On wage-led growth

Yesterday, I quoted Michal Kalecki pointing out that wage cuts cannot create full employment. The fact that GDP has flatlined recently as real wages has fallen is consistent with this.This raises the question: could it be that policies aimed at raising wages at the expense of profits would boost the economy? A nice non-technical paper (pdf) by Marc Lavoie and Engelbert Stockhammer discusses the issues.

The case for such wage-led growth is straightforward. If the marginal propensity to spend out of wages is higher than that out of profits, a transfer of incomes from profits to wages will boost aggregate demand. This could happen. Common sense tells us that the badly off tend to spend their incomes, whilst the fact that rising profits before the recession were not accompanied by strongly rising capital spending suggests that the propensity to spend out of profits has been low.

This casual empiricism is supported by a paper by Ozlem Onaran and Giorgios Galanis, who have estimated (pdf) that, in many developed countries, rises in the share of profits in GDP have been associated with lower aggregate demand.

Better still, say Lavoie and Stockhammer, wage-led growth might be self-sustaining, in one of two ways:

 - Verdoorn's law tells us that higher output growth is usually accompanied by better productivity growth. This means higher wages might partly pay for themselves, and that they might not be very inflationary.

 - Firms might respond to higher labour costs by investing more in labour-saving technology, which would also tend to hold down inflation. If policy-makers respond to this by loosening macroeconomic policy, we could get a virtuous circle of non-inflationary demand growth, investment and rising productivity. This happened in much of the 50s and 60s.

So, what could go wrong? For me, there are three issues here:

1. A rise in wages for worse-off workers (for example through a living wage) would lead to lower payments of tax credits. In this sense, transfering money from capitalists to workers would be partly a fiscal tightening. That would tend to depress aggregate demand.

2. Is the marginal propensity to consume out of low wages high? If households are over-geared, they could use the extra income to reduce debts instead.

3. The relationship between capital spending and profits is unstable, as it depends upon animal spirits. There are two especial difficulties here:

- Capitalists would be happy to invest with low profit margins, if they are accompanied by high expected demand and hence high output-capital ratios and a high profit rate. But confidence that this will be the case requires them to have confidence both that macroeconomic policy can maintain high demand and/or that overseas demand will be high. This isn't certain.

- For the last 30 years, capitalists have been accustomed to policy being made in their own direct, short-term interests. Any disturbance to this might weaken animal spirits by more than the prospect of high demand would improve them.

Such instability is no mere theory. In the 50s and 60s, wage-led growth was feasible because capitalists invested in the confidence that high aggregate demand would be sustained. But in the 70s, this changed as they fretted about the squeeze on profit margins.

These doubts hint at what Servaas Storm calls a "sobering asymmetry". He says:

Lowering real wages will be unambiguously counterproductive, but the opposite policy of raising real wages will not have much of an impact on the economic recovery.

Perhaps the ability of capitalism to provide full employment requires freakish historical circumstances of a sort we saw only in the 50s and 60s. And perhaps it is only wishful thinking by both rightists and social democrats that stops them seeing this.

Comments

[King Ubu]

Investment in education is the way to stimulate growth, but first, public attitudes towards education must change. Nowadays the public seem to perceive higher education as a pointless distraction from the true path to success, which as everyone knows, involves becoming a "celebrity" by shagging a footballer, or wanking off a pig on national television. There's clearly a problem here - people choose to follow that path because they're duped into thinking its a fulfilling life.

Not to stray too far from the main point, but this kind of perception error reminds me of the classic mistake people make when talking about Islam - the confusing of tolerance with submission. Islam is a totalitarian belief system: if the school bully comes round to your house and trashes everything, and you thank him for it, that isn't being tolerant, it's being a doormat.

Education may not result in any tangible benefits for the individual in the short-term, or even the long-term in the current economic climate, but on the large scale it is good for society and leads inevitably to progress, understanding and enlightenment, which will lead to economic growth as we reap the rewards.

[Rich C]

On 1) I'm not sure how the tax-credits you're referring to work in the UK, but unless the credit is clawed back at more than one-to-one, I don't see how the reduced provision of tax credits would reduce aggregate demand, since the provision of those credits is being (at least) made up for by an increase in wages. Are you just saying that the total impulse to aggregate demand from increased wages would be less than the aggregate wage increase because some of this wage increase would be off-set by smaller tax-credit provision? That seems unobjectionable to me as an observation, but it would not actually lead to a reduction in aggregate demand.

