt first, so that our economy can improve. And as our economy improves we can balance the federal budget and start paying down the federal debt. 

I don't know why the crotchety guys oppose the growth of federal debt. I oppose it because the federal debt reinforces and supports the financialization of our economy. Financialization is a bad thing.

By the way, as our economy improves, we will need less and less of the things the government spends more and more money on. We will need less and less of that spending. In that environment, federal spending can be reduced painlessly, without crotchety curmudgeons in Congress.

In the meanwhile I would ask you to remember that the Keynesian idea was to use government debt to improve economic conditions -- for example, to make recessions short and to restore vigor and prosperity to the economy. That plan doesn't work anymore because the excessive level of private-sector debt does so much harm to the economy. But it is important to recognize that the federal debt is incredibly large. And it is important to see that the immense size of the federal debt is simply a reflection of the immense size of the economic problem in the private sector.

It is not federal debt that is destroying our economy. Private sector debt is destroying our economy. Our debt. But I don't blame us. I blame economic policy. Policy is the cause. Policymakers think using credit is always good for economic growth, and they think that accumulating debt is never harmful. That thinking has to change.

My graph today shows the "compensation of employees" paid by corporate business, as a percent of corporate business spending. (Again, I am using total corporate business tax deductions as a measure of corporate business spending.) The graph also shows the cost of interest paid by corporate business, as a percent of corporate business spending.

In the early years of the graph, 1948 to 1981, the graph shows a fall in employee compensation and an increase in the cost of interest:

Graph #1: Compensation of Employees and Monetary Interest Paid
as Percent of Corporate Business Spending

I use the 1981 date because that was the peak of interest rates. Rates rose before 1981, and fell after. I use the 2008 date because that was the time of the financial crisis.

Employee compensation fell five percentage points, from 25% of corporate business spending in 1948, to 20% by 1974. It stayed near the 20% level for 40 years, and only shows uptrend since around 2012.

Interest cost rose from 1% in 1948 to near 5% in 1974 and reached 7.4% in 1981. Interest cost averaged 7.0% for the 1981-2008 period; employee compensation averaged 19.9% for that same period.

From the 1948 start-of-data to the 1981-2008 period average, interest cost gained 6 percentage points while employee compensation lost 5 percentage points.

If the cost of interest falls by a dollar and corporate spending on employee compensation increases by a dollar, the total corporate cost is unchanged.

If the interest cost business pays is substantially reduced, a substantial amount of revenue will be freed up for other uses like better pay and better profit. Reducing interest cost is a simple matter of policy. Existing policy is built upon excessive reliance on credit and on the wrong-headed notion that excessive debt is only a problem when it is government debt. Unfortunately, wrong-headed notions cannot fix our economic problems.

In 30-odd years after 1948, employee compensation drops 5 points, from 25% to 20%. Interest cost increases 6 points, from 1% to 7%. If interest cost had remained at the low 1% level, employee compensation could have remained at the high 25% level, and corporate profits would have increased by one percent of corporate spending.

Economic policy increased interest rates in the 1948-1981 period. And economic policy encouraged the availability and use of credit. In other words, policy encouraged the growth and increased the cost of private-sector debt. The graph shows the result: interest costs went up, and compensation of employees went down. That's a bad policy, if ever there was one. But it's not too late to fix it.

Wages, Profit, and the Cost of Interest

The first graph below compares employee compensation paid by corporate business to the interest cost paid by corporate business. Employee compensation was more than 25 times as much as interest cost in the late 1940s. 

There was little business debt back then, and interest rates were low. But corporate business debt was growing, and interest rates were rising, so interest cost grew faster than labor cost. Much faster. Relative to the cost of interest, the cost of labor fell markedly. That's what the graph shows in the early post-WWII decades.

Graph #1: Employee Compensation versus the Cost of Interest for Corporate Business

The growing cost of interest drained revenue from corporate coffers. Business found wage increases less and less affordable. That's the economics of those early decades.

