Wages & productivity

Would higher wages boost economic growth? They might, if the marginal propensity to spend out of wages is higher than that out of profits. However, Ben Chu suggests a different mechanism – that higher wages might stimulate growth via the supply-side rather than demand-side:

Perhaps wage increases will prompt higher productivity in firms that employ low-wage labour. Perhaps, in order to protect their profit margins, managements will be spurred into increasing the efficiency of their operations. Perhaps they will invest in more capital equipment to enable their workforce to produce more per hour of their time. Think of a hand car wash installing automatic equipment but retaining the same amount of staff, retraining them to operate the new machinery, and doing more business. This would make minimum wage increases positive for productivity.

Those words “doing more business” are important. Higher wages alone might merely induce capital-labour substitution, leading to unemployment rather than higher output. Which is why Ben is right to say higher wages must be accompanied by fiscal stimulus.

In this, he’s echoing Verdoorn’s law. This says that faster GDP growth is usually accompanied by faster productivity growth.

I’d like to believe this. But I’m not sure I do. For one thing, whilst the Bank of England research Ben cites finds that higher wages can lead to higher productivity, this is the case for only a minority of industries. And for another, Verdoorn’s law hasn’t been so strong recently. My chart shows that whilst there was a massive correlation between GDP growth and productivity from the 50s to the 80s, it hasn’t been so strong lately; productivity has been weak even relative to GDP.

This draws our attention to the possibility that there are several things that might throw sand into the wheels of the mechanism whereby higher wages might raise productivity, for example:

 - Uncertainty. If the car wash business is to invest in a new machine, it must be confident that the boost to demand will last. This requires something more than just looser policy – be it a looser inflation target, commitment to future easing or whatever.

 - Management quality. Do bosses have the skill to introduce new technology well? Bloom and Van Reenen have shown (pdf) that there’s a “long tail of badly managed firms” – but it is in these where productivity is lowest.

 - The fear of future competition. I suspect that one reason why capital spending has been low is that firms fear that their investments will be undercut by future, cheaper ones by their rivals: it’s the second mouse that gets the cheese. It’s not clear that fiscal stimulus will allay these fears.

 - Credit constraints. Another reason for low investment is that firms don’t trust banks to keep credit lines open in future. Again, fiscal policy doesn’t address this.

 - Weak profits. The hand car wash is probably only just getting by, and so lacks the means and motive to buy fancy kit. The care home sector, for example, is already teetering: why should it respond to higher minimum wages by increasing capital spending?

Now, I don’t say this to dismiss Ben’s idea entirely. Given that the Phillips curve is, to say the least, ill-defined in the UK, the cost of experimenting with fiscal loosening is perhaps low. And even if actual productive capacity isn’t terribly cyclical, estimates of it might be - and they are worth having even if we don’t get a renaissance in productivity. Erring on the side of loose policy seems to me to be better than erring on the side of tight.

The issue here is much bigger than it might seem. The question is: is capitalism cooperative or conflictual? Are the interests of workers compatible with those of capitalists or not? It’s this that divides social democrats from Marxists. Historically, the answer has been sometimes yes and sometimes no. I’m not sure which it is today, but I’d like to find out so I'd like to see Ben's suggestion tested.

Comments

[Jonathan da Silva]

Is there any negative effect from higher wages driving up rent and land prices? This might even be deleterious the other way? At least in terms of competitiveness?

[Shiney]

Thinking out loud... and maybe not thinking it through ;-D

What if VAT and/or NI was partially replaced with LVT this would increase the effective return to wages and stop the increase driving up rents (land prices being capitalised rent).

[Bob]

It's interesting watching the psychological barriers at work in these pieces.

If you make labour expensive you alter the capital labour ratio and make it more cost effective to replace people with machinery. So you get rid of the hand car wash and replace it with a full automatic machine. You get rid of foreign imported baristas and start getting your coffee from a machine.

The jobs are lost - permanently. That is the task of the private sector - to innovate, automate and eliminate jobs because people are expensive and not very efficient compared to a machine.

