As long as we believe the neoclassical farce, we will know nothing about what causes prices.
By Blair Fix – Let’s start with the evidence trumpeted as proof that productivity explains wages. Looking across firms, we find that sales per worker correlates with average wages. Figure 1 shows this correlation for about 50,000 US firms over the years 1950 to 2015.
Mainstream economists take this correlation as evidence that productivity explains wages. Sales, they say, measure firms’ output. So sales per worker indicates firms’ labor productivity. Thus the evidence in Figure 1 indicates that productivity explains (much of) workers’ income. Case closed.
Yes, sales per worker correlates with average wages. No one disputes this fact. What I dispute is that this correlation says anything about productivity. The problem is simple. Sales per worker doesn’t measure productivity.
To understand the problem, let’s do some basic accounting. A firm’s sales equal the unit price of the firm’s product times the quantity of this product:
Sales = Unit Price × Unit Quantity
Dividing both sides by the number of workers gives:
Sales per Worker = Unit Price × Unit Quantity per Worker
Let’s unpack this equation. The ‘unit quantity per worker’ measures labor productivity. It tells us the firm’s output per worker. For instance, a farm might grow 10 tons of potatoes per worker. If another farm grows 15 tons of potatoes per worker, it unambiguously produces more potatoes per worker (assuming the potatoes are the same).
The problem with using sales to measure productivity is that prices get in the way. Imagine that two farms, Old McDonald’s and Spuds-R-Us, both produce 10 tons of potatoes per worker. Next, imagine that Old McDonald’s sells their potatoes for $100 per ton. Spuds-R-Us, however, sells their potatoes for $200 per ton. The result is that Spuds-R-Us has double the sales per worker as Old McDonald’s. When we equate sales with productivity, it appears that workers at Spuds-R-Us are twice as productive as workers at Old McDonald’s. But they’re not. We’ve been fooled by prices.
The solution to this problem seems simple. Rather than use sales to measure output, we should measure a firm’s output directly. Count up what the firm produces, and that’s its output. Problem solved.
So why don’t economists measure output directly? Because the restrictions needed to do so are severe. In fact, they’re so severe that they’re almost never met in the real world. more>