The Productivity-Welfare Linkage: A Decomposition (ESCoE DP 2022-07)

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The Productivity-Welfare Linkage: A Decomposition (ESCoE DP 2022-07)

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According to Paul Krugman (1994, chapter 1), “Productivity isn’t everything, but in the long
run it is almost everything. A country’s ability to improve its standard of living over time
depends almost entirely on its ability to raise its output per worker.” But productivity and the
standard of living are different concepts and are measured in different ways, so the
question is, what is the linkage between them? Productivity is typically measured by GDP
per hour. The standard of living has potentially many aspects such as health, longevity,
personal security, and relationships. But here I take a narrower view and stick to the
national accounts. So the standard of living is measured by the household disposable
income of the median individual. I use the median rather than the mean so that inequality is
taken into account. I develop a decomposition of the growth of median household income
which relates it to the growth of productivity via eight additional factors, one of which is
inequality; four other factors are measures of labour market performance. I apply this
decomposition to the UK over the period 1977 to 2019. I find that productivity growth was
far and away the most important factor in accounting for the growth of living standards
which was substantial up to 2007; rising inequality prior to 2007 retarded the growth of
living standards but not by much. Since 2007 productivity growth has collapsed as has also
the growth of living standards. The fall in the latter has been mitigated a bit by a fall in
inequality.