Question

An article in the Economist noted that "for 60 years, from 1770 to 1830 , growth in British wages, adjusted for inflation, was imperceptible because productivity growth was restricted to a few industries." Not until the late nineteenth century, when productivity "gains had spread across the whole economy," did a sustained increase in real wages begin. Why would you expect there to be a close relationship between productivity gains and increases in real wages?

Short answer

Productivity gains can lead to increased real wages as firms gain more revenue and share it with their workers. However, for significant wage growth, productivity gains need to be widespread throughout the economy, not restricted to a few industries.

Step-by-step solution

Understand the Terms

Productivity gains refer to the improvements in the ability of workers to provide goods and services. It's typically measured as the ratio of outputs (goods and services) to inputs (hours of labor). Real wages, on the other hand, is the purchasing power of wages, that is wages adjusted for inflation. It's the wage rate divided by the price level.

Analyze the Relationship

When productivity in an economy increases, it means that the inputs are able to generate more outputs. If we keep the price of goods and services constant, this would lead to an increase in the real revenue of firms. If workers contribute significantly to the productivity gains, it would be fair for firms to share the gains with them in the form of increased wages. Therefore, productivity gains could lead to an increase in real wages.

Contextualize the Historical Perspective

In the British scenario from 1770 to 1830, productivity gains were restricted to a few industries, which implies that only a few firms or sectors had the capability to increase wages. That's why the growth in real wages was imperceptible. However, when productivity gains spread across the economy in the late nineteenth century, it provided a wider base of firms the ability to increase wages and thus led to a sustained increase in real wages.

Key concepts

Real Wages

Real wages are the actual buying power of the income that people earn, adjusted for inflation. Imagine earning a salary but then having to consider how much you can actually buy with that money.

Here's how you calculate real wages: take your nominal wages (the actual money you receive) and adjust them considering the current price level of goods and services. This gives you the real wage, reflecting your purchasing power.

• If your real wages rise, you can afford more goods and services, enhancing your standard of living.
• Inflation plays a big role because even if your nominal wages go up, high inflation can decrease your real wages.
• Real wages can be thought of as the 'true' value of your earnings.

Understanding real wages is crucial because it tells you how much more or less you can buy each year . When real wages increase, individuals often feel wealthier, which can lead to increased spending and economic growth.

Productivity Gains

Productivity gains refer to increases in an economy’s output, which means producing more goods and services using the same amount of input (e.g., labor, capital). When workers are able to produce more in the same amount of time, this is referred to as increased productivity.

So, how does productivity increase?

• Technological advancements, like better machinery or computer systems.
• Improved skills and education of the workforce.
• More efficient processes and innovation.

When productivity improves, businesses can produce more without needing extra resources. This often leads to higher profits for companies, some of which may be shared with employees in the form of wage increases. This is one reason why productivity gains can lead to an increase in real wages.

Economic Growth

Economic growth means an overall increase in an economy’s output over time. It's like the entire pie getting bigger, not just a single slice.

Several factors contribute to economic growth:

• Increased productivity gains, as more goods and services are produced efficiently.
• Innovations and advancements in technology that create new markets and opportunities.
• Investment in capital, such as infrastructure and machinery.
• A growing workforce, providing more labor to drive production.

Economic growth is vital because it generally leads to improved living standards. As the economy expands, it tends to create more jobs, reduce poverty, and lead to better public services. In the context of historical productivity and wage growth, when productivity gains spread across the entire economy, it fostered sustained economic growth, which eventually drove a rise in real wages across the board.