Category: wages

A Triangle of Income, Health and Education

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May 18, 2025

By Stephen Stofka

This is part of a series on persistent problems. The conversations are voiced by Abel, a Wilsonian with a faith that government can ameliorate social and economic injustices to improve society’s welfare, and Cain, who believes that individual autonomy, the free market and the price system promote the greatest good.

Abel scooped some egg on his waffle. “We’ve talked about the many responsibilities that schools carry and then I was reading a BBC article about clinics in Britain that treat severely obese kids. Since they started these clinics in 2021, they’ve treated almost 5000 kids (Source).”

Cain interrupted. “How many kids are in school over there?”

Abel replied, “Almost 8 million (Source). So this is a small percentage of the school population, but these are the kids referred by their family or school physician. The problem is probably a lot bigger.”

Cain glanced up from his coffee cup. “I always think of obesity as an American problem. I wonder how Britain compares to the U.S.?”

Abel nodded. “A few years back, New York City estimated that over 6% of K-8 kids were severely obese, but they use a slightly different methodology than Britain to classify kids (Source).”

Cain interrupted. “You mean if I walk into a New York City classroom of 16 students, one of them will be severely or morbidly obese?”

Abel shrugged. “They might not even be there. A lot more absences among those kids. They struggle academically.”

Cain frowned. “I expect more obese kids in towns that are car dependent. I always figured New York kids would walk a lot. Anyhow, how do they determine severely obese?”

Abel replied, “Britain uses a BMI over 40. They’ve been referred by a doctor. Some kids have BMIs over 50, like morbidly obese. Thirty percent of the kids who come to the clinics already showed signs of liver disease.”

Cain raised his eyebrows. “Liver disease at that age? Oh, wow. Did they say what the problem was? Does Britain have a program where poor kids get free lunches? Are the schools feeding these kids too much junk food?”

Abel glanced at his phone. “Hold on. I took notes. So, 40% of them came from poor neighborhoods and the schools in Britain do provide free meals for disadvantaged children. FSM they call it. Free school meals.”

Cain asked, “So how many school kids, fat or not, come from disadvantaged homes?”

Abel glanced at his phone again. “Yeah, what’s the baseline? Twenty-seven percent of all kids qualify for the free meal program (Source), but 40% of the severely obese come from disadvantaged neighborhoods. So, that’s a disproportionate amount of severe obesity among poor kids in Britain. New York City found that the percent of children with severe obesity has stayed about the same among all school kids during the past decade, but it has grown among minority students.”

Cain frowned. “My first instinct is to put some blame on the schools for the crap they serve in the cafeteria.”

Abel laughed. “Well, kids are not terribly fond of fruit and veggies. You can’t blame the cafeteria for that.”

Cain was equivocal. “Yeah, but all the white bread, the corn oil, the hot dogs and other prepared foods.”

Abel shook his head. “The kids who come from higher income homes are eating in the cafeteria as well. The only difference is their parents have to pay for it. If the school cafeteria were the chief culprit, there would a growing effect among the whole school population, not just minorities. Overall, though, that report showed a general decline among the entire student population during that decade. Obesity among disadvantaged students ran counter to the trend. So, what’s your next theory, Mr. Einstein?”

Cain smiled. “Hey, I’m improvising. How do they fatten up cattle? Feed them corn. Since the 1960s, we’ve been eating more processed food, more take-out food. What do those foods use? A lot of corn oil. It’s got a neutral flavor and a high smoke point. Great for deep fat fries. Too many Americans eat like it’s the state fair in July. Pass the grease, please.”

Abel argued, “That explains a growing obesity in the general population, but it doesn’t explain why obesity is growing even faster in disadvantaged communities, particularly among minority populations. A lot of those communities are food deserts. The big grocery store chains have moved out. The independent grocery chains struggle because they cannot get competitive pricing from their distributors. What’s left? Convenience stores. Packaged foods. Fried foods, ready to eat.”

Cain smiled. “Like the school cafeteria. Can families use food stamps for hot dogs at the convenience store?”

Abel shook his head. “Nope. Food stamps, or SNAP benefits, can’t be used for ready-to-eat meals.”

Cain argued, “But families can pay for a ready-to-eat hot dog and get a bottled soda with food stamps. Sugar, salt, and mystery meat with a bunch of chemicals, all in one convenient package, aided by taxpayer dollars.”

Abel frowned. “The amount a person gets on the SNAP program is relatively small, a bit over $6 a day (Source). RFK Jr. and his buddies want to ban the purchases of soda or candy with food stamps (Source).”

Cain scoffed. “Money is fungible. Like I said, they’ll just pay for the candy and use food stamps for something else. As we discussed last week, we’ve got an activist court. Now we’ve got an activist executive branch and an impotent Congress.”

Abel smirked. “This is who you voted for.”

Cain laid his hands in his lap. “What I voted for was what I thought was the better of two bad choices. Gallup reported that Biden and Trump have the two lowest average poll ratings in the modern era (Source).”

Abel asked, “Can I guess who has the lowest? Trump?”

Cain smiled. “Yeah. I was surprised. I thought it would be Bush and Trump. Bush had the worst Presidency, in my opinion. He kicked away a budget surplus, lied to the American people…”

Abel interrupted. “Lied to themselves as well. Johnson lied about Vietnam, but he knew he was lying. He’d only been in office a few months after Kennedy was shot and he thought Vietnam was going to be a boondoggle. He was worried that people would say he was weak, that he was an accidental president (Source).”

Cain nodded. “He lied to Congress about the incident in the Gulf of Tonkin to get authorization for an undeclared war (Source). Did the Democratic House impeach him? No. Nixon lies about Watergate and the Democrats impeach him. Noble principles? That’s the lie they tell themselves and the public to cover up the viciousness, deceit and self-dealing that is at the heart of everyday politics.”  

Abel replied, “I hate when you get so cynical.”

Cain shook his head. “It’s realism, not cynicism. Look, politics brings out the worst in people. We see it at City Council meetings, in state legislatures, in the White House and Congress. Lions and hyenas fight over a kill. It’s visible. People fight over invisible things like power and principles, but the carnage is just as ugly as a carcass on the African plain.”

Abel sighed. “So what’s your solution?”

Cain replied, “Make as few rules as possible. The smaller the carcass, the less incentive for politicians to fight over.”

Abel nodded. “Incentives. I was reading a book this week called “Hell To Pay” by Michael Lind. He writes about all the ways that companies suppress workers’ bargaining power. Non-compete clauses, legal and illegal immigration, salary bands.”

Cain asked, “What are salary bands?”

Abel replied, “It’s a way that companies in a sector can collude on wage levels.”

Cain interjected, “Price fixing, in other words.”

Abel nodded. “Yeah. It’s illegal so companies hire a third party HR consultant that tells them what other companies in that sector and area are paying.”