On 2)you're definitely on to something, but in so far as highly leveraged households will have to deleverage somehow, raising wages will if anything speed up the process.

On 3)I think this is the most substantive risk/objection you raise, but a lot seems to depend on the capacity of capitalists to coordinate investment plans so as to overcome the prisinors dilemma they would otherwise be in: they might all be better off if they all fail to invest in response to a wage-led increase in AD, but each individually would be at a competitive advantage if they responsded to AD with increased investment.

I notice you don't mention inflation, but it seems to me that a wage increase that raises real wage growth above the sum of productity growth and the central banks inflation target would create a counter-productive (from the point of view of increasing AD and getting unemployment down) decline in "animal spirits". Not clear that a lower wage increase than that would do so sufficiently to solve the prisoners dilemma.

[john malpas]

"could it be that policies aimed at raising wages at the expense of profits would boost the economy? "
So policies would decide if I pay more counter staff regardless of what I want ?
Really!
How long woulde this government stay in office?

[Edward Lambert]

Kalecki worked on the idea of effective demand, as did Keynes. I have researched it and written 60 posts so far on effective demand, full of graphs and equations.
The bottom line of my research is that raising labor share of income is imperative now. If it falls 2 more % points, the US economy will be in serious trouble. I have the equations and data behind this.
There is a lot of reading at my blog, but if anyone wants new economic thinking... here it is...
http://effectivedemand.typepad.com

A good post to start with is one of the basic ones...
http://effectivedemand.typepad.com/ed/2013/03/what-is-effective-demand.html

[David]

This recent paper by Alex coad and others for NESTA looked at the growth dynamics for firms I.e. what comes first sales growth, asset growth, profit growth or employment growth. It finds:

"We also observed that the growth of operating profits either has no causal effect on firm growth (full sample) or a small negative effect on employment growth (for the sub-sample of HGFs)........Put informally, the caricature would be that profits are withdrawn to be spent by investors on champagne, not on new jobs. Policies that are aiming to help firms generate jobs should not focus on helping them to first generate large profits, because the evidence suggests that profits are not reinvested into employment growth"

http://www.nesta.org.uk/publications/working_papers/assets/features/growth_processes_of_highgrowth_firms_in_the_uk

[chris]

@ Rich C - as workers incomes rise, tax credits are withdrawn at a rate of around 50%. If workers see only half of a £1 rise, their MPC from pre-tax wages is likely to be 0.5 at best. If there's a positive MPC out of profits, this could be the difference between wage and profit-led growth. Of course, this problem could be prevented by looser fiscal policy.
@ Edward - Onaran & Galanis' work suggests wage-led growth is more likely in the US than UK, partly as there's a higher MPC out of wages.
@ David - I'm a huge admirer of Coad's work, which seems to me to suggest that nothing much affects firm growth. But does his micro work really translate quickly to the idea that lower profit margins in aggregate would be a good thing?

[David]

No Chris you're right, I don't think the paper finds that. It says that it can't rule out the anticipation of profits as opposed to profits themselves that causes fims to create jobs. So my interpretation is that in order to create lots of jobs we need lots of firms who anticipate profits but haven't made any yet. So an excessive wage share in the economy overall may be a sign that we have too many firms making profits and therefore stopped or slowed down job creation.

[air jordan]

Remova a alguns minutos à verificação o Web site da cidade. Você encontrará uma série completa dos serviços que lhe ajudarão evitar um bilhete, ou mais mau. E, para fazê-lo mesmo mais rápido, nós alistamos as ligações para prepará-lo para quase toda a edição carro-relacionada em Boston.

[Oliver]

You don't need to introduce capital vs labour to tell a wage-led growth story. All you need is two classes, one of which has a lower MPC than the other, and an unequal distribution of income in favour of that low MPC class. Redistribute income to the high MPC class, et voila; growth.

[Astana Economic forum]

These days the community seem to accept that education is a useless diversion from the real direction to achievements, which as everyone knows.