The Reality of the "Real Wage"

November 13, 2013

Economists often debate the implications of trends in the "median real wage." There is no such thing. We have statistics on the hourly wages of workers and we can compare the median in 1970 to the median in 2012. However, that only gives us the median nominal wage, not adjusted for inflation, says Arnold Kling, a member of the Mercatus Center's Financial Markets Working Group at George Mason University.

To convert a nominal wage to a real wage, we need to apply a cost-of-living adjustment. A cost-of-living adjustment in turn is based on computing quality adjustments and price changes for a given market basket of goods and services. The problem is that every household has different tastes, and this means that there is no such thing as the cost of living.

  • In recent decades, the relative prices of goods and services have diverged sharply.
  • The hours of work at the median wage required to purchase basic household appliances had declined by over 80 percent between 1958 and 2012.
  • In contrast, average health care spending per capita relative to the median wage had more than quadrupled over that same period.

However, this comparison does not mean that the cost of health care has quadrupled since 1958. Much of the additional spending goes for MRIs and other advanced medical equipment, as well as for health care professionals with more extensive specialization and training than what was available 50 years ago.

It is debatable whether the value of health care has gone up sufficiently to justify the sharp rise in expense, or whether instead we undertake many medical procedures that are not cost-effective, particularly in the last year of life.

It is also debatable whether our "taste" for using health care services would be as strong if we were paying more out of pocket, rather than having 90 percent of our medical spending covered by either government or private health insurance. In any case, if health care spending is up because we have acquired a "taste" for advanced medical equipment, new medicines and new medical specialties, then we have to be careful about making statements about how the cost of living has changed over the last half century.

As a result, calculating trends in the real wage is much harder than we realize, because every household has different tastes. Such an exercise is misleading at best and meaningless at worst.

Source: Arnold Kling, "The Reality of the 'Real Wage'," The American, November 4, 2013.

 

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