When the share of wages in national income decreases, consumption decreases.
When the share of wages in national income decreases, consumption decreases
Seven years after the Great Recession, we have experienced not only the slowest recovery in the history of the UK, but also an upturn without a recovery in real wages.
Earnings are still lagging behind inflation. The rise in bonuses is exceeding wage growth. But there is one issue missing in the debate: the distribution of income between wages and profits. Real wages have increased slower than productivity in the post-1980s in the UK; hence the share of wages in UK GDP fell from 77.3 per cent in 1975 to 68.5 per cent in 2008.
While this has been a global trend, in the UK the fall in the wage share was further accompanied by dramatic hikes in the top 1 per cent income share and managerial wages.
In a new paper for the Centre for Labour and Social Studies (CLASS), I argue that this decline in the wage share was associated with weaker and volatile growth in the UK due to the negative impact upon demand.
When the share of wages in national income decreases, consumption decreases, because workers spend more as a proportion of their income compared to the owners of capital. Despite higher profits, the increase in private investment is insufficient to offset this negative effect on domestic consumption. Net exports (exports minus imports) increase due to a fall in labour costs, but this increase is also not sufficiently high.
Finally, in an environment of the global race to the bottom in the wage share, most of the positive effects on exports are wiped out as labour costs fall simultaneously in all countries. Thus, in the vast majority of countries a fall in the wage share leads to lower growth; this is what we call a wage-led growth economy. The UK is a typical example of a wage-led economy.
Growth until the Great Recession was driven by debt rather than wage growth in the UK as well as the US, Spain, or Ireland. Once again, the recovery in Britain is built on the shaky ground of household debt instead of wage growth.
In a wage-led economy like the UK and the EU, more egalitarian policies are consistent with high employment. The fall in the wage share is not an inevitable outcome of technological change or globalization, but rather a deliberate result of policies that led to the deterioration in the bargaining power of labour, welfare state retrenchment, and an increasing power of the financial sector.
The solution therefore lies in reversing this process. This is a question of optimism and the will for political change.
We need to close the gap between wages and productivity increases, and address not only low pay or high executive pay but also the distribution of income between wages and profits. Wages should increase in line with inflation and productivity. This should follow an initial gradual correction of the loss in the wage share in the past three decades.
A strategy of wage-led development requires a policy mix that includes policies aiming at decent wages in the labour market, i.e. pre-distribution, as well as redistributive policies through progressive taxation.
This is the economic background of TUC’s call at its Congress next week: ‘Britain needs a pay rise!’ A strong recovery needs a pay rise for the 99 per cent.
To achieve this Britain needs to re-regulate the labour market, improve union legislation, widen the coverage of collective bargaining. History shows that a government dedicated to institution building to strengthen the bargaining power of labour can make a big difference.
Regarding the bottom-end of wage distribution, the key priority is establishing a sufficiently high statutory minimum wage which gradually has to increase to the level of a living wage. The higher end of wage distribution must be regulated as well through enforcing top-to-bottom pay ratios.
Wage policies need to be complemented by redistributive policies through increasing corporation tax and top rates of income tax, along with more effective taxes on wealth.
At a macro level in order to rebalance both power relations and the wider economy, we need to strengthen the welfare state and reverse the process of financialisation.
Finally, it is crucial that policies for wage-led development are embedded into a broad mix of economic policy, because the effects that can come from a wage-led recovery on employment are modest, albeit positive, in magnitude.
Wage-led growth is not a magic bullet to solve all the ills of our current economic model. For sustainable and egalitarian development, we need to mobilise all of the tools of economic policy and public spending with an aim to achieve full employment with decent wages for both men and women, ecological sustainability, and equality.
Özlem Onaran is professor at the University of Greenwich. This piece is based on ‘State intervention for wage-led development‘ published by Centre for Labour and Social Studies. She will be speaking at the CLASS fringe event at the TUC Congress on 8 September
Özlem Onaran is speaking today at the Class fringe meeting at TUC Congress in Liverpool
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