Cain smiled. “Regulatory compliance is a game of cat and mouse.”

Abel continued, “Lind recommends allowing collective bargaining by sector for some industries. Railroads and airlines do it. For small businesses, he suggests a regional or local wage board that would set wages and working conditions.”

Cain looked doubtful. “Let me make this more concrete. Instead of Amazon workers at one facility bargaining for wage increases, all warehouse workers in the entire country would bargain collectively with all employers in warehousing. So all the pay structures are the same throughout an industry?”

Abel nodded. “I suppose so.”

Cain asked, “But there are both large and small employers in the warehouse sector. Are small businesses and their workers subject to a wage board or are they included in the collective bargaining with Amazon and its employees?”

Abel lifted his shoulders. “I have no idea. Lind didn’t get into those kind of details.”

Cain winced. “And if they can’t agree on wages or benefits? Do all warehouse workers go on strike? This scheme complicates contractual relationships.”

Abel replied, “I don’t know. He suggested an independent commission like the FCC that would oversee the whole process. I suppose it could step in and act as a final arbiter and prevent strikes.”

Cain asked, “Almost like a guild system, don’t you think? The merchant guilds protected the interests of shopkeepers and artisan guilds protected some workers in skilled trades, I think.”

Abel smiled. “I hadn’t made that connection. I thought you would like the idea because it allows private parties to resolve things. Lind suggested eliminating non-compete agreements as well. They disembowel workers as a prerequisite for employment. They should be illegal anyway.”

Cain replied, “You’re basically for any regulation that will give workers more pricing power. Companies markup any increase in wages, so workers might make more money, but everyone will be paying higher prices. In response to rising prices, the Fed will raise interest rates. That will make homes and cars less affordable because of the higher loan payments.”

Abel interrupted, “People will be less dependent on government charity. They will eat better. They will live longer. There is a strong correlation between life expectancy and per capita personal income in each state.”

Cain asked, “Will they? Higher rates means less investment growth, fewer jobs added, maybe some job losses. Some workers are making more money, some people are out of jobs, and everyone is paying higher prices. It’s not so simple.”

Abel argued, “The existing system is demeaning for some people. Wal-Mart employees often don’t make enough to provide for their families. They rely on various government programs to supplement their income (Source). That is an indirect subsidy from the government to Wal-Mart. That subsidy goes into the pockets of the Walton family that owns almost half of the stock (Source). If Wal-Mart employees belonged to a retail union, their representatives would be bargaining with Wal-Mart and Kroger and Target and Home Depot.”

Cain shook his head. “It’s too big, too broad. A person with plumbing knowledge working in Home Depot is going to paid the same amount as someone scanning groceries in a checkout lane?”

Abel argued, “Obviously, there would be different classifications of retail employees. However, a plumbing guy working in Home Depot for a certain number of years would get paid the same as a plumbing guy in Ace Hardware or Lowe’s.”

Cain asked, “Who is going to mandate these classifications?”

Abel replied, “No mandates. The stores and employee union will probably agree on some distinctions. They can resolve that in negotiations, I suppose.”

Cain asked, “What about small businesses? Would employees get the same pay and benefits as large businesses? If so, a company like Home Depot would be able to offer employees health care at a lower cost than small businesses. Would there be a law mandating that a small business get the same insurance rates as a big company? What about different living standards in different states? There would have to be an adjustment for that.”

Abel rolled his eyes. “Questions I can’t answer. I don’t know. The private sector would have to work that out. I thought you liked that.”

Cain nodded. “Benefits complicate any solutions. They introduce factors that are outside of the industrial sector that a company operates in. Health insurance, for one. Retirement plans involve the financial industry, also a different sector. Mandated taxes like Social Security and Unemployment insurance involve other government programs. The politicians will be eager to meddle.”

Abel replied, “Ok, so what if there were no benefit package for employees? Start there.”

Cain said, “In 1960, Ronald Coase wrote The Problem of Social Cost (Source). He pointed out that when government imposes a regulation on a firm, the government acts as a super-firm in the sense that it controls a factor of production for each firm subject to the regulation.”

Abel interrupted, “What? That’s like saying that the umpire is a super-team. The government is just there to make sure everyone plays by the rules.”

Cain smirked. “Umpires don’t write the rules. Coase’s point was that private firms must make production decisions within the constraints of the market. They have to adjust to changing market conditions. A government agency has no such constraints. Laws and regulations do not respond to changing conditions. That’s why I favor as few government rules as possible.”

Abel sighed. “Well, we can’t live in an ideal world. I thought this was a realistic solution. I liked the empowerment of workers. Lind gave a lot of examples of how businesses weaken the power of workers to command a living wage. Temporary work visas, for one.”

Cain nodded. “What a racket that is. People with highly specialized skills and there are no American workers to fill the positions? The software company pays visa holders relatively low wages for all these specialized skills. Why is that? Oh, and that knowledgeable visa holder needs to be trained by the same person they will replace. It’s a scam.”

Abel laughed. “You’re familiar with some of the things that Lind talks about in the book. He also mentions the fact that most of those H-1b visas are given to workers from India. It’s almost three-quarters (Source). No other software engineers or computer scientists in the rest of the world? Only in India?”

Cain smirked. “A scam to cut costs by paying workers less. Another persistent problem in Washington is illegal immigration. It increases the labor supply and lowers wages, which benefits employers.”

Abel interrupted, “More demand for housing which increases housing costs and hurts workers. Lind writes about that too. So, if companies can combine to lobby for policies that enhance their power with workers, why can’t workers do the same?”

Cain shook his head. “I have so little faith in politicians to promote self-reliance. They need the public to depend on them. It gives them a sense of purpose and bargaining power.”

Abel argued, “Well, we need an alternative to the current system. Too many workers cannot earn a living wage and have to rely on government programs to get by. Growing obesity in kids from poor families is an indicator of a diseased system.”

Cain sighed. “Now comes the rant against capitalism?”

Abel smirked. “No, no rant. Lind mentions Adam Smith’s comment that a worker should have enough to maintain himself, and extra to raise his family and deal with emergencies. That’s not a recommendation from some socialist economist, but someone who advocated a minimum of regulations. Implementing sectoral bargaining for workers has the promise of lightening government’s role in the marketplace while correcting some of the abuses that our political system has enabled.”

Cain said, “The promise of a lighter role for government? This commission. Is it composed of political appointees?”

Abel shook his head. “Lind, the author, suggested an independent commission.”

Cain asked, “Like the Fed?”

Abel nodded. “Lind gave the FCC as an example, I think, but the idea is the same. I prefer a model along the lines of the Fed, I think. Staggered terms that are longer than four years, so the members of the commission are less subject to the political whims of one party.”

Cain argued, “That’s too much power concentrated in one commission.”

Abel replied, “Look how much power the Fed has. For more than a hundred years, it has given our economy more stability than in the hundred years before the Fed. That stableness attracts capital from the rest of the world.”

