Wages, the financial sector & investment
Last week the International Labour Organisation released its annual Global Wages report and, as usual with recent volumes, it makes for thoroughly depressing reading. The headline message was that real wage growth across the developed economies is ‘double dipping’.
I was especially struck by the chart below which compares real wage growth to productivity increases between 2008 and 2011:
It is noticeable that the UK had the third largest fall in real wages of any developed country over this period.
And things aren’t, on current trends, set to get any better in the near term. This chart from the Resolution Foundation looks at median real wages over the longer term.
On the OBR’s central projection, median real full-time wages in 2017 will be at roughly 2000 levels – a near twenty year stagnation in earnings. What is worth noting from that chart is that the stagnation of real median wages didn’t begin with the crisis in 2008, but a good five years earlier in 2003.
The longer term story in the UK, over the past three decades, is of two related factors – a fall in the share of national output going into wages and an increasingly large share of that shrinking pool being taken by those at the top.
The history of wages over the last 30 years has three distinct phases. First, through-out the 1980s and 1990s productivity rose faster than earnings for most workers. Second, beginning in 2003 the real wages of those in the middle and below essentially stopped growing, despite an economy that was still expanding. Finally from 2008/09 onwards the story has been one of declining real wages (for what it’s worth I made a BBC Analysis programme earlier this year on these trends that can be listened to here).
Prominent economists have started to take note. Paul Krugman last week noted the declining wage share in the US and argued that for most of the 1990s economists tended to concentrate on inequality between workers rather than between labour and capital. He is now reconsidering some of these views:
I think our eyes have been averted from the capital/labor dimension of inequality, for several reasons. It didn’t seem crucial back in the 1990s, and not enough people (me included!) have looked up to notice that things have changed. It has echoes of old-fashioned Marxism — which shouldn’t be a reason to ignore facts, but too often is. And it has really uncomfortable implications.
But I think we’d better start paying attention to those implications.
Krugman lays much of the blame for the recent shift on ‘capital-biased technological change’ – the idea that recent improvements in technology have favoured capital over labour. This has promoted an outburst of very interesting posts on the econo-blogosphere on the impact of the ’rise of the robots’ – Bruegal has an excellent round up and I highly recommend this exchange between Izabella Kaminska and Tim Worstall.
Whilst there is certainly a strong role for ‘capital-biased technological change’ in explaining the falling wage share in the UK and USA, I’m far from convinced that it can be the sole explanation. Different developed countries, despite access to broadly the same technologies, have experienced different trends in wage growth.
A Touchstone Extra pamphlet from Howard Reed & Jacob Mohun Himmelwiet published this week by the TUC sheds some light on this discussion. Larry Elliott gave it an excellent and thorough write-up in the Guardian last week.
Howard and Jacob examine not only the falling wage share but also its counterpart – the rising profit share and their results are very interesting.
Crucially their work finds that:
the fall in the wage share is largely driven by an expansion of industries where the wage share is relatively high, and a contraction of industries where the wage share is relatively low, rather than falls in the wage share in individual industries.
In other words – the fall in the wage share is not being driven by a generalised rise in the profit rate (or fall in the wage share) across all industries but by the relative growth of sectors with a higher profit share and a relative decline of lower profit share sectors.
In particular they highlight the rise of the financial sector. The chart below shows finance profits (as a percentage of GDP) alongside all profits and all profits-excluding finance.
As can be seen the finance sector’s operating surplus was negligible throughout the 1940s, the 1950s, the 1960s and the 1970s. It began to rise in the 1980s and reached almost 5% of GDP on the eve of the crisis. Over this period a rising profits in the financial sector explain the entire increase in the UK profit share.
Later on in the report Howard & Jacob looked at the macroeconomics of a declining wage share. What is noticeable here is the rising profit share over the last three decades has not been accompanied by rising investment.
The steady rise in the profit share (the green line) since the 1980s has not be matched by rising investment (the red line). One way to explain this would be to turn to Chris Dillow’s long running point about a shortage of investment opportunities.
Could it be that there are no policies consistent with capitalism as we know it that would generate sufficient investment to create lasting full employment? It could be that the eastward migration of low-wage work, plus the slowdown in technical progress that’s created a lack of (monetizable) investment opportunities mean that any policies to promote investment will be at best only mildly effective.
Another explanation though might be found in the data supplied by Howard & Jacob. They explain the rise in the profit share by movements towards the financial sector since the mid 1980s and it could be that too large a financial sector is bad for investment.
Yet even while it was still inflating, this bubble was already having silent costs – costs to the economy and indeed costs to other parts of banking. Many of the best people and the best financial resources were drawn away from other sectors, including the retail banking sector. Industries outside of finance were starved of sunlight.
The costs of this great sucking sound are only now being properly understood. Recent research by the Bank for International Settlements suggests that, once bank assets exceed annual GDP in size, they begin to act as a drag on growth.
Why? Because human and financial resources are drained from elsewhere in the economy. The sectors hardest-hit by this financial vacuum-cleaner effect are R&D-intensive businesses (who might otherwise have attracted the scarce, skilled labour that flowed into finance) and businesses reliant on external funds (whose financial cake was instead being eaten by the banking system). These are the very businesses that today we are seeking to re-nurture
Interestingly this explanation fits with the UK data. Since the mid 1980s an unconstrained finance sector has vastly expanded its own profits without, it would seem, supporting investment in the wider economy. It could even be argued that excessive financial profits have constrained investment in the real economy.
This leads to the interesting conclusion that there is a mix of policies that would both increase the wage share and lead to higher investment – but that they wouldn’t succeed unless the economy is decisively rebalanced so as to be not so dominated by finance.