8 THE CONNECTICUT ECONOMY WINTER 2007 BY DENNIS HEFFLEY, WILLIAM LOTT AND ALDO PONCE Working harder with little to show for it? If so, you have plenty of company. Earlier this year, the Federal Reserve’s Survey of Consumer Finances reported that the average real income of American families fell 2.3 percent between 2001 and 2004. When incomes fail to keep up with inflation, households either must dig into savings or cut their consumption of goods and services: fewer bags of groceries, smaller apartments, maca- roni and cheese instead of a meal out. So, are workers really becoming less productive? Are they being com- pensated less for their efforts? Or are they just being paid differently? And do rising health care costs have any- thing to do with these patterns? COMPENSATION LAGS PRODUCTIVITY Firms compensate their workers with money wages or salaries (earn- ings) and with employee benefits- health insurance, life insurance, retire- ment plans, etc. The earnings/benefit mix of total compensation is affected by a combination of public policies (e.g., income tax exemptions for most fringe benefits), employee preferences for benefits versus money income, and employer decisions about how to structure compensation packages to best attract and retain qualified work- ers. But regardless of the mix, we might expect total compensation, adjusted for inflation, to closely track worker output. In the graph (below left), U.S. data for the last 45 years show that real compensation (earnings plus fringes) per hour worked has grown less rapidly than hourly output, as measured by real GDP per hour worked in the non-farm sector. We’ve normalized each series in the diagram—hourly output, real hourly compensation, and real hourly earnings—to a value of 1.0 in 1960. This allows us to readily see the rate of growth in each variable. The top two lines show that hourly output in 2005 was more than 2.6 times its 1960 level- an average annual growth rate of 2.17%. Hourly real compensation grew more slowly (1.44% annually), but still managed to nearly double between 1960 and 2005. The extent to which real compensation has failed to keep pace with output may itself be an interesting story, but the focus here is on the other gap—between compen- sation and earnings—since this gap reflects the growing role of fringe ben- efits in the rewards to workers. REAL EARNINGS LANGUISH Surprisingly, hourly real earnings in 2005 were only slightly higher than they were in 1960. After a period of reasonable growth (1960-1972), real earnings per hour fell throughout the remainder of the 1970s, stabilized dur- ing the mid-1980s, fell a bit more in the late 1980s and early 1990s, and only began to grow again in the late 1990s. This strikingly lackluster per- formance seems to support widespread The Painful Burden of Health Care Costs While the hourly rewards to workers have barely kept up with inflation, the benefits component has grown more rapidly. 0.0 0.5 1.0 1.5 2.0 2.5 3.0 2004 2000 1996 1992 1988 1984 1980 1976 1972 1968 1964 1960 Hourly Output Hourly Real Compensation Hourly Real Earnings Index Value (1960=1.0) HOURLY OUTPUT OUTPACES REAL COMPENSATION AND REAL EARNINGS, 1960-2005 Source: The Connecticut Economy based on data from the Economic Report of the President 2006, and the Bureau of Labor Statistics.