Cain looked doubtful. “Talking about the Fed. As I said before, higher incomes will lead to higher prices, higher interest rates. It’s something we could talk about at another time. You said life expectancy had a strong correlation with income. What’s strong?”

Abel replied, “.85. That was based on 2021 figures.”

Cain looked thoughtful. “I wonder what the correlation is in Canada or Britain. I want to check on that. Maybe read that book. Hey, I need to get going. An interesting discussion this week. ”

Abel nodded. “Yeah. See you next week.”

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Image by ChatGPT.

The Party Swamp

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June 30, 2024

by Stephen Stofka

This week’s letter is on expectations and alliances. After separating voters into two parties, alliances within each of the parties coalesce to form intra-party squabbles. These alliances can form despite radically different approaches to managing problems: analytical and instinctual. Voting for the same candidate might be a person with an instinctive dislike of government and a business owner who estimates the impact of that candidate’s policy preferences on a company’s bottom line. These two different approaches also produce conflict.

In past weeks I have distinguished between expectations and anticipations, the first being more analytical and the second more imaginative or instinctual. The two work symbiotically in our individual lives but that symbiosis becomes outright conflict in a group. Some prefer a more analytical approach to discussing and solving problems while others rely on their gut, their moral compass. Individuals participating in that debate want to convince others to adopt their perspective and values. Perspective evolves over our adult lifetime and its purpose is to protect our values which have evolved since childhood. Attacking a person’s perspective can be perceived as an attack on their values, so we are resistant to persuasion. A variation of a 17th century quote goes, “A man convinced against his will is of the same opinion still.” The trick to persuasion is to insert your argument into another person’s perspective like a key and let them turn the key.  

In the Democrat Party, the center left contends with the radical left who weaponize shame. Advocates of DEI funding and mandates within all public institutions honestly believe that such training will moderate or eliminate racist attitudes. The majority of U.S. colleges and universities require students to take these non-credit classes to graduate. For students with a heavy academic schedule and work commitments, the burden of that mandate multiplies a student’s stress. Those within and without the academic community debate the conflict between these mandates and academic freedom.

Those favoring more spending on affordable housing disagree with voters in the party who prefer the personal space buffer that R-1 Single Family Home zoning gives residents. Proponents of free needle exchange must overcome fears that such tolerance will introduce a moral hazard that promotes more rather than less drug use. Supporters of more resources for  immigrant housing, job and medical services encounter principled opposition from those who are mindful of the resources and money that must be diverted from other programs. Should the needs of newcomers take higher priority than those of long- time residents, particularly the descendants of those African-Americans brought to this country centuries ago? Party leaders struggle to manage these ideological conflicts because these issues permeate the leadership ranks as well.

The Republican Party is more dominant in the ex-urban and rural parts of each state. Party leaders and candidates express strong support for religious faith as a cornerstone of American society. According  to Pew Research, Republicans attend church more often than Democrats or Independents but the majority of Republican voters do not attend church weekly. Like Democrats and Independents, a third of Republicans rarely step inside of a church. Those who believe that public institutions should be secular confront those who think religious principles and doctrine offer the only sound foundation to good governance. A person supporting their argument with Bible verses may truly believe that they are taking an analytical approach. In their belief framework, the Bible is history, recorded by various authors or sources but inspired by God himself. To those devotees, the Bible is fact, not an arbitrary assembling of oral traditions and myths. Two Republican voters, each with very different religious beliefs, practices and priorities still vote for the same candidates and issues. Leaders within the party must negotiate a compromise between Christian compassion and checkbook constraints.

Immigration is a key issue on ideological lines even though most immigrants initially settle down in urban areas where political sentiments skew Democratic. When the labor market is strong in the U.S. relative to other countries, that acts as a draw to legal and illegal immigration. The emphasis is on the “relative to other countries” part. A mismatch in labor market demand between the U.S. and neighboring countries is an important contributor to immigration flows. The strong economy in the late 1990s and early 2000s attracted a surge of immigrants, far more than today’s levels when adjusted for population.

 A recent analysis by the Federal Reserve estimated that restrictive immigration policies from 2017 to 2020 made it moderately more difficult for employers to fill job vacancies.  Farmers and ranchers, a strong Republican cohort, have long lobbied for changes to the H-2A “guest worker” program that would help them meet seasonal worker demand. The number of slots for foreign workers is not enough to meet demand and the application process is burdensome. Employers have similar complaints about the H-2B program for non-agricultural workers, and are heavily used by janitorial and landscaping services. Regardless of the impact of restrictive immigration policies on their businesses, owners may still vote for a candidate who promotes an immigration crackdown.

Jobs and sustainable wages are the cornerstones of family support, individual self-respect and autonomy. Those in rural areas are keenly aware that urban areas offer a more developed communications and transportation network that attracts companies, jobs and talent. For the past several decades, small to medium-sized manufacturing has migrated to foreign markets which offer lower labor costs. The influx of immigrants is yet another potential threat to community stability and resources. Long established immigrants who came to the U.S. through a legal process may not feel welcoming to those who have jumped ahead in the immigration line.   For decades, rural areas have fought to retain businesses and develop more jobs at a sustainable wage. Those who advocate more government spending on infrastructure to attract businesses clash with those having an ideological preference for laissez-faire markets.

Candidates within each party search for and exploit the shifting alliances within their party’s voters. Challenges to incumbents emerge not from the other party but from a primary election by a candidate in their own party. Primary elections attract only a small percent of party faithful whose political passion gives their small numbers a lot of leverage within the party. Fringe candidates with less funding can appeal to special interest groups to further an agenda with a dedicated party base. A candidate can appeal to a single-issue like abortion, immigration, or project a no-nonsense, get-tough persona and attack an incumbent who compromised on a piece of legislation. A Representative must learn to manage different sets of alliances: those in their district and state, and those in Washington. Next week, I will look at several Representatives and how they have navigated relationships of political power within their party.

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Photo by Ryan Noeker on Unsplash

The Choices We Steer By

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October 29, 2023

by Stephen Stofka

Last week’s letter explored income and wealth distribution within a framework that involves choice as well  as chance. The emphasis on choice was first presented in a 1953 paper by the Nobel economist Milton Friedman. This week’s letter develops the implications of Friedman’s speculation.

Friedman suggested that a wage implicitly contained an insurance premium charged by employers for reducing an employee’s income risk. Debt instruments involve an ongoing relationship between debtor and creditor and carry a risk premium that is a component of the interest rate on the debt. The employer-employee relationship is an ongoing financial relationship as well. An employee’s desire for a consistent income leads them to accept a lower income, a tradeoff of some income for some certainty about future income. This implies that a worker’s wage is not just the marginal product of their labor, a bedrock assumption of neoclassical economics. A worker who has a tolerance for more risk will demand higher pay from an employer, reducing the insurance premium embedded in a wage.

