Wage rises are required – real wages must grow in line with productivity

There was an interesting article in the UK Guardian last weekend (March 29, 2015) – Why falling inflation is a false pretext for keeping wages low – which examined wage trends in the UK and the validity of the argument that “Falling inflation now provides employers with a pretext for keeping wage settlements low”. Employer groups never support wage increases and are continually trying to suppress real wages growth below productivity growth so that they can enjoy a greater share of national income. As part of my research to discover the nature of the ideological shift accompanying the emergence of Monetarism as the dominant policy paradigm I have been examining wage distributions. This is part of a book I will complete next year (fingers crossed) on the demise of the political left. In this blog we examine the shifting relationship between labour productivity growth and real wages growth since 1960. The results are illuminating and open up a broad research front about which I will write more as time passes.

I have considered the shift in national income distribution in other previous blogs:

1. There is a class warfare and the workers are not winning.

2. Massive real wage cuts will not improve growth prospects.

3. The origins of the economic crisis.

4. Redistribution of national income to wages is essential.

5. Declining wage shares undermine growth.

Distributional shifts towards profits of the magnitude we have seen since the 1980s are damaging to economic growth and financial stability.

The wage share was constant for a long time during the Post Second World period and this constancy was so marked that Kaldor (the Cambridge economist) termed it one of the great “stylised” facts. So real wages grew in line with productivity growth which was the source of increasing living standards for workers.

The productivity growth provided the “room” in the distribution system for workers to enjoy a greater command over real production and thus higher living standards without threatening inflation.

Since the mid-1980s, the neo-liberal assault on workers’ rights (trade union attacks; deregulation; privatisation; persistently high unemployment) has seen this nexus between real wages and labour productivity growth broken. So while real wages have been stagnant or growing modestly, this growth has been dwarfed by labour productivity growth.

As a result, the wage shares in most nations have been falling. Where has the real income gone? To the profit share!

The declining wage share and the resulting credit binge in many nations were clearly causal in creating the global financial crisis. The mainstream economists believed that the markets were efficient and that there would be no problems with placing an increasing proportion of real income into the hands of the Casino economy.

The problem that arises is if the output per unit of labour input (labour productivity) is rising so strongly yet the capacity to purchase (the real wage) is lagging badly behind – how does economic growth which relies on growth in spending sustain itself? This is especially significant in the context of the increasing fiscal drag coming from the public surpluses or stifled deficits which squeezed purchasing power in the private sector since the late 1990s.

In the past, the dilemma of capitalism was that the firms had to keep real wages growing in line with productivity to ensure that the consumption goods produced were sold. But in the lead up to the crisis, capital found a new way to accomplish this which allowed them to suppress real wages growth and pocket increasing shares of the national income produced as profits. Along the way, this munificence also manifested as the ridiculous executive pay deals and Wall Street gambling that we read about constantly over the last decade or so and ultimately blew up in our faces.

The trick was found in the rise of “financial engineering” which pushed ever increasing debt onto the household sector. The capitalists found that they could sustain purchasing power and receive a bonus along the way in the form of interest payments. This seemed to be a much better strategy than paying higher real wages.

The household sector, already squeezed for liquidity by the move to build increasing federal surpluses were enticed by the lower interest rates and the vehement marketing strategies of the financial engineers.

The financial planning industry fell prey to the urgency of capital to push as much debt as possible to as many people as possible to ensure the “profit gap” grew and the output was sold. And greed got the better of the industry as they sought to broaden the debt base. Riskier loans were created and eventually the relationship between capacity to pay and the size of the loan was stretched beyond any reasonable limit. This is the origins of the sub-prime crisis.

So the dynamic that got us into the crisis is present again and with fiscal austerity emerging as the key policy direction the welfare of our economies is severely threatened. This is a dramatic failure of government oversight.

The UK Guardian article cited at the outset bears on this topic.

Larry Elliott, the journalist, notes that:

Earlier this year Shinzo Abe, Japan’s prime minister, told his country’s business elite that he wanted them to take a brave decision. He wanted them to raise wages.

