Transcript The perverse effects of declining wages and declining wage share

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 of households becomes
higher (V/P). They feel richer. Positive effect
on consumption.
– The economy will become more competitive
on international markets. Positive effect on net
exports.
The standard view (Patinkin wealth effects):
A reduction in wages has favourable effects
Potential
GDP
S0
Price Level
S1
D
Lower
wages
E
100
F
90
S0
D
S1
5,000
6,000
Real GDP
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 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 burden of fixed debt is larger for
households; they may also wait for further
price decreases. Negative effect on
consumption.
– The burden of fixed debt is larger for firms, so
profitability gets reduced; they may also wait
for further cost reductions. Negative effect on
investment.
The alternative view (Fisher debt effect):
A reduction in wages has perverse effects
Potential
GDP
D
Price Level
S0
E
100
90
S0
S1
F
D
5,000 5,700
Real GDP
Lower
wages
S1
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 or in the wage share lead to
faster growth of economic activity.
• An economy is said to be profit-led when
increases in real wages and wage shares
lead to slower growth of economic activity.
Empirical studies on growth
regimes
• There has been a large number of recent
empirical studies (Hein, Stockhammer,
Naastepad, and their co-authors) 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). Some countries seem to be wage-led,
others profit-led.
• However, some generalizations can be drawn.
Generalizing the empirical results
• Most countries appear to be wage-led, including Korea.
• Some countries seem to be profit-led, including China,
(because the saving rates of households are high).
• However, profit-led countries are mainly driven by the
positive impact of reduced real wages on net exports.
• In other words, the positive effect of higher wage shares
on consumption is generally bigger than, or equal to, the
negative effect on investment
• But 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.
Means to stop wages from falling
• Governments must stop asking for concessions from
labour unions when firms go bankrupt (GM, Chrysler).
• Upkeep or increase minimum wages.
• Improve unemployment benefits, to improve the
bargaining power of workers.
• Change laws so as to make it easier for labour unions to
become accredited.
• Let the government act 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.
• If adopting work sharing, hourly wages must be
increased at least in proportion with expected hourly
productivity gains, otherwise there will be hardly any
favourable impact on employment.