During economic crises when there is higher unemployment, employers should be able to charge a higher risk premium, i.e. a lower wage, to workers who would have a greater desire for certainty. But wages are slow to decline during these times. In Chapter 17 of the General Theory, Keynes claimed that wages were “sticky.” Economists attributed it to union wage contracts that do not respond to changing circumstances. Today union membership in the U.S. is less than 10% of the workforce, reducing that as a causal factor in this country. So why don’t workers accept much lower wages to obtain work?

Employers and employees bargain over the price of certainty, each of them aware that certainty at any price is in short supply. In times of stress, employees may be concerned that a smaller employer, the implicit insurer of a worker’s wage, cannot provide the degree of income safety that the lower wage would purchase. Because the employer-employee relationship is a persistent one, employees are concerned that working for a much lower wage might set a precedent that is not easily undone. When economic conditions improve, how likely is an employer to restore wages to their former levels? This was a point of contention in ongoing wage negotiations between the UAW – the auto workers’ union – and car manufacturers. During the financial crisis, the union made wage concessions to help the automobile companies stay in business. When business improved, wage increases were based on the reduced wages. Recent hires were paid less than a delivery driver for Amazon.

In the closing decades of the 19th century, neo-classical economists like Stanley Jevons, Francis Edgeworth, Leon Walras and Alfred Marshall cleaved Economics away from Political Economy in an effort to treat economics as a mechanistic science of exchange. They argued that an employee’s wage was just a factor of production like machines and land. They excluded from their analysis the political and legal constructs that protected private property and the social institutions that were a part of the community that surrounded firms and their employees. The wage was a component of the marginal cost to produce one more unit of whatever the company sold. Economists called it the marginal product of labor, or MPL.

There was a moral implication that employees were being paid their “fair share” of the cost to bring the next unit into production. This model suggested that employees who demanded higher wages wanted to be paid more than their marginal product, or more than they deserved. This provided moral justification and political appeal when employers clashed with employees over wages and working conditions. In 1877, railroad owners convinced West Virginia Governor Henry Mathews to provide state militia to end a workers’ strike (White, 2019, 347).

In the late 19th century there were few legal protections and no social insurance programs for workers. Today an employer acts as an insurance broker for a host of mandated government insurance programs. These include Social Security, unemployment insurance and workers’ compensation. An employer does not provide mandated benefits for free. They are included in an employer’s labor costs and deducted from an employee’s wage. Neither employer nor employee have any choice in these government mandated insurances. The choice an employee does have is how much they must pay their employer for income stability. The employer may charge that fee in many ways. These include a lower wage or the expectation that employees will work varying shifts or staggered hours. The employer may include other working conditions in the employment bargain that require compromise from the employee. This is all part of the insurance premium that an employer charges for providing future income certainty.

An employee’s choice whether to pay that insurance premium is bounded by their expectations, personal circumstances and the broader economy. An employee who asks for a higher wage, refuses to work a varying schedule or declines working overtime risks negative consequences. If the job market looks poor, the employee is more likely to comply with employer demands. An employer calculates the degree of difficulty to replace that employee and the “domino effect” of a higher wage on other employees in the company. Employers may stress confidentiality but employees often spread news of a wage increase, or the lack of one, to their coworkers. This is a series of opportunity cost calculations made by both employers and employees.

In the late 19th century, economists devised a mechanistic interpretation of human interaction that is still a component of economic studies today. Bargaining between parties is illustrated by supply-demand diagrams, Edgeworth boxes and other graphical teaching tools. Keynes’ 1936 General Theory is entirely founded on the principle that investors bargain with uncertainty but it wasn’t until the following decade that economists incorporated game theory into their analysis. Friedman’s 1953 paper was an exploration of the choices that underlay the dynamics of economic relationships. Like Keynes, Friedman was fascinated with the interaction between choice and chance in our lives. Chance is like being in a raft on a river. Our choices are like oars that help us navigate the perils of the moving water and the hidden rocks in our way. Throughout his life, Friedman pointed out the hidden aspects of our lives.

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Photo by Bluewater Sweden on Unsplash

Keywords: marginal product of labor, neoclassical economists, wages, insurance, uncertainty

White, R. (2019). The Republic for which it stands: The United States during reconstruction and the gilded age, 1865-1896. Oxford University Press.

Labor Productivity

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September 24, 2023

by Stephen Stofka

This week’s letter is about labor productivity. The autoworker’s union (UAW) expanded its strike to 38 parts and distribution plants in the hopes that a wider impact will incentivize further concessions from auto executives. Labor constitutes only 10-15% of the price of a car yet labor disputes may give the impression that rising car prices are entirely or mostly the fault of labor union demand.

For more than 100 years, auto plants of the Big Three automakers have been union shops. Foreign manufacturers like Toyota and Honda have built non-union plants in southern states where union organizers have less influence with policymakers. There are almost a million auto workers now in Mexico where wages have been lower. In 2022, GM Mexico paid its workers between $9.15 and $33.74 an hour, but relatively few auto workers in Mexico make more than $16 per hour.

Two weeks ago, the BLS released their productivity figures for the second quarter. Productivity rose faster than labor costs by a good margin – notching a 3.5% annualized gain versus a 2.2% increase in unit labor costs. The manufacturing sector that car manufacturers belong to had a lower productivity gain of 2.9%. In that productivity release the BLS provided a chart grouping productivity gains by decade. The 75-year average is a 2.1% annual growth rate.

An often repeated theme of union workers and workers in general is that wage gains have not kept up with productivity gains. The BLS charted both series since 1973 and the divergence keeps growing by decade. American workers are competing with lower wage workers in Mexico, China and southeast Asia.

The annual gain in Productivity is erratic, rising sharply at the onset of recessions when workers are let go and the total hours worked declines. Recessions reduce the percentage of hours worked far more than the percentage reduction in output. I charted the annual gain in Labor Productivity (FRED Series OPHNFB) to show the effect of these shocks. The pandemic caused a particularly sharp rise and fall, as shown in the red rectangle below.

A five-year chart smooths out the divergences, letting us see the patterns more clearly. The red line in the graph below is the 1.5% current growth rate.

Trends in productivity growth are a medium term process, longer than any Presidential term. Despite that, candidates promise big productivity gains if they are elected. Republican candidates promise that lower taxes will boost productivity because that claim appeals to Republican voters. When productivity growth declined following the Bush tax cuts in 2001, conservatives blamed the stifling effects of regulatory compliance and called for more tax cuts. Democratic politicians promise more subsidies to an industry that is not nimble enough to respond to changing economic circumstances.

There are many factors that contribute to productivity growth. Some economists claimed that lower interest rates after the financial crisis would raise productivity. It fell. Those believers assert that declining productivity growth would have been worse without lower interest rates. This claim also cannot be disproved. Hypothetical situations are the favorite shield of a believer.