So you then have to find something else for the people to do to fill their time. Often the private sector pulls those people in at the next higher level of automation, and then the process repeats - as it is doing with IT workers being outsourced to India and ultimately replaced with deep learning AI neural nets for the boring stuff.

This is the virtuous cycle that drives productivity forward. You have to have enough spending to create the demand, and expensive scarce labour to make the machines worthwhile.

To make labour scarce in a modern economy, the public sector has to take it away at the living wage. The alternative is to starve people to death or finish them off with the diseases of poverty.

[Blissex]

«If you make labour expensive you alter the capital labour ratio»

The topic of the post and this argument have been advanced (and IIRC our blogger mentioned it in the past) as the main of several reasons why the industrial revolution developed in England: relatively expensive workers made capital relatively cheaper replacing workers with steam powered machinery.

The government of Singapore had a similar deliberate strategy: at some point 2-3 decades ago they raised wages by decree, to make labour relativelively more expensive and put a *ceiling* on the wage level that qualified for a work permit for immigrants, in order to price Singapore citizens out of low-wage jobs (and in effect reserve them to low skilled immigrants), and to push employers to create higher added-value jobs, to escape what is called today the "middle income trap".

That was done cleverly and apparently worked pretty well. Something like that is pretty much inconceivable in England today because the elites still remember the attempt at their unseating by the syndicalists in the 1970s and have chosen for England a low skills low wages "plantation economy" model.

[Blissex]

«Is there any negative effect from higher wages driving up rent and land prices?»

That's a very interesting topic, and is an aspect of "Baumol's cost disease".

Indeed usually demand, often from rising exports, drives up wages, that drives up immigration and asset prices, for example as in Germany's post-WW2 boom. Consider conversely northern England: falling demand, from falling exports etc, drove down wages, drove emigration, and a collapse of northern asset prices.

But there is the strange case of southern England: low wages, big imports, are happening at the same time as high immigration, rising asset valuations.

Usually that combination does not make sense.
The most likely explanation of that combination happening in southern England today is that immigration and asset prices have become detached from imports and wages thanks to ballooning government sponsored credit funding years of asset stripping. A pretty common strategy in the anglo-american culture countries (but not only them), as it delivers huge electoral success for tory parties.

[Hugo Evans]

Cooperative or conflictual?
Is this not the question posed by the Neo-kaleckian model of demand regimes? The mechanism that operates to bring about investment and associated productivity gains is high utilisation rates, and tightening labour markets. The social democratic dream on the upswing goes awry as capital seeks to reassert discipline, even over profit. Is there any way to bring this mechanism about today without regional coordination to reflate and defend labour market institutions, rather than shunting the reserve army around. The eurozone institutionalises what was once a phase in the political business cycle, leaving us with neither cooperation or conflict, but indifference.

[Blissex]

As usual for our blogger's posts so many interesting issues raised, like a good tutorial topic...

«Those words “doing more business” are important.»

As to that I think that if JM Keynes had used "effective sales" instead of "effective demand" and "sales" in general instead of "demand", because his policies were really about stimulating sales, his approach would have been much better received by business and less liable to be associated with inflationary pressure.

[Blissex]

«is capitalism cooperative or conflictual? Are the interests of workers compatible with those of capitalists or not?»

Political or economic? Short term or long term? That probably matters a great deal.

«It’s this that divides social democrats from Marxists.»

I suspect perceptive Karl would argue that in the short term the economic interests of some (significant) parts of labour and some (significant) parts of capital can be aligned, e.g. against rent, but not only.

But I reckon that social-democrats don't necessarily think «the interests of workers compatible with those of capitalists», but that the interests of capitalists as a whole don't include an interest in the complete exploitation of workers, precisely to avoid the collapse of capitalism because of an excess of exploitation leading to a collapse in sales.

My guess is that the mroe common social-democratic view is that while capital is politically dominant "managing" the rate of exploitation and alienation is both tolerated by capitalists and more achievable than trying to abolish exploitation.
Regrettably that can become more like defending the rate of exploitation and alienation "because competitiveness" or "because end of history" (see the Rubin wing of the Democratic party or the Mandelson wing of the Labour party).