A month or so later David Cameron followed suit. Addressing the chambers of commerce, the prime minister said it was time for Britain to have a pay rise. Two prime ministers, same message, one subtle difference: in Japan there is evidence that executives took notice of what Abe said, while in the UK we are still waiting for the long-anticipated pick up in pay.

His hypothesis is that in Japan they have a “corporatist model” which means that if the Governments speaks, business listen.

The UK went ‘individualistic’ in the Thatcher years and has lost that solidarity to pursue national interest in a collective fashion.

Larry Elliott says that the corporate sector in the UK believes that the stagnation in real wages and tendency to deflation (not yet realised) is temporary, and that once unemployment falls further, the tighter labour market will push wages growth up.

He contests that claim and argues that:

The relationship between unemployment and wage pressures appears to have changed, so that a much bigger drop in joblessness is needed to provide upward pressure on earnings.

One of the reasons for this is that with rising casualisation and underemployment, labour market wage pressure is no longer driven by unemployment or the lack of it alone.

I covered that argument in this blog – Why did unemployment and inflation fall in the 1990s? – where I reported on research we were doing to augment the Phillips curve (the relationship between unemployment and inflation) with the impact of underemployment.

This underemployment suppression effect is well entrenched in many nations now.

Larry Elliott quotes a recent study which concludes that:

Employers now call the shots not unions. “Once workers would have been looking for the first opportunity to press for higher wages; now employers are looking at pay rises as a last resort” …

He rejects the argument that “Falling inflation now provides employers with a pretext for keeping wage settlements low” as being dangerous and likely to “embed the idea that disinflationary pressures are stronger or longer lasting than previously imagined, that’s the start of a deflationary spiral right there”.

Which is the problem that Japan has become caught up in, given its extremely low wages growth over the last few decades.

And that is one reason why the Japanese PM is urging higher wage settlements.

Larry Elliott thinks the British government should push for:

… bigger increases in minimum wages; they could insist that those companies bidding for state contracts pay a living wage; they could make it easier for trade unions to organise and bargain collectively. Like Abe in Japan, they could tilt the playing field back in favour of labour.

That would require a major ideological shift!

Some historical evidence

The following graph shows the growth in labour productivity (%) for various time periods since 1960 (using AMECO database) on the horizontal axis and the corresponding growth in average real wages (%).

The straight blue line is the 45 degree line where labour productivity growth and real wages growth are equal. This is a special point in the graph because it marks the point where real unit labour costs (RULCs) and the wage share are constant.

To understand that point, here is a quick refresher.

Labour productivity (LP) is the amount of real GDP per person employed per period (it can be measured in hours worked or persons employed). Using the symbols already defined this can be written as:

LP = GDP/L

so it tells us what real output (GDP) each labour unit that is added to production produces on average.

The real wage is the purchasing power equivalent on the nominal wage that workers get paid each period. To compute the real wage at the macroeconomic level, we need to consider two variables: (a) the nominal wage (W) and the aggregate price level (P).

Workers do not determine the real wage. The nominal wage (W) is paid by employers to workers is determined in the labour market by the contract of employment between the worker and the employer.

The price level (P) is determined in the goods market by the interaction of total supply of output and aggregate demand for that output although there are complex models of firm price setting that use cost-plus mark-up formulas with demand just determining volume sold.

The point is that the real wage is the outcome of forces prevailing in two separate (though linked) areas of the economy and a worker cannot easily ‘cut’ his or her own real wage even if they accept work at a lower nominal wage.

The wage share is the share of GDP in nominal terms that the workers command. So it is defined as:

Wage share = (W.L)/P.GDP

W.L is total labour costs, and P.GDP is real GDP valued by the price level.

As I explain in this blog – Saturday Quiz – June 14, 2014 – answers and discussion – it is easy (for someone familiar with algebra) to rearrange the wage share expression in another way.

So Wage share = (W.L)/P.GDP is equivalent to (W/P)/(GDP/L)

that is, the real wage (W/P) divided by labour productivity (GDP/L).

That expression is also equivalent to RULCs.

RULCs are the ratio of real wages to labour productivity and if they are falling it means that productivity growth is rising faster than real wages and the economy is redistributing national income towards profits (usually).

