A gradual rise (in the 1990s)

Last in a series

Two notes on Graph #4 from yesterday (here renumbered):

Graph #1: Monetary Interest Paid by Domestic Business, relative to Total Labor Cost

1. The latter half of the graph shows three highs, but these seem to be of three different types:
 a. A sustained high (in the 1980s)
 b. A gradual rise (in the 1990s), and
 c. A sharp rise to peak.

The middle one, b, corresponds to the good years, when productivity was up and the Federal budget got balanced: the "macroeconomic miracle" years. Goldilocks.

2. I wonder if there is some relation between these peaks and Ed Lambert's "effective demand".

Can that be right?

Second in a series

Unit Labor Cost (ULC) is figured by taking Total Labor Cost (TLC) and dividing it by real output (RGDP):

Work backwards and multiply both sides by real output to get Total Labor Cost:

I put that number on a FRED graph along with the Monetary Interest Paid number from yesterday:

Graph #1: Oops!

Ouch. Labor cost dwarfs interest cost.

Can that be right??

No, I messed up. Read the units in the left-hand border. It's an "index" (the Unit Labor Cost number is an index) times billions of chained 2009 dollars, for the blue line. But the 2009 value of the index is 100. So Graph #1, for 2009, shows a number that is 100 times what it should be. For all the years, 100 times what it should be.

I have to take the ULCNFB*GDPC1 formula (in the top border of Graph #1) and divide it by 100:

Graph #2: Total Labor Cost (blue) and Monetary Interest Paid by Domestic Business (red)

Yeah, that's more like it.

Still, the cost of labor is far more than the cost of interest.

Fair enough. And I should hope so! Nonetheless, I argue that it is the increasing cost of interest that is the source of our economic troubles, going back to the 1960s or before.

High numbers on a graph like this squeeze the low numbers down near zero and you lose the detail. You can't see what's happening in the early years. So, to compare the two lines, divide one by the other:

Graph #3: Total Labor Cost relative to Monetary Interest Paid by Domestic Business

What the comparison shows is that Total Labor Cost was growing much more slowly than interest cost all the while, until 1981 or so. It's an important detail that has disappeared from Graph #2.

Graph #3 look familiar? Looks just like yesterday's Graph #4, Unit Labor Cost relative to Unit Monetary Interest Cost.

Well, yeah. It's only a slight re-arrangement of the same source numbers.

Graph #3 here is better though. The numbers on the vertical scale are better. The high point of the blue line here is between 70 and 80. On yesterday's graph it was between 7000 and 8000. Yesterday, I didn't even know what the numbers meant.

The reason these numbers are lower? Because I divided by 100 to fix my error. 7000 divided by 100 is 70, and 8000 divided by 100 is 80, so that's how the numbers changed. And suddenly the numbers become meaningful.

Back before the 1950s, total labor cost was about 70 times the total cost of interest paid by domestic US businesses. From 1980 to the crisis it was generally less than 10 times as much. That means that for every $70 US business paid to labor in the late 1940s, they had one dollar of interest cost. Since 1980, for every $70 US business paid to labor, they've had about $7 to $10 of interest cost, maybe more. That's what the graph says.

Here, let me invert the ratio:

Graph #4: Monetary Interest Paid by Domestic Business, relative to Total Labor Cost

Before the mid-1950s, there was less than two cents of interest cost for each dollar of labor cost. By the mid-1960s it had doubled to four cents per dollar of labor cost, and by the mid-1970s doubled again, to eight cents per dollar. After that it doubled again, and went even higher, but till now has not yet gone back below the eight-cent number.

If we had kept the interest cost to US business at four cents per dollar of labor cost, there would have been a whole lot of money left over to boost business profits. The economy would have grown like gangbusters.

Some of those boosted profits could have been spent giving people raises. That would have increased aggregate demand and living standards... and would likely have quelled the anger that vents itself these days in politics.

If interest costs were restrained, the financial sector would not have grown so much. Finance would today be a smaller segment of GDP. But then, with higher profits in the nonfinancial sector, GDP would have grown much more.

Unit Monetary Interest Cost

First of three in a series

An old post opens with a definition of Unit Labor Cost:

unit labor cost business definition

An important measure of productivity calculated by dividing total labor compensation (including benefits) by real output. An increase in unit labor costs will result in a reduction in profitability unless a firm can pass along higher labor costs to its customers. Economists view increases in unit labor costs as an important indicator of potential inflation.

An actual cost -- ie, not an inflation-adjusted cost -- is divided by the inflation-adjusted measure of output. That division skews the resulting number upward along a path comparable to the path of rising prices. Economists practice this sort of self-deception all the time. Let's go along with it this time.

Here's Unit Labor Cost (ULC) for Nonfarm Business:

Graph #1: Unit Labor Cost

ULC goes up, along a path comparable to the path of prices. They tell you it means labor costs drive inflation. I say their arithmetic is corrupt.


The definition of ULC says "An increase in unit labor costs will result in a reduction in profitability unless a firm can pass along higher labor costs to its customers." Sure. But an increase in any cost will result in a reduction of profitability unless bla bla bla, just the same.

An increase in any cost. For example, an increase in interest cost would result in a reduction of profitability bla bla. Here's a picture of monetary interest paid by domestic US business. The "sector" is not exactly the same as the "nonfarm business sector" of Graph #1, but it's as close as I could find:

Graph #2: Monetary Interest Paid: Domestic Business

The Unit Labor Cost is figured by dividing a particular cost (labor) by real output. I will figure the "Unit Monetary Interest Cost" (UMIC) similarly -- by dividing the Monetary Interest Paid number by real output:

Graph #3: Unit Monetary Interest Cost

You should note the units shown in the left-hand border: Billions of dollars, divided by billions of inflation-adjusted dollars. Right away this should tell you the graph is garbage. Of course, it's the same units as the Unit Labor Cost graph. But on the ULC graph, that important piece of information is lost.

Oh, well.

So now we have a unit cost we can compare to the unit cost of labor. To make the comparison, I look at the unit cost of labor relative to the unit cost of monetary interest:

Graph #4: Unit Labor Cost relative to Unit Monetary Interest Cost

Labor cost was high in the early years, relative to interest cost, high but falling. Since around 1980, labor cost has been on the low side. Basically, the ratio was falling all the while interest rates were rising. Then the ratio got stuck low while interest rates were falling, because business debt kept growing.

The economy was good when the ratio was high. Since the ratio went low, the economy sucks.

Oh, and the ratio fell all through the Great Inflation. Labor cost fell, relative to interest cost, all through the Great Inflation.

Do you still think labor cost is the cost that drives inflation?