I got all kinds of distracted by an interesting chart that Ted Nesi linked to, yesterday.  Basically, the chart shows that the productivity of labor per hour has continued to climb while median family income has nearly stagnated since the 1970s.  Ted subsequently linked to some arguments suggesting that the gap pretty much vanishes if some more-realistic adjustments are made to the numbers (different measures of inflation, and such).

But there’s something more substantial that bugs me about the chart.  Productivity is more or less a raw measurement — so much of thing A turned into so much of thing Z per hour.  The raw measurement of income is, well, income, or dollars. Why should one raw thing be adjusted to the broader economy and the other not?

If we don’t adjust family income for inflation (that is, if we use current dollars instead of real dollars), median family income gains blow productivity out of the water.  After all, if there’d been no inflation after 1947, the median family income in 2012 would have been around $6,000, instead of over $60,000.

This reality takes on added significance if we consider the effect that productivity gains ought to have on prices.

If the resources necessary to turn A into Z decrease, where does that capital go?  The economists who made the chart suggest that, in practice, it has gone to profits (and, ultimately, owners and investors) and to higher-end workers.  Before assessing that claim, though, we have to reason out where it would go, in theory, if nobody meddled.

Well, in a totally free market, the supplier of A could claim some of the gains by raising his prices, but only so much, because if he goes too far beyond his costs, then competition will wipe him out.  The same is true of the business that does the producing of Z from A.  Indeed, the fact that it’s now easier to do that production should force the price down.

If production increases across the entire economy, fewer workers are needed, which will push down incomes.  That, in turn, should apply additional pressure on prices, because people have less to spend.

In other words, productivity should deflate wages and prices.  In a certain way of looking at it, part of the productivity gain should be cashed out of the economy as free time for workers.  The economy is producing the same amount of stuff, but the population doesn’t have to work as hard to get it.

Here’s the thing:  In the mid-1900s, Federal Reserve policy became focused on price stability, and in the early 1970s, the Nixon administration enhanced this ability by severing the final tie of dollars to anything real, meaning gold.  Throughout that entire span, government debt has been accelerating in transporting future dollars into the current economy.

Applied to my topic, here, the government has deliberately been keeping prices from dropping, with a general expectation that it’s better that they go up a small amount consistently.  If policies are going to prevent the price of Z from going down, they inherently must cancel out the deflationary force of productivity on prices, and then some.

The fact that the dollar amount of income has outpaced productivity while the purchasing power of earnings has stagnated shows that workers are losing out on the deal.

So, whom does this state of affairs benefit?  Conspicuously, inflation benefits (and deflation would harm) those who hold debt at a fixed rate, notably the government.  As it takes more cash to do the same things in the economy, the government’s revenue increases automatically, making its debt easier to pay.  (The same principle applies to public-sector pensions, by the way, to the extent that they aren’t tied to an adjustable inflation measure.)

In a more general way, a policy of inflation benefits the financial markets.  If each dollar is going to be worth significantly less in the future, workers can’t simply work and save, because their money won’t be worth what they earned it for when they dig it up out of hiding.

By contrast, if prices were deflating over time (that is, if each dollar were worth more as time went on), that would benefit lenders (because they can do more with the money when they collect it back than they could when they lent it out).  It would also benefit workers, because their hours of work in the past would be worth more in the future.  (An hour of swinging a hammer in 1984 could buy a bag of groceries that year, but if you hid it in a drawer for 30 years, you’d be able to buy the groceries and a case of beer.)

As it is, the artificial inflation of prices allows companies to be more profitable, which passes on to the investment markets, inherently giving them an edge in keeping up with inflation.  When it comes to workers, unless they can find new reasons for savers not to save (that is, new must-have products, including managing machines or operations) or new markets to which to sell, they are at a distinct disadvantage.

It’s less the greed of business that’s to blame than the greed of government.