Doubts about wage-led growth

“Higher wages prompt improvements in productivity”. This is one of the central claims in the IPPR’s report this week. But I wonder: how true is it?

Certainly, it can be for individual firms. An employer who pays better than the going rate will attract better workers, motivate them more, and enjoy lower staff turnover. Not everybody, however, can pay better than average. What’s true for one firm, therefore, need not be true of all.

Instead, there are two other mechanisms whereby higher aggregate wages might raise overall productivity.

One is that a shift in the distribution of income from profits to wages might increase aggregate demand and – via Verdoorn’s law – this would boost productivity. This would happen if the marginal propensity to consume out of wages is higher than that to consume and invest out of profits.

Personally, I’m sceptical of this. Without other changes, pay rises for the low-paid would be partially offset by lower tax credits and might be used to pay off debts rather than for consumption. Also, many low-wage employers are not high-rollers squirrelling profits overseas but instead, spend a high proportion of their incomes, either on capital or consumption goods.

Which brings a second mechanism into play. If fiscal policy maintains proper full employment, the prospect of continued high wages and strong demand might induce firms to invest and innovate more, thus raising productivity.

The question here, then, is: can we have wage-led growth, whereby higher wages trigger growth and productivity improvements? Or do we need profit-led growth, in which firms are induced to invest by high profit margins? A famous paper (pdf) by Steven Marglin and Amit Bhaduri showed that both are possible in theory: see too papers by Marc Lavoie (pdf) and Engelbert Stockhammer (pdf).

Empirical evidence here is mixed. One the one hand, we got wage-led growth in the 50s and 60s, when labour shortages and rising wages encouraged firms to raise productivity. And Özlem Onaran and Giorgos Galanis have shown (pdf) that in recent years a lower wage share has been accompanied by weak aggregate demand in many countries.

On the other hand, though, a study of investment in the 70s and 80s by Robert Boyer and Sam Bowles found that the chances of wage increases fuelling faster investment are “extraordinarily small”*. The profit squeeze of the 70s led to weak capital spending and lower aggregate growth. And Robert Allen has argued (pdf) that low wages and a high profit share were crucial in stimulating investment and innovation in the early phase of the industrial revolution.

There’s a reason why the empirical evidence is so mixed. So much depends upon the nature of capitalists’ animal spirits. They could react to full employment, high wages and an incipient profit squeeze by thinking “demand will stay high and we need to cut labour costs, so let’s invest in labour-saving technologies.” Or they might figure: “this boom is unsustainable, and the government might further restrict our property rights, so let’s not invest.” Both reactions are possible.

Here, two things make me pessimistic. One is that the Bank of England thinks the Nairu is high; it raised Bank rate last month even though unemployment was almost 3.5 million**. This makes genuine full employment impossible; it’ll be countermanded by tight monetary policy.

This barrier can be overcome by changing the Bank’s mandate. (Personally, I suspect a money GDP target or higher inflation target would be better than a dual mandate, but that’s another matter.)

Another barrier, though, might be more intractable. It’s that neoliberalism is partly performative. For decades, the dominant ideology has been that economic growth requires a quiescent labour force. As a factual claim, this is wrong. But if firms believe it, they’ll respond to the sort of policies advocated by the IPPR by reducing investment. To this extent neoliberalism might be self-fulfilling. And even if this is not the case, a government implementing a meaningful shift towards social democracy would be seen as radical, which in itself might create uncertainty – and uncertainty, we know, often tends to depress capital spending.

Why, given these reservations, do I welcome the IPPR report so much?

One reason is that it is obvious to everybody except the 1% and their shills and lackies that capitalism is failing in its current form. Equally, though, capitalism has served us reasonably well for decades. It therefore deserves the chance of reform, which is what the IPPR offers. And I might be wrong***.

But what if I’m right? It doesn’t necessarily follow that the neoliberal status quo is right. We could equally well draw a Marxian inference instead – that capitalism is spent and no longer compatible with acceptable living standards for working people and that we need more radical measures than the IPPR is proposing – among them that the task of investment can no longer be entrusted to capitalists. Perhaps, as the man said, “a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment.” (That man was Keynes.)

* In Epstein and Gintis’s superb Macroeconomic Policy after the Conservative Era.

** 1.4m officially unemployed and two million out of the labour force who want a job.

*** These words are rarely heard, but they should be a central part of all policy-making and debate.

Comments

[Christopher H.]

we might as well try. what is the alternative? There is actually good evidence higher wages entails higher productivity gains. England industrialized first b/c of higher wages. Post-war soc dem years had higher growth and productivity gains than after the Reagan/Thatcher years.

If capital goes on strike, then you move to more radical reforms.

I like the SWF-Social dividend / McDonnell reforms b/c they take the power of capital away from the rich.

https://www.theguardian.com/politics/2018/sep/08/john-mcdonnell-labour-proposal-workers-ownership-funds

-----

In the U.S. about a third of income goes to the rich via capital income. Divert that to the rest of the population along with other reforms.

[Tony of CA]

I think I would go with Capitalism is spent- time to move on.

[Geoffrey Ferrari]

Your second paragraph is ambiguous between two claims. First, improvements in productivity for one firm might come because it is paying more than the average for firms in its class. This does indeed fall to the objection that, logically, not all firms can pay above average wages.

The alternative claim is that productivity for one firm can increase because it pays higher absolute wages. This could certainly increase productivity through the mechanisms of improving motivation and leading to lower staff turnover, for example. It's also logically consistent that all firms could pay higher absolute wages and so what's true for one firm could be true for all.

[rogerh]

I read the IPPR summary and came away thinking - all good stuff but unlikely our government will implement any of it.

The growth period from the 1950s seemed driven by new hope, new technology and getting rid of old Victorian machines and systems. That cannot be repeated unless some truly useful innovations come along - and I can't see any. A wage led growth seems to be playing the same musical chairs game hoping we will create a few more chairs. The only path I can see is a race to the bottom - except for the top 5 percent.

Then looming dark on the near horizon is Brexit. We are already seeing signs of more austerity, the austerity card is easy to play and will get support from the right wing press. Which brings us to the 2022 election. Much heat and noise but the hard question remains as ever - how is a small rather overpaid nation going to make a living. Labour or Tory, I don't see a happy answer.

[Luis Enrique]

Chris you might enjoy this paper on inequality and aggregate demand by two of the profession's rising stars:

http://mattrognlie.com/inequad.pdf

(their other recent work looks v good too:

http://mattrognlie.com/IKC.pdf

http://mattrognlie.com/kn_comment_rognlie.pdf

)

[Kaleberg]

Higher wages lead to higher productivity since they improve the return on investing in capital to eliminate work needed.

Higher wages also lead to higher productivity when the economy is overcapitalized and has more installed capacity than required for peak efficiency. (Hint: Stock buybacks are a sign of overcapitalization.)