Transcript The perverse effects of declining wages and declining wage shares II

The perverse effects of declining
wages and declining wage shares
Marc Lavoie
Department of Economics
University of Ottawa
Two issues that need to be
conceptually distinguished
• What if wages and prices fall together, without
any change in real wages (assuming a constant
level of labour productivity)?
• What if real wages relative to productivity fall,
that is, what if the wage share falls?
• These issues need to be tackled at the
macroeconomic level. If we only look at these
questions at the micro level, we are likely to be
subjected to the fallacy of composition.
The impact of lower prices
and lower wages
The standard view
• Lower prices with lower wages have a
positive impact on real aggregate demand
because:
– The real wealth (V/P) of households becomes
higher. They feel richer. Positive effect on
consumption.
– The economy will become more competitive
on international markets. Positive effect on net
exports.
A critique of the standard view
• Nominal wealth is unlikely to remain constant when
prices fall. The value of real estate will fall and stock
market prices will fall.
• What about real debt (D/P) ? Households still need to
pay their mortgages, their credit card balances, their car
loans, etc. All of these remain unchanged in nominal
terms, thereby leading to a rise of the debt burden in real
terms.
• Firms still need to make interest payments on their bank
loans, on the bonds they issued in the past, etc. Their
real debt also rises.
• In a global financial crisis, where prices or inflation rates
are falling in all countries, the export channel is nonexistent.
The alternative view
• Lower or falling wages and prices have a
negative effect on real aggregate demand
because debt is usually in nominal terms:
– The real burden of fixed debt becomes larger
for households; they may also wait for further
price decreases. Negative effect on
consumption.
– The real burden of fixed debt becomes larger
for firms, so profitability gets reduced; they
may also wait for further cost reductions.
Negative effect on investment.
The alternative view is now
endorsed by many central banks
• Central bankers now fear wage and price
deflation because:
– Monetary policy is conducted through changes in the
real interest rate (nominal rate minus the expected
inflation rate)
– Nominal interest rates cannot fall below zero.
– With wage and price deflation, real interest rates
cannot be pushed down to zero or into the negative
range. Therefore expansionary monetary policies
become impossible.
– Japan (1994-2004) is a good empirical illustration of
monetary policy impotence under wage deflation. The
non-conventional monetary policies now suggested,
such as raising bank reserves, were also totally
useless.
Lawrence H. Summers (and Delong)
on the Great Depression, AER 1986
The impact of lower real
wages and lower wage shares
Macroeconomic impact of real wages
• Aggregate demand is made up of four components:
Y = C + I + NX + G
• Increases in real wages relative to labour productivity (or
in the wage share) will have an impact on the first three
of these components.
– A direct positive impact on consumption because the propensity
to consume out of wages is higher than the propensity to
consume out of profits (by about 0.30).
– A direct negative impact on investment, because profitability at
given rates of capacity utilization gets reduced (with however a
possible indirect positive impact through the accelerator, with
higher real wages raising rates of capacity utilization).
– An uncertain, but usually negative impact on net exports.
Wage-led or profit-led ?
• An economy is said to be wage-led when
increases in real wages relative to labour
productivity (that is, the wage share) lead
to higher economic activity.
• An economy is said to be profit-led when
increases in real wages relative to labour
productivity (the wage share) lead to lower
economic activity.
Empirical studies on growth
regimes
• There has been a large number of recent
empirical studies (Hein, Stockhammer,
Naastepad, and their co-authors), in particular
on various OECD countries, based mainly on
1960-2005 data.
• As is often the case of macro studies, the results
are somewhat ambiguous (the same author may
obtain contradicting results in two different
studies with different methods). Some countries
seem to be wage-led, others profit-led.
• However, some generalizations can be drawn.
Generalizing the empirical results
• Some countries appear to be wage-led or neutral,
including France, Germany, Italy, Spain, the UK, Korea.
• Some countries seem to be profit-led, including Austria,
as well as Japan and China (because the saving rates of
households are high).
• However, neutral or profit-led countries are often driven
by the positive impact of reduced real wages on net
exports.
• For instance, the Euro 12 area as a whole is clearly
wage-led (an increase of 1 percentage point in the wage
share leads to an increase of 0.2% in GDP).
• Once again we face a fallacy of composition: not all
countries can simultaneously increase net exports by
reducing real wages.
• In other words, taking into account only the consumption
and investment effects, we conclude from these studies
that the world economy is wage-led.
Conclusions
Fallacies of composition
• It is in the best interest of each firm and each
country taken individually to reduce nominal and
real wages when others don’t.
• However if all firms and all countries act in such
a way, the overall profits of firms and overall
growth will be reduced by spreading competitive
deflationary pressures.
• Governments must take actions to prevent
wages and real wages from falling.
Some means to stop wages from falling
• Enabling factors: State or public support
– Improvement of unemployment benefits, to improve the
bargaining power of workers, stopping wages from falling.
– Government as an employer of last resort, offering meaningful
work to whoever asks for it, so that this labour force will be ready
to enter the private employment market when needed, with no
loss in human capital.
– Governments must stop asking for concessions from labour
unions when providing financial help to failing firms, especially
when these firms are from bellwether industries (e.g.,
automobiles: GM, Chrysler), as these concessions may spread
to other sectors of the economy.
• Specific measures
– Upkeep or increase minimum wages.
– If adopting work sharing, hourly wages must be increased at
least in proportion with the hourly productivity gains expected to
arise from work sharing, otherwise there will be hardly any
favourable impact on employment.