The wage & profit squeeze

What is happening to profits and wages? On the one hand, Labour complains about the squeezed middle whilst the broader left complains about the fall in the share of wages in GDP since the mid-70s. But on the other hand, Allister Heath says the situation for corporate profits is "horrendous."

So, who's right? The answer is: both, to a point. My first chart shows income shares since quarterly ONS data began in 1955*. This shows three things:

- The wage share fell between 1975 and 1997, but recovered thereafter, only to slip back since 2009.

- The profit share tends to be cyclical, but is slightly higher now than in the low-points of the downturns of 1975, 1981, 1992 and 2001. These numbers, though, include the profits of oil companies, so might overstate the health of the non-oil sector.

- Other incomes (rent and net taxes on production) have trended upwards. They jumped after 2009, I suspect because of the rises in VAT. In this sense, both capitalists and workers have suffered because the other incomes wedge has risen.

We can look at this another way. Back in 1938 Michal Kalecki proposed a simple framework for thinking about the share of wages in GDP.

Start from the national income identity that GDP equals wages (W), profits (P) and other incomes (O), and also equals gross final expenditure (what he called proceeds) minus imports (M). This means:
     P + O = (k-1)(W+M)
where k is the ratio of proceeds to (W + M). He called this the degree of monopoly. You can think of it as the mark-up over costs**.

This means we can write the wage share as:
     w = W/W + (k-1)(W+M)

If we let j = M/W, then this gives us:
     w = ¹/_{1+[(k-1)(j+1)]}

In other words, the wage share moves inversely with the degree of monopoly, k, and the import-wage ratio, j. This is an identity. My second chart shows moves in these since 1955.

You can see that the import-wage ratio has trended upwards, reflecting the increasing globalization of the supply chain. But within this, there have been spikes, due in large part to jumps in oil prices.

The degree of monopoly slumped in the 70s, as wage militancy squeezed profits, but trended upwards until 1997 since when it has trended downwards.

You can think of this as the interplay of two factors. On the one hand, the fact that capitalists have increasingly had the whip hand over labour has tended to raise the degree of monopoly. But on the other hand, international competition has tended to erode their monopoly. Since the mid-90s, the latter force has predominated.

This chart tells us that since the mid-00s, the import-wage ratio has risen, thanks I suspect to higher commodity price whilst the degree of monopoly has fallen. This means wages have been squeezed by higher oil prices, rather than the power of capitalists.

The bottom line here is simple. Both capitalists and workers have cause for complaint. Capitalists have lost pricing power - the degree of monopoly has fallen - which has tended to depress the profit share. But this has not benefited workers because instead the "wedges" of other incomes and higher imports have depressed their share.
 

* The numbers come from tables C1 and D here. GDP is YBHA, imports are IKBI, wages are DTWM and profits are CGBZ. For my purposes, all the other numbers are derived from these.

** You might object that imports are not a cost for capitalists to the extent that they comprise consumer goods. You'd be wrong. If workers buy domestic consumer goods, their wages are not a cost to capitalists in aggregate. This is because what they lose through the back door in higher wage costs is recouped through the front in higher spending. If, however, workers spend their incomes overseas, then wages are a net cost. In this sense, all imports are a cost to UK capitalists, either directly (imported materials) or indirectly.

Comments

[Luis Enrique]

wow, this is going to take some time to digest, I can't say I understand it - I'm very confused by the role of imports.

you write: "If workers buy domestic consumer goods, their wages are not a cost ... because what they lose through the back door in higher wage costs is recouped through the front in higher spending."

doesn't that amount to saying that in a closed economy there is no such thing as a "cost to capitalists" because any income paid out to factors of production (the back door) comes around again through the front door? Does it make sense to say there's no such thing as costs-to-capitalists in a closed economy?

