Capital versus Labor: The Great Decoupling

This article explores the concept of the Great Decoupling, or the supposed discrepancy between increased labor productivity and higher worker wages. Prior to 1970, increases in labor productivity translated into wage increases, just as economic theory dictates. However, it appears that since the 1970s, wages have barely increased or have increased much slower than productivity. What is the reason for this?

The Great Decoupling: Wages Are Not Growing as They Should

Let us first provide a visual snapshot of the Great Decoupling. In this graph, prepared by the Economic Policy Institute and published by the World Economic Forum, we can see that wage increases went hand in hand with increases in labor productivity up until 1970. Since then, wages have practically stagnated while productivity has continued to increase. Graphs similar to this one can be found in many articles.

Traditional economic theory tells us that a worker’s wage is determined by their marginal productivity. Productivity increases should translate into wage growth. Other issues must be taken into account; however, the basic principle holds true.

Explanations for the Great Decoupling

What explains the Great Decoupling? There have been several flawed attempts to explain this problem. Those most critical of the market system have suggested that the decline of unions is responsible. The assumption is that workers have lost the ability to negotiate so that productivity increases have been appropriated almost entirely by employers and barely by workers.

Another explanation put forth by the enemies of capitalism is that the 1980s were a time of triumph for supply-side economics, liberalization, and deregulation, and large businesses were the main beneficiaries of these triumphs.

Those in favor of the free market have argued that the decoupling was caused by the end of the gold standard in 1971. The removal of a monetary asset external to the financial system led to constant monetary interventions to save companies, creating a market focused more on courting political favor than the favor of consumers.

What Is Causing the Great Decoupling?

In 2007, the economist Martin Feldstein published a paper in which he masterfully explained that the Great Decoupling is an illusion based on two mistakes.

First Mistake: Wages versus Compensation

The first mistake is to focus on wages and not on workers’ total compensation. It is true that wages are almost stagnant in real terms (that is, after accounting for inflation); however, in recent decades, nonwage forms of compensation such as contributions to pension funds, private medical insurance, and Social Security have increased significantly.

In the graph below, we can see that wages almost completely uncoupled f