If Wages Are Falling, Who Buys the Products?

by Dirk Ehnts, Econoblog101

The FT has an article about capital and labour shares of income (a.k.a. the pie) in which there is a nice little story that in three sentences sums up the big problem very nicely:

In 1958, Walter Reuther, a powerful US union leader was taken on a tour of a newly automated Ford Motor plant. “Aren’t you worried about how you’re going to collect union dues from all these machines?” he was asked by a (no doubt smug) company manager.

“The thought that occurred to me,” Mr Reuther replied, “was how are you going to sell cars to these machines?”

Let’s make that more extreme. From the perspective of a single business it makes perfect sense to lower wages to zero if it can be done keeping all things constant. However, there will be less demand from workers and maybe more demand from capital owners and entrepreneurs. Since they save a large share of their income the net effect is very likely a fall in income and this means that the whole idea of lowering the labour share is pretty much self-defeating. If it only were so easy. In the article, the usual reasons for the fall in the labor share are cited – globalisation – and this study from the ILO (International Labour Organisation) is examined. Onaran and Galanis conclude:

Rebalancing growth via increasing domestic demand in the major developing countries, in particular China would also be helpful in addressing global imbalances. Our results show that redistribution of income in favor of labor increases consumption. However, this rebalancing can only take place in an international environment where the developed countries not only leave space for developmentalist trade policies, and support technology transfer, but also create and expansionary global environment by avoiding a race to the bottom in wages.

It is interesting to think about the effect of the integration of the Chinese into the world economy in this context. In the first period, China was cheap and that might have had a deflationary (disinflationary) impact on the global level. As the renminbi revaluates, will we see higher inflation as a result? This will be an interesting one to watch and I’m not so sure what my intuition is. The lower inflation rates that we’ve had since the 1980s might also be due to lower labour shares. What is the reason behind this is still an open question, it seems. Some point to technology, others at trade, maybe it is sociological. This is a very large issue which normally is discussed in the Great Moderation paradigm, which has ceased to be.

A speech at the BIS by Malcolm Knight summarizes the three key issues briefly, as seen by neoclassical economists (my highlighting):

The integration of emerging market economies into global production processes has arguably influenced labour market policies and wage setting behaviour in advanced industrial countries through three main channels. First, increased international labour mobility has helped to ease supply constraints in labour markets. Second, the relocation of production has curtailed the bargaining power of workers and trade unions. Third, the opening of markets for goods and, increasingly, services to international competition has intensified competitive pressures on producers.

A different view is presented by Hein (2009, my highlighting):

From a Post-Keynesian macroeconomic perspective we have identified theoretically and empirically the main channels of influence of ‘financialisation’ on investment, saving and distribution in order to obtain a precise macroeconomic meaning of ‘financialisation’ in a distribution and growth context. Regarding investment, ‘financialisation’ has been associated with increasing shareholder power vis-à-vis management and labourers, an increasing rate of return on equity and bonds held by rentiers and decreasing managements’ animal spirits with respect to real investment in capital stock, which each have partially negative effects on firms real investment. Regarding consumption, ‘financialisation’ has been considered to imply increasing potential for wealth-based and debt-financed consumption. And regarding distribution, ‘financialisation’ has been viewed to be conducive to a falling labour income share and to increasing inequality of wages and salaries.

Whatever is happening, at least the economists seem to agree on the empirical facts.