"But on the other hand, international competition has tended to erode their monopoly"

isn't more usual to say that by being able to close down production in the UK and outsource abroad, capitalists have strengthened their bargaining power against workers. It is also sometimes claimed that simply being able to source cheap imports improves profits (I'm not sure that last claim makes sense, but one often encounters it - i.e. Primark is profiteering by using cheap labour in Bangladesh).

when you say M is imports, do you mean gross imports or net imports (i.e the trade balance)? If oil prices rise, for example, but we use that oil to produce things we flog to foreigners, I don't see how that squeezes wages or profits.

In this framework, is it both wages and profits that are squeezed by imports, or just wages?

[chris]

Yes - in a closed economy, all wages would come back to capitalists, except insofar as they got saved. One reason why profits stayed high in the 50s and 60s was precisely that this happened. And one reason why they fell in the 70s was that workers increased their savings.
It is true that outsourcing tends to raise profits, with 2 caveats. One is that cheap imports also raise real wages, so that the share of profits in GDP mightn't rise; instead, everyone;s real incomes rise. The other is that it's not just UK capitalists who are outsourcing, but foreign capitalists too, and their sales to the UK intensifies the competition faced by UK capitalists.
And all this refers to gross imports, not net.
A rise in oil prices tends to reduce real UK incomes, because the price rise cannot be wholly passed onto foreigners, not least because oil exporters tend to save their extra revenues, which is bad for global aggregate demand.

[Luis Enrique]

thanks v much.

So that seems to suggest profits are higher in closed economies? I haven't come across that idea before.

And it still seems weird to claim you can't talk of costs-to-capitalists in closed economies - imagine two closed economies, so wages return to firms as income, but workers have more bargaining power in one than the other. Don't capitalists face higher costs in that world? You can't say they also enjoy higher incomes, because profits also return to firms as income in closed economies, so the division of income between wages and profits does not change what comes back to firms as income.

(I'm also puzzled by the "except if they save" thing - isn't spending on investment goods also income for capitalists? but that's probably enough of my confusions for now).

[chris]

I'm not saying profits are necessarily higher in a closed economy; there are all sorts of reasons why they mightn't be.
But bargaining power alone cannot be bad for profits, insofar as higher wages mean higher consumer spending. If we see high wages and weak profits, something other than bargaining power explains the two.
That something might well be workers' savings. Please remember Keynes - a decision to save is NOT the same as spending on investment goods.

[Paolo Siciliani]

First, I wonder whether the profit share tells the whole story about income inequality here, how big corporations move profit around through sophisticated intra-group transactions involving IPRs and other stuff to cut their overall corporate tax, plus the all issue of executive pay, which if accounted as part of the wage share really do distort the view, in particular, if we assume these various trends have increased during the recent years...
Anyway, I would like to note that up to 2007 the wage and profit share where negatively correlated, reflecting the shifting bargaining power story. This correlation broke down in 2007, with both profits and wage share first briefly increasing and than falling at the same time - whereas the residual share of others went up. This to me is where the system started to eat itself up, in that there cannot be a healthy corporate sectors when incomes of private households are squeezed and access to easy credit is over.

[Luis Enrique]

oh boy, I'm really not sure about that. I think bargaining power alone can reduce profits. Take for example a limiting case where the marginal propensity to consume out of wages is 1 and worker bargain power is such that they secure 100% of the surplus. Then it doesn't matter how much spending rises when wages rise because whatever extra income firms enjoy, workers capture the resulting surplus by assumption. So if you start from any given level of worker bargaining power and increase it, I think at some point profits fall no matter what you assume about the MPC. [I hope I'm not embarrassing myself here - these are just off top of my head thoughts]

And if you take this sort of story at face value (if wages rise, firm incomes rise etc. we have a perpetual motion style growth machine at our disposal - so long as workers spend rather than save[*]. This story needs the addition of a supply-side, and I'm not sure where that addition would take us)

[*] yep, sorry, saving can mean accumulating money.

[UnlearningEcon]

'The bottom line here is simple. Both capitalists and workers have cause for complaint. Capitalists have lost pricing power - the degree of monopoly has fallen - which has tended to depress the profit share.'