Corporate profits are up sharply since the start of the pandemic. For the past year, GM has enjoyed strong profit growth but they have had far too many down quarters since the financial crisis. Ford has fared better but its profit margin of 2.4% is only slightly more than the high-volume, low margin grocery giant Kroger. Stellantis has struggled to make a profit since 2018. For decades, federal and state governments have subsidized these auto giants with tax breaks and loans because the industry as a whole employs 1.7 million workers and contributes more than 10% to GDP. It is an industry where politics and economics are tightly intertwined. The politics clouds the economic analysis and the economics contorts the political calculations.

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Photo by carlos aranda on Unsplash

Keywords: auto industry, GM, Ford, Stellantis, union, UAW, labor, workers, wages

The Power in Our Pockets

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September 17, 2023

by Stephen Stofka

This week’s letter is about wages and income and the real purchasing power in our pockets. The auto workers’ union (UAW) went on strike limited to three auto plants while they continued negotiations with the auto companies. Nurses at Kaiser Permanente have voted to go out on strike by September 30th if they cannot resolve outstanding differences with Kaiser’s management. Executive compensation at the auto companies is now more than 300 times the average worker’s pay, the UAW points out, claiming that workers have as much right to share in the profits as executives and shareholders.

Legislation passed after the financial crisis required that publicly held companies report their CEO-to-Worker pay ratios. A recent analysis of companies in the SP500 estimated a pay ratio of 272-1 in 2022. The auto industry is part of the consumer cyclical industry, whose median executive compensation in 2021 was $13.7 million, as reported by Equilar. In 1965, the pay ratio was approximately 20-1. In the 1980s, the Reagan administration adopted a relaxed regulatory stance to corporate mergers and companies have grown much larger in the past decades. The pay ratio, however, has grown out of all proportion to the growth in corporate size.

A combination of factors contribute to high relative CEO pay. Thomas Greckhamer (2015) identified six paths – configurations of various factors – that are present in countries with high CEO pay and those without high CEO pay. He found that the relative pay of CEOs is high in countries where equity markets are well developed and highly liquid. Ownership is widely dispersed so that the CEO enjoys more power relative to stock owners and can negotiate higher compensation packages. CEOs do not have high relative pay in high welfare states where there are strong worker rights. A cultural acceptance of inequality and hierarchical authority, termed “power distance” by Geert Hofstede in 1980, contribute to high relative CEO pay. Here is a quick explainer. As a comparative example, the power distance factor in the American culture is low, half that of Mexico.  

Companies today derive their revenue and profits globally. For that reason it is not accurate to divide corporate profits by the number of employees in the U.S. I am going to do it anyway just to show the profound change that has taken place since the 1970s, a benchmark decade often cited as the beginning of growing inequality in the pay ratio. In the chart below I have adjusted after-tax corporate profits (FRED Series CP) for inflation, then divided that by the number of employees reported by the BLS (FRED Series PAYEMS). The trend is more important than the actual figures. Even though the 2010s were relatively flat the level of profits per employee was about double the level of the 1990s. Let’s compare that to worker incomes.

Since 1992, median household income adjusted for inflation has risen 23%, a level that is far below the rise in profits per worker. The chart below shows the gain on a log scale. Real incomes have gained less than 1% per year.

A few weeks ago I proposed adjusting prices by a broad index of house prices instead of the CPI. Two-thirds of American households own their home and home values reflect the discounted flow of housing services that we get from a home during our lifetimes. Housing costs are already almost half of the CPI and trends in home prices capture the feel of inflation on household budgets more accurately than the many CPI measures economists currently use.

During the 1980s and 1990s, housing prices increased 4% annually. The chart below describes the median household income adjusted by the all-transactions home price index (FRED Series USSTHPI). Notice that household incomes during those two decades stayed on an even keel.

Had the Fed structured their monetary policy to keep home price growth at the same level as the 1980s and 1990s, real incomes would be near the level of the green line, 10% higher today. Instead, workers feel as though they are on the path of the red line, regardless of what official measures of real household income indicate. The red line reflects a sense of discomfort and tension in many American households that plays out in our politics. The trend began with housing and finance policies enacted by both parties in Congress across five Presidential administrations.  

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Photo by Charles Chen on Unsplash

Keywords: home prices, labor unions, wages, income, household income

Greckhamer, T. (2015). CEO compensation in relation to worker compensation across countries: The configurational impact of country-level institutions. Strategic Management Journal, 37(4), 793–815. https://doi.org/10.1002/smj.2370

Historic Employment Boom

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September 10, 2023

by Stephen Stofka

This week’s letter is about the mix of full-time and part-time workers and what it tells us about the economy. Although unemployment remains below 4%, it rose slightly, according to the most recent unemployment report. This was a good sign, however, because much of that increase was due to formerly discouraged people returning to the labor force and looking for a job. This economy is producing historic employment numbers. Let’s dig in.

I’ll be looking at ratios of workers to the working age population so I’ll discuss that briefly before heading into the data. The Bureau of Labor Statistics now defines the working age population as someone 16 years and older. According to that definition, a 90 year old person is working age. The U.S. is part of the OECD group of developed countries, which uses a more traditional definition of the working age population as 15 to 64.  I am going to use the OECD definition to make historic comparisons more accurate. Two-thirds of this working age population is employed full or part time.

The percent of working age people who are employed full time – the red line in the chart below – is about 64%, a historic high that has eclipsed the economic boom of the late 1990s.

Only 2% of working age people are working part time.

The ratio of full-time workers to part-time workers reveals the strength of the economy. When it is high, employers have the confidence to commit resources to full-time workers, including better benefit packages. Workers have more bargaining power. The chart below shows the peaks in that ratio since the 1960s. A rise in investment accompanied each period. Defense spending led the surge in the 1960s. Investment in technology was a major driver of emploment growth in the 1990s. Spending on infrastructure has been a key driver of growth since the pandemic.

In the post-pandemic recovery, employers have sharply increased wages to fill positions, as shown below by the Atlanta Fed’s wage growth tracker. The decrease in wage growth during the past year is more typical of recessions but without a recession. In the chart below, note that today’s wage growth is one percent higher than the peak during the strong labor market of the late 1990s.   

The greater the number of full-time workers, the more the federal government receives in FICA taxes, reducing the yearly deficit in the Social Security Trust Funds. Since the early 1980s, income tax rates have been indexed to inflation but social security taxes have not. Only the earnings subject to social security, the earnings cap, is indexed. According to the latest Trustees report, the drain on the trust fund last year was $22 billion, less than 1% of the $2.8 trillion fund, but a drain, nevertheless. The first of the historically large Boomer generation were eligible for retirement almost a decade ago. The last of that generation will be eligible for retirement in eight years. The era of annual surpluses in the trust funds is over. During the past decade, outlays increased at a 4.5% annual pace while tax collections increased at a 5.3% rate. This was a welcome change of pace from the previous decade 2003 through 2012 when social security tax collections grew at only 3.6% annually, while outlays grew at a 5.4% rate.

