On Tuesday I started trying to explain why I save and invest such a high percentage of my income at such a (relatively) young age.
In that post, we spent some time exploring how a high savings rate can buy you options and can free up how you spend your time in the future. It was an optimistic pitch for saving.
Today will be a bit less optimistic. It will be about a sad truth of our modern economy. (And, more positively, what you can do about it.)
Hard work doesn’t pay.
At least, not as much as it used to.
In economics, there is a rule called Bowley’s Law. Named for Arthur Bowley, the British economist who discovered it, the law states that the percentage of income going to labor and the percentage of income going to capital in a country remain relatively constant over time.
To better understand this, let’s pretend we’re talking about a single company rather than a country.
Let’s say that a company is selling widgets for $1 each. Of that dollar, 60 cents goes to the workers who made it. If that company is selling $100,000 worth of widgets in a year, then the workers are getting paid $60,000.
Bowley’s Law says that if that company grows to sell $1,000,000 worth of widgets, those workers will get around $600,000. As the economy grows, the share that goes to workers stays constant.
In the same way, the share that goes to capital (the shareholders of our company) stays constant. If the company’s sales 10x from $100,000 to $1,000,000, the shareholders will get 10x the value.
This is great! A rising tide lifts all boats. When the economy does better workers do better and shareholders do better. Everybody wins.
The problem is that Bowley’s Law is no longer true.
The Decline of Labor
The following graph shows the share of income going to labor in the United States from 1947 to 2016:
If Bowley’s Law were true, we would expect to see a lot of short term movement, but long term stability. That may look something like the section from 1947 to 1970. There are some ups and downs, but the center is pretty consistent.
From 1970 to around 1995 we see a gradual trend downward. This is a period where the amount that we pay workers is falling, but not sharply.
There is a recovery from 1995 to 2000 before we immediately fall of a cliff.
We are now at a point where labor’s share is nowhere near its historical range. This means that we are paying much less for work than we used to.
I spend a good amount of time reading blogs and listening to podcasts in the entrepreneur space as well as the personal finance space. In both of these worlds, the advice to “create more value” prevails. If you work harder, you will be rewarded. The market rewards value.
But does it anymore?
Worker productivity has skyrocketed. Workers today are twice as productive as workers 30 years ago.
And yet, their salaries have barely moved.
If you really want to know why Millennials can’t afford houses, stop blaming avocado toast and start looking at a system that pays them 50% of what they’re worth.
This is stark.
Prior to 1970, workers were rewarded for their increasing productivity. When workers were more productive, they made more money. The lines on the graph match up almost exactly.
Since then, worker compensation has been completely divorced from productivity. Workers are being far more productive, but are not seeing any corresponding raise. Even the slight raise that does appear in this graph is largely illusory. “Compensation” on this graph includes health care benefits. As the cost of health care rises drastically, workers are seeing their “compensation” increase without seeing any more money in their paycheck.
The Rise of Profits
With productivity rising, companies are making a whole lot more money. And if they aren’t paying any more to their workers, then companies must have increasing profits.
And boy are there profits.
So that’s where our productivity gains are going.
The economy is growing. Companies are growing. Profits are growing.
But instead of sharing those profits with workers, the benefit of the growth is going entirely to shareholders.
The System Needs to Be Fixed
My preference is to fix the system.
I want workers to be paid what they are worth. If people are becoming more productive and more efficient, then they should be paid for that.
Corporate profits are at an all-time high and yet many of those corporations refuse to pay their workers a living wage. It is morally wrong and needs to be corrected.
If that doesn’t sell you, then the system needs to be fixed to save itself.
Inequality is worse than at any point since 1929. Judging by the graphs above, it looks as if it will only increase in the years ahead. This can only lead to a more and more frustrated electorate seeking more and more drastic change. And that can go awry very quickly.
With that mini-rant out of the way, I don’t have the power to fix the system. I will do what I can and I will keep advocating for change, but this is a big problem and I am one person.
In the meantime, I have to assume that the trends will hold.
Work will continue to be less and less rewarded. Capital will continue to be more and more valuable.
Because of this, it makes sense to build up as much capital as possible as early in my life as possible.
The reason that the 1% is pulling away from the rest of the country at a rapid pace is because they have more of their money in investments.
The reason that the 0.01% is pulling away from the 1% even faster is because they have even more of their money in investments.
While I don’t intend to catch the 1%, it stands to reason that the quicker you can jump on this trend, the less far behind you will be left.
If the trends reverse, then I will be able to make a fair wage in the workplace. If they don’t, then my money will make money faster than I could. Either way, my family will be financially stable and secure.
So what do you think? Are these trends problematic to others? Am I just a tin foil hat alarmist? Do you see flaws in my plan or my reasoning? Do you want to debate economic policy? Join us in the comments!