By 1981 when interest rates stopped rising, employee compensation was only 2.4 times the cost of interest. Rates started coming down, then, but corporate business debt was still growing. The growth of business interest cost slowed to about the same rate as the growth of employee compensation, so on the graph the ratio remained low and fairly stable through the 1980s and '90s and up to the 2008 financial crisis. 

Since the financial crisis, employee compensation has been gaining on interest cost, but not because our paychecks have been swelling. It's because interest rates went low.

Here's a similar graph showing a similar pattern. This time the graph compares corporate business profit to the interest cost paid by corporate business:

Graph #2: Profit versus the Cost of Interest

The patterns are similar mostly because the growth of interest cost is the same on both graphs. Not so much because profits are similar to wages. As you can see, the second graph starts in the 1940s at about $10, profit about ten times the size of interest cost in the late 1940s. For the first graph it was over $25, employee cost more than 25 times the size of interest cost. So employee cost must have been about 2½ times the size of corporate business profit in those early years.

But if you really want to compare employee cost and corporate profit, we need one more graph. I put the compensation-to-interest-cost line and the profit-to-interest-cost line together on this new graph, and indexed them so they both start at the same level in 1947:

Graph #3: A Comparison of Corporate Business Costs
Employee Compensation relative to Interest Cost (blue)
and Business Profit relative to Interest Cost (red)

The indexing gives both lines the same value in 1947, so we can see how they differ in later years. They run close together, start to finish, because the patterns are similar. Because of the indexing, we don't see the one being 2½ times the other. But we can verify the pattern similarity. And we can see that profit runs lower than compensation for almost all the years, even though they start at the same level on this graph.

It also appears that profit has been rising faster than compensation since around the time of the post-covid inflation. 

Profit is what remains after the costs called "deductions" are subtracted from business receipts. If interest cost is reduced by a dollar, other things equal, profit increases by a dollar. 

Of course, if the cost of interest falls by a dollar and corporate spending on employee compensation increases by a dollar, corporate costs are unchanged. But that would violate our "other things equal" assumption. 

My point of course is that if the interest cost business pays is substantially reduced, a substantial amount of revenue will be freed up for other uses like better pay and better profit. Reducing interest cost is a simple matter of policy. Existing policy is built upon excessive reliance on credit and the wrong-headed notion that excessive debt is never a problem (unless it is government debt). Unfortunately, wrong-headed notions cannot fix our economic problems.

The damage was done by 1980

Revisiting mine of 26 July 2013, the second graph from that post. Here updated:

Compensation of Employees relative to Interest Paid in the US economy
This graph at FRED

Employee compensation falls from 6½ times the cost of interest (in 1960) to about 2 times the cost of interest (in 1980). Compensation remains low until the financial crisis. It is now in the neighborhood of 4 times the cost of interest -- less than two-thirds the 1960 level.

The damage to compensation was done before 1980. The ratio rises since the financial crisis, not because compensation rises but because interest rates fall.

Where, oh where did the money go--
An interesting question, no?

Overwhelming evidence

Milton Friedman didn't like too much money. But he also didn't like too little money. In chapter 2 of Money Mischief he wrote:

There is strong evidence that a monetary crisis involving a substantial decline in the quantity of money is a necessary and sufficient condition for a major depression.

Insufficient money can cause a depression. If the "monetary base" grows too slowly it can cause a major downturn. That happened twice in the past hundred years:

Graph #1: Growth Rate of the Monetary Base
The downtrend before the Great Recession runs from 2001 to 2008
This graph is from 2014, when each series at FRED could have its own start- and end-date.
This graph replaces mine from 10 Feb 2021.

 

Graph #2: Federal Debt 1970-2023 and the 2001-2023 Exponential Trend
From mine of 7 March 2024
The "below trend" data before the Great Recession runs from 2004 (or before) to 2008-09.

Graph #3: The Quantity of Transaction money per Dollar's Worth of Output
The low before the Great Recession runs from 2004 to 2009.

