Doubts about wage-led growth

Today’s GDP figures suggest that even one of the left’s better economic ideas might not be effective.
I’m referring to wage-led growth - the idea that a shift from profits to wages will raise aggregate demand.
This would be true if the marginal propensity to spend out of £1 of wages is higher than the marginal propensity to spend out of profits.
For most of the 00s, this was in fact the case. Between 2005 and 2010, non-financial firms’ capital spending fell even though retained profits grew by 21.7% - implying a slightly negative marginal propensity to spend. However, during this time consumer spending rose 19.9% as disposable income grew 19.1% - an MPC of over unity*.
These numbers suggest a shift from profits to wages would raise aggregate demand.
But today’s news suggests the numbers are changing. They show that in Q2 nominal consumer spending rose only 0.1%; it fell 0.8% in real terms. But wage incomes actually rose, by 0.4% nominal. This suggests the marginal propensity to consume out of wage income is low now.
If this is the case - and the usual caveats apply to one quarter’s numbers - then policies aimed at boosting wages might not increase aggregate demand by much. This could be because people would use wage rises to repay debt.
By contrast, business investment rose 8% in Q2 despite a fall in profits. This would be vindication of wage-led growth, if investment rose because capitalists anticipated that higher wages would raise aggregate demand. But I don’t think this is the case. Instead, it could be that firms are finally starting to spend the cash they built up during the 00s.
It might be, then, that shifting incomes from profits to wages now would actually depress aggregate demand. Workers would use pay rises to repay debt, whilst capitalists might regard falling profits as a reason to hang onto their cash.
You might wonder how this story fits in with my long-held view that there’s a dearth of investment opportunities.
One possibility is that the dearth is diminishing. Another  is that overconfident bosses are spending their cash piles on projects that might not turn out to be as profitable as hoped.
Whatever. My point is that wage-led growth could be an idea whose time has passed. Even if there were policies that would raise the wage share - which is not clear - doing so mightn’t raise aggregate demand. As I’ve said, it’s harder for governments to  raise economic growth than generally supposed.
 * Tables A22 and A40 of this pdf.

Comments

[Alex]

Another one would be that the wages number is going to get revised down:-)

[Luis Enrique]

if households are busy repaying debt, won't higher wages help them do that faster and get us out of this hole sooner?

[Jackart]

"You might wonder how this story fits in with my long-held view that there’s a dearth of investment opportunities.
One possibility is that the dearth is diminishing..." perhaps an (anticipation of) slower issuance of gilts might reduce the crowding out effect of Government deficit spending on investment. Or maybe the negative real yield on these assets is doing it?

Either way it could show crowding out to be real? No?

[Tom Addison]

FWIW, my personal situation (and it's the same for many people my age) is that even though I should be getting a good payrise next year, I'm still going to saving as much as I can (as I am now) because of how much you need for a bloody deposit to buy a house nowadays.

[Paolo Siciliani]

You are assuming a costant MPC, but how do you feature in future expactations into that?

I mean, if employees believe that the trend in favour of profits to the expense of wages will be reverted for good, they will probably move to a higher MPC in line with the life-cycle theory of consumption.

That is to say, the wage increase you refer to is hardly an indication of a long-term change backed up by a wage-led growth political agenda.

[chris]

@Jackart - if capex were sensitive to gilt yields, it should have been stronger in the 00s as yields fell. Thios makes me suspect the impact of the risk-free rate on capex is small in itself.
@ Paolo - good point, but I suspect capex is more sensitive to profit expectations than consumer spending is to wage expectations.

[Keith]

May be if British workers had more employment protection they would be more inclined to spend their pay? Instead there is austerity cuts and more attacks on employment rights and social security from this Cabinet of moronic millionaires. The fear that ministers want to impose on workers will merely make them more cautious and less inclined to spend reducing the most important component of demand. Repayment of private sector debts will reduce total demand if State spending is reduced at the same time. Not an optimistic situation.

[Robs]

More employment protection means less employment, ceteris paribus.

[Ralph Musgrave]

Chris ignores the fundamental purpose of the economy, which is to produce what the consumer wants: both in the form of private sector produced stuff and public sector produced stuff. Stimulus should therefor ALWAYS take the form of extra public sector spending and feeding more purchasing power into consumers’ pockets.

As to the fact that investment spending is currently higher than normal (as indeed it is in the US) that is not a reason for abandoning the above principle. There will ALWAYS be erratic variations in investment spending, consumer confidence and a dozen other variables.

Put another way, I agree with Luis Enrique above (and not for the first time).

[Mcfuckingduff]

"Wage led growth" would be nice, but surely the important thing is more wage-led wages. The importance of giving people money so that they can buy food should not be underestimated, I believe.