The financial crisis had a deep negative impact on the trust funds and the current estimate is that the trust funds will be depleted in 2034. After that date, retirees will not receive full benefits without some legislation to provide additional funding. In 1990, the trustees estimated a depletion date of 2043, almost nine years later than today’s estimate. These long-range forecasts necessitate many assumptions about economic growth and benefits and such forecasts cannot anticipate outlier events like the financial crisis. There is a lot of catching up to do. We need all the boom we can get.

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Photo by bruce mars on Unsplash

Keywords: social security, taxes, employment, wages

Note: In the past twenty years, the number of working Americans who are older than 65 has jumped from four million to 11 million, or 6.5% of the labor force.

Wages and Services

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December 4, 2022

by Stephen Stofka

This week’s letter is about the effect of wages on inflation. In an address this week, Fed (2022) chair Jerome Powell explained the Fed’s view of the latest trends and signaled that the Fed might ease up slightly on a rate increase at its December 13-14th meeting. Friday’s jobs report had stronger than expected gains so that may temper the Fed’s willingness to ease up on the “rate brake.” In his speech, Powell cautioned that “nominal wages have been growing at a pace well above what would be consistent with 2 percent inflation over time.”

The services portion of the economy consists of mostly labor so the Fed focuses on just that sector to gauge the underlying demand for labor. In the graph below are total wages and salaries (blue line) and the services sector (red line). Both series bent upward from their pre-pandemic trends but the Fed is focused on the upward momentum of wage increases (blue line) as an underlying driver of “core” inflation.

Core inflation does not include volatile food and energy prices. Those matter a great deal to consumers but the variance makes it more difficult to predict a future price path. Imagine walking a dog on a leash down a park path. The dog might dart from side to side to sample the smells along the path but the walker stays more centered on the path. An observer who could not see the path would likely watch the person rather than the dog to predict the direction they were taking. Below is a chart from Powell’s presentation.

On a long-term basis there are two trends that are likely to produce upward wage pressures. Growth in the working age population has slowed and the participation rate has declined. Since the beginning of 2021, wages have increased 11%. The labor force has increased only 3%, partly due to demographics and partly due to a participation rate that is 1% less than the pre-pandemic level. Should the trend continue, it will affect the supply of workers, causing employers to compete by paying higher wages or give up and abandon expansion plans. The first leads to persistent inflation. The second leads to a recession.  

While the Fed might moderate their rate increases, history has warned not to ease up on rate increases at the first sign of slowing inflation. In the early and late 1970s, the Fed eased and inflation resumed its upward climb. It’s like relaxing the tension on a leash and the dog immediately rushes ahead. The Fed’s tools are blunt instruments, relatively easy to deploy, but lack any surgical precision. Increasing rates dampen inflation, but both have the hardest impact on low income families who will welcome the relief of lower inflation. They can expect little help from a divided Congress as it struggles to enact any fiscal policy.

I worry about the next two years. Republicans have been out of power for a century. By that I mean that voters rarely given them the full reins of power, a trifecta where the same party controls the Presidency, the Senate and the House. They held power in the 83rd Congress from 1953-1955 and again in the two years of the 115th Congress, from 2017-2019. Their longest stint was the four years 2003-2007, a time of repeated failure and scandal – the mismanagement of the Iraq war, Hurricane Katrina, the accounting and energy scandals. They are not a party that governs well because they do not respect governing, only the political power that accompanies governing. They have become a reactionary party whose strategy is a “Lost Cause” narrative familiar to the southern Democrats they absorbed into the party over the past five decades. Party leaders and conservative talk show hosts echo a constant refrain that Republicans are the last standing guardians of traditional American values. I worry because Republicans are a party who breaks things and people are more breakable in the aftermath of the pandemic.

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Photo by Justin Lawrence on Unsplash

Federal Reserve. (2022, November 30). Speech by chair Powell on inflation and the labor market. Board of Governors of the Federal Reserve System. Retrieved December 3, 2022, from https://www.federalreserve.gov/newsevents/speech/powell20221130a.htm

U.S. Bureau of Labor Statistics, Employment Cost Index: Wages and Salaries: Private Industry Workers [ECIWAG], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/ECIWAG, December 2, 2022.

U.S. Bureau of Economic Analysis, Personal consumption expenditures: Services (chain-type price index) [DSERRG3M086SBEA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DSERRG3M086SBEA, December 2, 2022.

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Groundhog Day

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April 24, 2022

by Stephen Stofka

As the press announces the latest inflation numbers, we hear that this is the highest inflation number in four decades. These two periods share few similarities. In 1982, the economy was in a deep recession, the worst since the Great Depression. A clerical position or warehouse job would draw forty in-person applicants. Inflation had been sporadic and persistent for a decade. Two oil supply shocks and a surge of young Boomers into the workforce led to high unemployment and high inflation, a phenomenon termed “stagflation.” Since that time, economists have struggled to understand the peculiarities of that era.

Human behavior produces what economists call simultaneous causality, a recursive loop where event A causes event B which feeds back into event A. Just the anticipation of a policy causes people to act differently before the policy is implemented. This week Fed Chairman Powell strongly hinted that the Fed would raise interest rates by ½% at their May 3-4 meeting (FOMC, 2022). Anticipating that the rate increase could be as high as ¾% and more rate hikes than the market had already priced in, the market sold off on Friday. When in doubt, run, the survival strategy of squirrels and their large cousins, groundhogs.

Uncertainty joins all decades. Policymakers and investors must make forecasts and decisions with less than complete information. The more unusual the circumstances the more likely the flaws. In 1977, Congress enshrined the Fed’s independence in law and gave it a twin mandate of full employment and stable prices (Fed, 2011). A year later, Congress passed the Full Employment and Balanced Growth Act. The text of this act demonstrates how several years of stagflation had confused the direction of causality. The Act reads:

 High unemployment may contribute to inflation by diminishing labor training and skills, underutilizing capital resources, reducing the rate of productivity advance, increasing unit labor costs, and reducing the general supply of goods and services.

(U.S. Congress, 1978)

High unemployment accompanies or is coincident with diminished labor skills, resource utilization and productivity. Unemployed people lowers demand and that contributes to lower prices, not inflation. In 1979, a year after this act was passed, the Iranian Revolution overthrew the Shah and strikes in the oil fields cut global oil production by 6-7% (Gross, 2022). U.S. refineries were slow to switch production to alternative sources. Typical of that time, the Congress and U.S. agencies overmanaged prices, supply and demand in key industries. This regulation contributed to long lines at gas stations and a 250% increase in gas prices.

