Since 1978, productivity in the nonfarm business sector is up 86% but real compensation per hour is up just 37%. Is that fair?

That's the question economist Alan Blinder asked in his Friday column in the Wall Street Journal. There are two levels to the conundrum: (1) Why is this happening and (2) What, if anything, should government do to fix it?

Let's turn to the first question: If the US worker is making more stuff in less time, where is that productivity going if it's not going to higher wages? For the answer, look at manufacturing. Our industrial production has grown by a factor of five since the 1950s (graph below). Over the same period, manufacturing jobs as a share of the economy have fallen from 25% to 11% in 2008. The difference is machines. Technology helps companies make more stuff, faster, for less money. It also replaces the need for workers. So in the last few decades, manufacturing has learned to produce much more stuff with fewer humans.

FRED Graph 1

Technology isn't the only disruptive force. Outsourcing, which started to take off in the early 1990s, targeted low-level white collar jobs in IT infrastructure, customer service and software, sending millions of jobs overseas while holding down their wages at home. The decline of US labor unions further depressed median wages. The inexorable rise in health care costs stole, and steals, raises from average Americans when bosses put more money into untaxed health care premiums and less into taxed earned income. More controversially, you could say that the rise of a CEO Culture has only recently elevated quarterly earnings over hiring considerations, which concentrates corporate earnings in the corner office rather than the cubicles.

So where is the productivity going? More goods, lower prices, richer C-suites, more expensive health care -- but not into paychecks.

How do we fix this? Well, first let's think about what we can fix. We can't unmake the machines that do the work of a dozen 1940s-era manufacturers, nor would we want to. We can't control health care costs without major reforms in both doctor's offices and the US tax code. But perhaps we can create new industries that fill the middle-class vacuum left by the decline in manufacturing employment.

If manufacturing lost 15% of its share of the labor force in the last few decades, where did the jobs go? Three places, basically: (1) finance and real estate; (2) professional and business services; and (3) the health care/education/social services sector. Some of these jobs -- bankers and consultants and doctors -- require many years of post-secondary education, and they pay very well. But some of these jobs -- like personal services and food prep -- don't require much education and don't pay very well. Here's what the hollowing out of the middle class looks like: jobs at the top, jobs at the bottom, and a valley in the middle.

job growth across industries high low education.png

The last three decades have worked the US labor force like a centrifuge, spinning jobs away from the middle and toward the top and bottom.

What can we do about this at the government level? You can fix the pay gap directly by taxing the wealthy and redistributing their income to the middle and lower classes in the form of earned income tax credits, child credits, lower tax rates, and better public services. Or you can guide the economy to create new industries with more opportunities for the middle class -- by either investing in research and development where we see the potential for growth (green energy, biosciences, etc), or by investing in college education in the hopes that a smarter workforce will research and develop its own ideas.

There is no easy silver bullet to exterminate the myriad causes of this 30-year middle class wage freeze. Those who see US income inequality as a matter of ethics and fairness are more likely to advocate for the short direct route of higher taxes at the top for higher spending for the bottom.