Osborne's exhilarationist gamble

What’s the link between profit margins and capital spending? I’m prompted to ask by Martin Wolf’s latest piece:

Against this background [of falling real wages], I find it hard to understand why the government is so confident that the economy would withstand the sharp fiscal squeeze that lies ahead. This has depended on an inordinately optimistic view: higher net exports and corporate investment will offset the contractionary impact of tough constraints on public spending.

There is, though, a possible defence of Osborne here. And it lies in the very fact that worries Mr Wolf - that real wages are falling. This old paper (pdf) by Silvia Ardagna says:

The labor market is an important channel for the transmission of fiscal policy shocks…GDP growth is higher the larger the decrease of public spending, and especially of the government wage bill.

We can put this into Marxian terminology. Government spending cuts are a weapon in the class war. In sacking public sector workers, their effect is to increase unemployment and thus shift bargaining power in favour of capitalists. This leads to lower real wages and, ceteris paribus, higher profit margins.
And here’s the thing. It is possible that this shift in the distribution of incomes raises the aggregate propensity to spend. Higher profit margins might boost capitalists’ confidence and so raise their inclination to invest, by more than lower real wages reduce consumer spending. This is what Marglin and Bhaduri called an exhilarationist regime.
This possibility has occurred in the past. It explains the expansionary fiscal contractions described by Ardagna. And it happened in the UK in the mid-late 80s. And it happened in reverse in many countries in the 1970s; a profit squeeze killed off capital spending.
The question is: can it happen in the UK here and now?
I wouldn’t rule it out entirely. The very fact that they’ve survived the recession might have increased bosses’ overconfidence and hence their tendency to see investment opportunities even where none exist.
But I have my doubts. For one thing, in the last few years - before and during the crisis - the British working class was remarkably quiescent, profit shares were high, and yet investment was low. This speaks against the idea that higher profit margins alone raise capital spending. I suspect low investment has more to do with a genuine dearth of opportunities, rather than to the fear that workers would seize the fruits of such opportunities.
And with at least some firms likely to remain credit-constrained, one vitally important channel through which increased confidence leads to increased investment - a rise in corporate debt - is blocked.
So, even if I were on Osborne’s side in the class war, I would be doubtful of whether now is the time or place to be waging it.

Comments

[Luis Enrique]

I agree - how many UK firms are on that margin where a small decline in UK wage costs will open up profitable investment opportunities, after accounting for offsetting demand effects? besides, if real wages are falling because imported input prices have risen, that doesn't help firms anyway. I guess FDI might increase?

Is there some reason to think firms have pent up investment demand anyway? if so, investment might save his bacon even if the wage squeeze has nothing to do with it.

nb - have you seen most recent WWCI on this topic?

when does data on income shares get released? will be an interesting series to watch.

[Paolo Siciliani]

I guess that the argument is that exports would make up for reduced consumer spending at home.
But my point is that to penetrate export goods markets (let alone labour intensive services) you need to provide good quality, which I believe most of it is due to a committed and happy (if you like) workforce. Now I doubt that lower real wages could actually be a boost to growing exports in this respect. See the German example and the comparison in terms of market outcome between WW happy workforce and FIAT squeezed ones....