The RULC measure is equivalent to the share of wages in national income. If it falls, workers have a lower share in GDP or National Income.

So in terms of the graph that follows, any observations below the 45 degree line indicate a falling wage share or RULCs and any observation above the 45 degree line indicate a rising wage share or RULCs.

This graph gives you a relative sense of what happened over the decades.

The neo-liberal period is touted as the exemplar of ‘efficiency’ but in general labour productivity growth fell (on average) and real wage suppression became more pronounced as the dominance of the ideology spread.

The ‘Keynesian’ period of the 1960s produced far more balanced and superior outcomes in almost every nation.

To see the graph in more detail I have produced the following decade by decade composite graph. The straight line is the 45 degree line, which looks different in each graph because the scales alter.

The trend over the decades has been obvious.

In the 1960s, with some exceptions, the wage shares were stable and real wages grew in proportion with labour productivity.

By the 1970s, the wage shares were increasing in most nations, but not alarmingly.

Then the neo-liberal attack on trade unions began in earnest and wage shares fell in most of the nations shown with large declines in some.

Labour productivity was no longer being passed on in the form of real wages growth and RULCs were falling sharply in some nations.

By the 1990s, this pattern was entrenched.

In the period before the GFC began, the suppression of real wages became more pronounced in many nations, particularly, Spain, Portugal, Germany, Australia, and Austria, while productivity growth was generally slower.

It is hard to blame trade unions and excessive wage demands for what happened in 2008.

In the period since the crisis, wage shares have risen slightly but that is a typical situation in a major recession because labour productivity slows more than real wage growth.

Greece and the UK (and Luxemburg) have cut real wages sharply in the period since the crisis.

Government conspiratorial attacks on workers

A related theme I have been examining is the extent to which we can document the conspiratorial attacks on workers by their governments.

On March 6, 1984, the UK National Coal Board, which managed all the British coal mines, announced it would close 20 ember mines as part of its plan to rationalise the public subsidies to the mining sector. 20,000 jobs were to go in this move.

The leader of the National Union of Miners (NUM), Arthur Scargill immediately challenged the government by saying that their true aim was to close 70 mines, which would decimate employment, and, clearly, weaken the union.

The Tory government and the NCB Chairman Ian McGregor (a Thatcher appointment) denied Scargill’s claim and assused him of misleading the workers and the public.

The facts belied the honesty of the Government’s and its appointed henchman. Last year, the British National Archives released cabinet documents relating to this period, which clearly showed that the Government was planning to close the 5 mines all along and cut 64,000 jobs overall.

It also wanted the discussion about job losses and mine closures to be kept totally secret. A key document informing a meeting meeting attended by just seven people (including Thatcher, McGregor, the Chancellor, Employment and Energy Secretaries), began with the following statement:

It was agreed that no record of this meeting should be circulated.

Another document tightly circulated one week later among the same cast said that “there should be”:

… nothing in writing which clarifies the understandings about strategy which exist between Mr MacGregor and the secretary of state for energy.

It was a conspiracy to undermine the working class in Britain and destroy the unions.

The BBC radio journalist who covered the story at the time commented when the archives were opened that “If this document had ever emerged during the strike it would have been devastating for the credibility of Margaret Thatcher”. Why? Because she lied about the intentions of the Government and its part in leading the conspiracy.

You can refresh your memories of that particular piece of bastardry by reading this BBC exploration of the Archives release (January 3, 2014) – Cabinet papers reveal ‘secret coal pits closure plan’

Conclusion

The Japanese Prime Minister is clearly on the right track. A fundamental shift in our attitudes to national income distribution is required to allow consumption growth to be driven by real wages growth and to stay in line with productivity growth (so that inflation is kept in check).

That ideological shift is one part of an overall shift in economic policy thinking that is required to allow economies to grow again in a stable fashion without the extreme income inequality that is now entrenched.

Otherwise, a new crisis will emerge – and given the existing private debt levels, the next crisis will be worse than the GFC.

What are the chances of that sort of shift in thinking? Not great at the moment. The policy making circles are thick with neo-liberal Groupthink aka arrogant blindness.

That is enough for today!

(c) Copyright 2015 William Mitchell. All Rights Reserved.