Today, much of the supply line has been affected by the pandemic and the effects linger. China has again shut down some tech manufacturing regions. The prices of building materials have been erratic. The ratio of home prices to median household income has now exceeded the heights during the housing crisis (Frank, 2022). Millennials have endured the dot-com crash, 9/11, the housing crisis, and the pandemic. Now a housing affordability crisis. The Fed’s survey of household finance reports that the median amount of household savings is $5300 (Wolfson, 2022).

War in Ukraine, crazies in Congress and little accountability. Since the end of 2019, inflation-adjusted wages have not improved (FRED Wages). Low unemployment should have driven wages far higher. Profit margins shrank or turned negative during the pandemic. Supply constraints have presented businesses with an opportunity to raise prices and make up for profits lost during the pandemic. As prices climb, policymakers and economists engage in a round of finger pointing.

Now comes the bit about a recession. Casual readers may have heard of a yield inversion. Time has value. Risk has value. A debt that is due five years from now should return or yield more than a debt due one year from now. There is more that can go wrong in five years. When shorter term debt has a greater yield than longer term debt, that is called a yield inversion. The yield curve is a composite of interest rates over different periods. A common measure is the difference between the 10 year Treasury note and the 2 year Treasury. When that spread turns negative over a period of 3 months, investors show their lack of confidence in the near future. A recession has occurred within 18 months.

Why should this be? As I noted at the beginning, we are a feedback machine. Our anticipation of events contributes to the likelihood that they will occur. The weekly version of the graph above did turn negative a few months before the pandemic struck in the spring of 2020. However, the weekly chart may give false forecasts. The quarterly chart captures sustained investor sentiment.

At the right side of the chart, we see how negative the sentiment has turned. The Fed knows that rising interest rates will drive that sentiment further down. By law – that 1977 law I mentioned earlier – they can’t ignore the force of rising prices. Employment, their other mandate, is strong enough to withstand some rate hikes. What worries the Fed now is a different type of unemployment – idle capital. Worried investors and business owners are less likely to begin new projects. That lack of confidence becomes self-fulfilling, creating an economic environment of pessimism. To Millennials, it feels like Groundhog Day all over again.

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Photo by Pascal Mauerhofer on Unsplash

Fed. (2011). The Federal Reserve’s “Dual Mandate”: The Evolution of an Idea. Federal Reserve Bank of Richmond. Retrieved April 23, 2022, from https://www.richmondfed.org/publications/research/economic_brief/2011/eb_11-12

FOMC. (2022). Meetings Calendars, Statements and Minutes (2017-2022). Board of governors of the Federal Reserve System. Retrieved April 23, 2022, from https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm

Frank, S. (2022). Home price to income ratio (US & UK). Longtermtrends. Retrieved April 23, 2022, from https://www.longtermtrends.net/home-price-median-annual-income-ratio/

FRED Real Wages, Series LES1252881600Q. Index level 362 in 2019:Q4. Index level 362 in 2021:Q4.

Gross, S. (2022, March 9). What Iran’s 1979 revolution meant for US and Global Oil Markets. Brookings. Retrieved April 23, 2022, from https://www.brookings.edu/blog/order-from-chaos/2019/03/05/what-irans-1979-revolution-meant-for-us-and-global-oil-markets/

U.S. Congress. (1978). Public law 95-254 95th Congress an act. Congress.gov. Retrieved April 23, 2022, from https://www.congress.gov/95/statute/STATUTE-92/STATUTE-92-Pg187.pdf

Wolfson, A. (2022, March 2). Here’s exactly how much money is in the average savings account in America. MarketWatch. Retrieved April 23, 2022, from https://www.marketwatch.com/picks/heres-exactly-how-much-money-is-in-the-average-savings-account-in-america-and-psst-you-might-feel-inadequate-in-comparison-01646168736

A Generation’s Legacy

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October 24, 2021

By Steve Stofka

There are two types of federal benefit programs: those that require “dues” to qualify for benefits and those that are means-tested. Social Security is an example of the first type. With some exceptions recipients must contribute to the program to qualify for benefits. Supplemental Security Income (SSI) and the SNAP food program are examples of the latter. A person’s circumstances, not their contributions, determine their qualification for benefits. Because people think of Social Security as an insurance program, not a government charity, it is the “third rail” of politics. Voters feel that they have paid into the system and deserve their promised benefits. The Boomer generation points to the $2.9 trillion in the Social Security Trust Fund as evidence they have indeed paid into the system. Talk of cutting benefits can earn a politician the boot. The question is: have workers paid in enough?

Our choices today are constrained by the priorities and choices of past generations. The Social Security program was created in 1935 to relieve seniors burdened with crushing poverty. The failure of thousands of banks prior to that time had wiped out the lifetime savings of many workers. With a commanding majority in the House and Senate, Democrats responded to the plight of many seniors. Those first generations received far more in benefits than they paid in contributions and created what is called a “legacy debt.”

In 1965 the program was expanded and in 1975 benefits were indexed to inflation. By that time, the sum of contributions exceeded benefits paid so that the trust fund had a reserve of 56% of benefits expected to be paid that year. By 1983, the reserve stood at only 18% of that year’s anticipated benefits. High inflation during the 1970s and some miscalculations in computing inflation adjustments to beneficiaries had depleted reserves. At that time, the Boomer generation ranged in age from 20 to 37, about the same as the Millennial generation today. By 2008, the first of the Boomer generation would be eligible for benefits. A commission recommended accelerating tax increases to build up the trust fund in anticipation of this demographic bulge. When the great financial crisis hit in 2008, the trust funds had 358% in reserves. It should have been much more.

Economists and politicians have remarked on the slow wage growth of the past decades. The cause of that slow growth is a matter of political perspective, but one thing is certain. Labor productivity has slowed as well and there is no consensus on the cause of that. In the chart below, I’ve smoothed out some data from the Bureau of Labor Statistics on Labor Productivity to show the long term trends. I set the 70-year average of 2.2% annual growth at zero to show the periods of below average productivity. The chart shows the two decades of below average growth from 1975 to 1995.

Labor Productivity – 70 year average of 2.2% annual growth set to zero

In a 2001 paper William Nordhaus (2001, 2), a researcher at the National Bureau of Economic Research (NBER) noted “after growing rapidly for a quarter century, productivity came to a virtual halt in the early 1970s.” Nordhaus attributed the growth of the late 1990s to the “new economy,” the communications technology and software development at the dawn of the internet. The productivity surge lasted about a decade, succumbing to the drag of low productivity in the service sector in general.

Because many service jobs have low productivity growth, America has given up the robust growth of the modern industrial age in the post-WW2 period. Low wage growth means less taxes to fund benefits and political tension. Since 2010, Social Security has been tapping the trust funds to pay benefits as the Boomers retire. By 2034, the trust funds will be depleted and the trustees estimate that each year’s taxes will be enough to pay about ¾ of promised benefits unless taxes are raised or general taxes are used to pay benefits. As much as workers have paid in SS taxes, it wasn’t enough. The Social Security trustees estimate that an additional 2.83% in taxes would cure the problem for another 75 years but politicians don’t have the courage to push taxes higher.