Fiscal and monetary policy cooperated, creating a substantial decline in the quantity of transaction money, from the record low of 2000-01 to a level at which our economy could no longer function.

 "... substantial decline in the quantity of money is a necessary and sufficient condition for a major depression."

The evidence is overwhelming.

Employee Compensation as a Percent of GDP

Two questions:

1. Why does no one say the Biden economy is good?  One reason: As a percent of GDP, employee compensation has never been lower:

2. Is that Biden's fault?  No. Employee compensation has been all downhill for half a century. That's not Biden's fault.

 

Third question: What is to be done?  The first three steps in solving a problem are

1. Correctly understand the problem.
2. Correctly understand the cause of the problem.
3. Correctly understand the cause of that cause.

Hint: Low employee compensation is not the problem. It's a result.

A Political Note

For those on CNN and MSNBC who repeatedly wonder why no one appreciates how great the Biden economy is...

and setting aside my ordinary response BECAUSE THE ECONOMY ISN'T GREAT...

there is this statement from J. M. Keynes, quoted by Milton Friedman in chapter 8 of Money Mischief:

There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction ...

Keynes said it, and Friedman quoted it. That makes the statement twice as valuable, no matter which side you're on.

Don't brag about our economic growth, make it worth bragging about

My wife insists on watching CNN and MSNBC. I find the shows tiresome because their arguments are often weak. For example, a Biden supporter comes on the show and says the U.S. economy is doing better than any other country. I don't believe it. Last I checked, China's economic growth rate had fallen from 10% to 6%. That may be slow for China, but 6% annual growth is about twice the U.S. rate. 

But even if it is true, it is not a strong argument. A strong argument would be to compare recent U.S. economic growth to our own past growth, and point out how well we are doing now. But we cannot do this because, by that standard, we are not doing well.

To see how good our economy is now, I compare our current performance to the high points of our past performance. The red line on the graph below shows the trend of those high points:

Annual US Real GDP Growth Rate and the Trend of Peaks  1948-2023

I connected the 1955 peak (7.1% growth) to the 2018 peak (3.0% growth), then extended the red line out to 2023 and back to 1948. Three above-trend peaks are easy to spot:

• 1950-1951: Probably due to Korean war spending
• 1984: Reagan's "Morning in America"
• 2021: Real GDP growth in the year after the covid shutdown

In addition, U.S. economic performance surpasses the trend of peaks briefly in the mid-1960s, and again in the latter 1990s. Other than that, all the peaks are at or below the trend line. Even the 2023 data (which is preliminary and will likely change) is below the trend of peaks. If I was Biden, I would be embarrassed that my people are bragging about how good the Biden economy is. His people are probably losing him votes. 

By the way, the trend line itself shows a downtrend nearly as long-lived as Biden. This downtrend is clearly not Biden's fault. Maybe he should say as much, and add that he wants to turn the trend upward in the next four years. 

That trend can't go much lower. It fell five percentage points in less than 80 years, and is now near 2.5%. If the trend continues another 40 years, it will be approaching zero growth. Zero GDP growth means the only way to get a raise is to take income from someone else. That's not how things are done among a civil people.

There are better ways to run an economy, other than expanding credit and accumulating private-sector debt until the economy wants to die. "Perhaps the U.S. needs another, more modern Keynes..."

I checked: They dunno 2023 yet. But for 2022, China's real GDP grew 2.99%. So, 3 percent in 2022. The U.S. GDP grew 1.9% in 2022, and 2.5% in 2023. In 2021, the bounce-back year after the covid-shutdown recession, U.S. GDP grew 5.8% while China's economy grew more than 8%. 

"Which country is doing better?" is the not the question to ask. Better would be "How do we fix this?"

 

To my good eye, comparing US growth to that of other nations makes for a weak argument. Comparing our current economic growth to that of our own past makes a much stronger argument. But Biden can't do that until he makes the trend turn upward. And the trend will not show growth improving until we start making better economic policy decisions.

Don't brag about our economic growth, make it worth bragging about. All we need is the right plan.