America Works: Thoughts on an Exceptional U.S. Labor Market

CHAPTER 2. When Markets Drive Outcomes

 CHAPTER 2  WHEN MARKETS DRIVE OUTCOMES May the Invisible Hand be with you. At the turn of the twenty-first century, the U.S. labor market did better in two important ways than the labor market of most other advanced countries. The United States generated rising employment relative to the working-age population while European Union countries were mired in low employment and lengthy spells of high unemployment rates. The United States also generated large gains in productivity as it moved into a more knowledgebased “new economy.” The combination of rising employment per adult and increased productivity brought about a substantial growth in GDP per capita that could have improved the living standards of all U.S. citizens and enabled the United States to maintain its economic edge in output per capita over other advanced countries . Huzzah for the market-driven labor market. But the United States also experienced one great failure in the labor market. It failed to distribute the gains from economic growth and rising productivity to workers in the form of rising real wages and benefits. Looking at the flat or declining growth of real wages for the average American worker, most observers would think that the economy had stagnated. Family incomes rose modestly, but this was because more households had two earners rather than because the earnings of workers rose. In the 2000s, reductions in employerpaid pensions and increased employee premiums for health insurance cut into the economic well-being of even two-earner families. Market-driven labor market? Boo, hiss! This chapter describes the successes and failures of the U.S. labor market. It asks why real wages did not increase with productivity, 20 as they had in past decades. Stagnant real wages when productivity grows at a healthy clip is not what a market-driven labor system is supposed to deliver. As Einstein might have said, the “invisible hand” may be subtle, but it is not malicious. Could it be that the most market-driven labor system falls spectacularly short of the competitive ideal? Success in Employment: The Great Jobs Machine Jobs, jobs, jobs. Who wants a job? During much of the post–World War II period, Western Europe and Japan generated rising employment and lower unemployment rates than the United States. One of my Australian friends used to say to me, “We teach competitive labor market theory, but we don’t believe it. In Australia, judges on a commission set wages after hearing management and labor lawyers argue for lower or higher wages, and we have 1 percent unemployment. Compare that to the U.S. The market determines wages, and unemployment exceeds 5 percent. Only a nutter would believe that the market theory was right. It’s a good story for the textbooks, but . . .” This attitude, common also in Western Europe throughout much of the post–World War II period, came to an end in the decades of the 1990s and 2000s, when unemployment in other advanced countries rose above U.S. unemployment. Figure 2.1 compares unemployment rates, employment per adult, and hours worked per adult between the United States and advanced Europe in 1970 and 2005. In 1970 the United States had a higher unemployment rate than Europe and a lower employment-to-population rate. American adults worked 2 percent fewer hours than Europeans. But in the ensuing decades, employment per adult and hours worked per adult in the United States increased relative to employment and hours in other advanced countries. In 2005 Americans worked 15 percent more hours than Europeans and 27 percent more than the traditionally hardworking Germans.1 For the first time in modern economic history, the United States had lower unemployment than most EU countries. This reversal of historic patterns led many EuWhen Markets Drive Outcomes 21 America Works 22 Figure 2.1 Unemployment Rates, Employment per Adult, and Hours Worked per Adult, the United States and Advanced Europe, 1970 and 2005 9 8 7 6 5 4 3 2 1 0 1970 2005 United States Advanced Europe 4.9 4.1 5.5 7.9 Unemployment Unemployment Rate 2,000 1,900 1,800 1,700 1,600 1,500 1,400 1970 2005 United States Advanced Europe 1,822 1,884 1,804 1,603 Hours Worked per Adult Hours Worked 72 71 70 69 68 67 66 65 64 63 62 1970 2005 United States Advanced Europe 68.4 67.2...