The program was created during the depths of the Depression. The generation that enjoyed SS benefits far above their contributions has passed on, leaving their legacy debt with us. They believed that the future would be like the past, that strong productivity and wage growth could pay inflation adjusted benefits for 15-20 years of retirement. Across a divided country and a divided Congress, we must put down the word weapons and ask ourselves “What are we going to do?”

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Photo by Markus Spiske on Unsplash

Nordhaus, W. D. (2001, January 01). Productivity growth and the New Economy. Retrieved October 24, 2021, from https://www.nber.org/papers/w8096

SSA. (2021). Social Security – Trust Fund Ratios. Retrieved October 24, 2021, from https://www.ssa.gov/oact/tr/2020/lr4b4.html

Finger Pointing

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April 18, 2021

by Steve Stofka

Some restaurant employers complain that they can’t find workers and blame the stimulus payment and the extension of unemployment benefits. Workers complain that businesses are not willing to pay for the additional health risk of close contact with the public. Child-care remains an ongoing obstacle for many. Pick your target – the bums in Washington and their relief programs, cheap business owners, belligerent customers, or unmotivated employees. Oops, almost forgot one other culprit – the Covid virus. Finger pointing does not build solutions. Finger touching does.

In its March survey, the National Federation of Independent Business reported (2021) that 42% of owners reported that they could not fill a job opening, yet only 28% reported offering higher wages. Some expressed their concern that unemployment benefits were too generous, reducing the demand for jobs.

In a recent study, Gabriel Chodorow-Reich and his colleagues at Harvard (2018) found that an extension of unemployment benefits had only a small macroeconomic effect on unemployment, employment, job vacancies, and wages. However, they noted that some studies focusing on particular industries and workers have found greater effects from more generous unemployment benefits.

In macroeconomic models benefits for employed or unemployed workers does affect the unemployment rate. Benefits for the employed raise the input cost of labor and causes an increase in the price of a product. An increase in price leads to a reduction in demand. Employers respond to that demand reduction by laying off employees or not adding to their workforce. Unemployment benefits reduce incentives for workers to find work. States charge employers a fee for additional benefits, further driving up labor costs. However, in the aggregate, a change in benefits has only a small effect on wages and unemployment.

In a crisis, providing relief to specific populations and business sectors is difficult. When the CARES act was passed at the start of the pandemic, the paycheck protection aspect was designed to help small businesses. Big corporations took advantage of loopholes in the law’s language and exhausted that targeted relief for small businesses. Big business got big by being voracious, leaving little for the competition. A government that enacts broad relief measures are criticized for giving relief to those who don’t need it. We would rather blame each other than blame a virus.

Inflation

Inflation expectations have an effect on wages. If workers expect higher prices in the near future, we want higher wages to cover our living costs. We see the price of gas go up from $2 per gallon to $2.80 per gallon in the past six months and reason that a lot of prices will be going up. We listen to the news in our car and hear inflation is up such and such a percent. We check the price of hamburger or some other grocery item. For the sake of simplicity, some economic models assume that consumers are knowledgeable about setting inflation expectations. We don’t have the time to be experts, so we guess at it and correct our expectations as we get new information.

In a recent paper, Ehsan Ebrahimy (2020) and fellow economists at the International Monetary Fund studied the effects that pandemics and wars had on inflation. Pandemics generated uneven swings in prices during the pandemic, but the recovery period brought an offsetting of those price swings. They found no net inflation effects from pandemics like the Spanish flu.

Expectations contribute to inflation. The price of residential toilet paper during the Covid crisis is a small example of this phenomenon. Different production plants make commercial and residential toilet paper because consumers are willing to pay more for a softer product. In the first months of the pandemic, panic buying and hoarding caused a shortage of toilet paper and a rise in price. Manufacturers like Kimberly-Clark built more production of residential toilet paper and store shelves were restocked in recent months. Responding to the increased inventory, people started using the toilet paper they hoarded. Now there is a surplus of toilet paper and prices have dropped below pre-pandemic levels.

Unlike pandemics, war involves the destruction of  physical capital, factories and offices. In the recovery periods following war, the IMF researchers found a persistent inflation in developed economies because some of the productive capacity had been destroyed. When there was less supply to meet demand, prices went up. Even a country not directly damaged in a war, like the U.S. in the past two world wars, suffered lasting inflationary effects in the post-war recovery periods. During WW2, the U.S. used up a lot of raw materials and production to make weapons. Following the war, inflation shot up over 10% in the U.S., five times the current rate. Following that inflation spike, the economy fell into recession, which caused a price plunge, followed by another spike in inflation to over 7%. The inflationary shock waves following the war took seven years to dissipate.

The researchers concluded that there was little evidence to support a belief in a sustained inflationary trend during the recovery from this pandemic. That does not rule out the possibility of uneven short-lived price rises. As shown above, expectations have an effect on prices.

We are more comfortable when we humanize the causes of inflation, pointing the finger at “those people.” We prefer to live in a world of intent, not random chance. Attacks on Asian-Americans have increased as if someone born and raised in America had something to do with the Covid virus. Employers blame Congress or unmotivated job applicants, who blame heartless employers. As Rodney King said, “Can’t we all just get along?” (Sastry & Bates, 2017). We can use our fingers to connect, not blame.

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Photo by Humberto Arellano on Unsplash

Chodorow-Reich, G., Coglianese, J., & Karabarbounis, L. (2018). The macro effects of unemployment benefit extensions: A measurement error approach*. The Quarterly Journal of Economics, 134(1), 227-279. doi:10.1093/qje/qjy018. Retrieved from https://scholar.harvard.edu/files/chodorow-reich/files/ui_macro.pdf

Ebrahimy, E., Igan, D., & Peria1, S. M. (September 10, 2020). The Impact of COVID-19 on Inflation: Potential Drivers and Dynamics. International Monetary Fund Research. Retrieved from https://www.imf.org/~/media/Files/Publications/covid19-special-notes/en-special-series-on-covid-19-the-impact-of-covid-19-on-inflation-potential-drivers-and-dynamics.ashx

NFIB. (2021, April 13). Small business owners struggle to find qualified workers. Retrieved April 17, 2021, from https://www.nfib.com/content/press-release/economy/small-business-owners-struggle-to-find-qualified-workers/

Sastry, A., & Bates, K. (2017, April 26). When L.A. erupted in anger: A look back at the Rodney King riots. Retrieved April 17, 2021, from https://www.npr.org/2017/04/26/524744989/when-la-erupted-in-anger-a-look-back-at-the-rodney-king-riots