Those poor capitalists, losing monopoly power :(

[chris]

@ Luis - if workers were to secure 100% of the surplus, capitalists would stop investing. Profits would then fall because lower investment spending means lower profits. You could then say that the profit squeeze is due to wage militancy - but it operates via its impact on investment
To remind you of the identities:
Y = C + I + G + (X - M)
Y = W + P + O (other incomes).
so:
P = (C - W) + (G - O) + I + (X - M)
Wage militancy affects P only via its impact on the RHS.

[Andrew]

@Chris - I think Luis is right; you have performed a classic partial analysis that I suspect comes from holding an implicit equilibrium model in your head. And frankly, what are you talking about above - "profits would then fall" - what? from 0%?

It makes no difference to your accounting identities what capitalists would or should do. If wages are 100% of the surplus then they do not return to the capitalists, by definition. It is irrelevant to the accounting identity what the capitalists' response is. I need hardly go through the 99% case.

A symmetrical argument might be made that excess profits of capitalists are not a cost on workers because 100% of profits return as wages in a closed economy (except for

You are using an accounting identity that is valid over an accounting period, and then extending just a part of the analysis beyond that period. This would work if the system was at equilibrium.

[Andrew]

And how can we be talking about gross imports and not consider exports?

Consider two identical closed economies operating as described.

Then let them export to each other symmetrically. What has changed?

If imports are considered a cost to capitalists we must also consider the benefit in terms of increased foreign demand for exports.

[chris]

@ Andrew - I did NOT have any equilibrium in mind, merely accounting identities which must always hold for any period.
To take your example, if a country opens to trade then if X > M, GDP rises and so P, O or W must rise. If M > X, then GDP falls and some incomes must fall. It's as simple as that. Note that I am NOT (of course) arguing here for autarky or protectionism. For the purposes of my analysis, the point is merely that a worse terms of trade is bad for some domestic incomes.

[theartteacher]

Great post. I think the highly technical aximoatic underpinnings of neoclassical economics can be limiting though, and I think this is framed in these terms.

I'd love to hear some views on the 'Other' line on the graph, because I suspect this is particularly significant. It'd also be worth pointing out how many people are represented by the groups 'wages','profits' and 'other.

In commenting about capitalist loss of power - is there not arguably a class to whom this power has gone? I'm thinking those not limited by national boundaries, national fiscal policies.....

Out of interest - "if workers were to secure 100% of the surplus, capitalists would stop investing."....if this were to happen then in effect wouldn't capitalists cease to exist, along with capitalism? I'm not saying that's an absolutely bad thing by the way, I think the arguments against capital ownership in terms of elementary rights (what is the justification for the ownership and the power over others' labour), or criticism of the effects of such systems are very powerful.

[Luis Enrique]

(art teacher this post contains absolutely no neoclassical economics)

[Erik]

Wow the recent posts are so good! Thanks for that from a devoted reader (and Swedish political economy blogger!).

[theartteacher]

@Luis Enrique

I'd be genuinely interested to hear why you think it doesn't? I'm keen to learn.

My primary reasons for saying what I did is that I think that analysis is in a tradition of

1. non-normative analysis and
2. of rational/mechanistic utility as the root of analysis.

If one were to take the view that 'an implicit equilibrium model' underpins the analysis then that might indicate reference to the neoclassical tradition. Someone else can argue that, I'd be interested to hear it.

[McDuff]

The "other" thing is interesting to me, too. When you say that it's a problem for capitalists because business profits have fallen, that's surely excluding the wide swathe of capitalists who make their money from rents and who appear to be in robust health.

[theartteacher]

Would also still like to hear more about the 'Other' group, would be very interesting I'm sure.

[Cannibal Economy Blog]

I'm thirding the interest in a little more info on the 'other' category of income share. Is it something to do with financialisation, and the beginnings of the credit boom?