Who cares about wages?

David Altig of Macroblog argues (continued here) that we should just ignore wages and look at total compensation. Greg Mankiw agrees. Brad DeLong disagrees, but only because we don’t have good enough data on total compensation. I would suggest, however, that there are a couple of reasons we should care about wages for their own sake.

First, even though compensation is the theoretically correct variable that rational firms and workers should care about, their behavior in the real world may reflect rules of thumb that give precedence to wages over benefits. As a result, the behavior of the Phillips curve – the short-run tradeoff between inflation and output – may depend on the exogenous behavior of benefit costs. Recent increases in the real cost of health insurance have, in my opinion, had an inflationary impact. In principle, they shouldn’t: firms facing rising benefit costs should just keep wages down. In practice, I suspect this is often not what they do. I can’t prove it, but I believe that the weak wage growth in recent years has been the result of weak labor market conditions – conditions that would normally have been disinflationary – and not the result of increasing benefit costs.

At the place I used to work, I was there for 6 years, and every year, they would announce a 5% wage increase. I found it kind of amusing because the memo always said what the inflation rate was, but it never seemed to make any difference: we automatically got a bigger real wage increase in years when the inflation rate was low. Since our benefits included health insurance, we also got a bigger increase in total compensation in years when the cost of health insurance rose more rapidly. (That part wasn’t even in the memo.). Firms have to take benefit costs into account in making employment and pricing decisions, but when it comes to wage-setting decisions, I would guess that a lot of firms behave like my old employer.

The second reason has more troubling implications. Wages, I think, have a lot to do with the subjective sense of prosperity. “Honey, I got a raise!” sounds a lot better than, “Honey, they expanded our health insurance to cover several newly developed procedures!” Even though rising benefit costs largely reflect real improvements in the quality of health care, these improvements don’t make us feel richer. Unfortunately (this is the troubling part) they really represent an acknowledgement that we weren’t doing so well to begin with. There are all kinds of health problems we could get, and it’s a good thing when new solutions are developed, but for those who are currently healthy, it is much easier to ignore the potential problem when we don’t have to pay for a potential solution.