Saturday, October 6, 2012

Kaminska and Unit Labor Cost

Another look at the FT post we considered yesterday.

Izzy Kaminska is poking around, trying to explain what the economy is doing. Her discussion starts with a review of several unsatisfying explanations for the excellent productivity of the late 1990s in the U.S. economy. But that excellent productivity long since expired, and Kaminska ends up trying to explain the very bad economic recovery of the present day.

She seems to think Alan Greenspan's original explanation -- technology -- is now working in reverse, undermining jobs instead of creating them.

She shows some graphs to make her case. One of those graphs is the Unit Labor Cost graph. It is the reason we come back to Kaminska for this post. She writes:

unit labour costs — the labour cost attached to the production of one unit — are staying positively muted

She shows a FRED graph:

Graph 1: The Unit Labor Cost scam

The "positively muted" remark refers to recent data at the right end of the plot, where at first glance the blue line seems to be running flat rather than rising. At second glance, however, the line isn't running flat. It went down a bit during the recession, but it has been going up since the recession. And if you look a third time, it appears that the "going up" part is going up at about the same rate as the "going up" that was going on for 20 years before that recession.

So I don't know what Kaminska's talking about. Whatever it is that the Unit Labor Cost graph shows, it is going up now just like it was going up before the Great Recession.

What does it show?

Kaminska seems to think the graph shows labor cost. How does she describe it? "The labour cost attached to the production of one unit". Oh right, right: "One unit".

As I showed the other day, the Unit Labor Cost plot is almost identical to the price level plot:

Graph #2: Unit Labor Cost (blue) and the price level (red)

The similarity between ULC and the price level is so remarkable as to inspire disbelief. And well it should, for the red line is used to calculate the blue line. To calculate Unit Labor Cost, labor costs are multiplied by prices.

And then the graph is used to claim that Labor cost makes prices go up.

To use the Unit Labor Cost graph is to say

INFLATION times X looks like INFLATION, so X is the cause of INFLATION

The price number series is used to calculate Unit Labor Cost. But if you take the price number out of the labor number, you see that the labor number is just going down, relative to GDP:

Graph #3: Total Labor Compensation (including benefits) relative to GDP
(Index 2005=100)
Click graph for FRED source page

Again: The labor number is going down. The labor number multiplied by prices is going up. And the labor number, multiplied by prices, is used to support the claim that the labor number is what makes prices go up.

The graph is worse than worthless. It's fraudulent.

Related posts:
Unit Labor Cost
The Uses of Fake GDP (2): Unit Labor Cost
No Matter What the Red Line Does
The Fraudulent Use of Arithmetic


Anonymous said...

I'm afraid you've got everything upside down. Unit labour costs are exactly as described, the cost of one unit of output. Normally when we say this, we mean nominal unit costs. Since labour costs account for most costs, as labour costs go up so do prices. It is therefore not remotely surprising that the labour cost line and the price line move together.
Labour costs are NOT multiplied by prices. They are a nominal variable which at least partially drive prices.
There is nothing about multiplying by prices involved. Nominal gdp does go up as prices go up or or as real gdp, which is nominal gdp divided by prices, goes up. It is the nominal gdp which is the directly observed measure.
This is REALLY simple. Just check definitions on the BEA website

Jerry said...

The nominal cost of labor goes up with inflation, just like the nominal cost of everything else. The nominal cost of a loaf of bread is also correlated with inflation -- does it mean that the price of bread is driving inflation? or that inflation is driving the cost of bread? Of course, you can't tell.

The second graph is essentially "real cost of labor", which suggests that labor costs are actually not really even keeping up with inflation after all.

The Arthurian said...

Go Jerry!

Anonymous, I worked out my arithmetic in a new post:

The Arthurian said...

Jerry, did you mean the THIRD graph?

The Arthurian said...

I have removed my earlier comments in this thread, and removed the post I wrote in response to the comment by Anonymous. (Anyway, my post was a response to something I imagined, rather than to something Anonymous said. Oh, well.)

This is a big deal. Either the denominator of Unit Labor Cost is Nominal, or it is Inflation-Adjusted. Either Anonymous is wrong, or I am. I have to work through this and figure it out.

Back to BEA...

The Arthurian said...

Yeah, I put everything back. Didn't find numbers yet to satisfy myself, but I'm sure I have it right.

The Arthurian said...

Here ya go. It's not BEA, it's BLS.

Under the heading What are unit labor costs?Unit labor costs can be computed by dividing employer labor costs (payments made directly to workers plus employer payments into funds for the benefit of workers) by real value added output.

"REAL value added output".
REAL output.
Inflation-adjusted output.
In the denominator only.

I was right.

Jerry said...

(Yes, the third graph.)
It seems like it might be a fair thing to look at, to divide total labor costs by nominal GDP, to get "what fraction of spending is associated with labor", or something. (I don't know what exactly this would tell you. Maybe it is a step toward firing out the relative weights of the "factors of production" costs, or something. But wouldn't you want to look at "total expenditures" instead of GDP?)

But, in any case, to just look at the nominal cost of something, and then act surprised that it's correlated with inflation, that's silly. That is the definition of inflation - that the nominal cost of things go up over time, and by how much.

I am having a hard time figuring out what the value/meaning of this metric could be, I guess.

If you looked at a particular industry, maybe ... you could say something like: "in 1950, we have on average 10 employees per automobile we make per year... in 2010 it's 1 employee per 10 automobiles because there're a bunch of robots and stuff (I made those numbers up)." - i.e. you'd expect that some definition of productivity-per-worker increases over time because of technology. But, maybe not, because the portion of the car company employees who actually make cars is probably very small (dwarfed by the number of advertisers and financiers and salesmen, etc - e.g. ). So, I don't know.

I guess that I am not convinced that even if you calculated it correctly this would be a useful number. I could see value in looking at "fraction of total business expenditures that go to each of: labor/rent/capital/interest"; I could see value in measuring "real median household income". But this one, I don't know.

BCG81 said...

I agree it does not make sense to talk about a "correlation" between ULCs and inflation, because they're the same thing. But as I understand it, the reason *nominal* compensation is compared to *real* productivity is to measure the extent to which compensation can rise (as a result of compensation or inflation rising) without putting pressure on prices. You can't see that without holding output prices constant. Also, when using ULCs as a measure of international competitiveness, you want to see both cost (i.e., nominal i.e., labor share) competitiveness and price competitiveness (i.e., relative rates of inflation).

The Arthurian said...

Hi BCG81,
It took a couple days for your words to register in my brain, but I think I got it now. You say, "the reason *nominal* compensation is compared to *real* productivity is to measure the extent to which compensation can rise ... without putting pressure on prices."

Yes, okay, I buy that. An increase in compensation is in a sense justified by an increase of output per hour. I have no trouble with that idea. But sometimes, your nominal-to-real ratio is compared to the price level and the similarity is held up as evidence that increasing compensation is the cause of inflation. And that's wrong. When they call it evidence, I rise up and say THE EVIDENCE IS FAKED.

From my perspective, someone who says ULCs and inflation are "the same thing" has perhaps been taken in by faked evidence.