From the TUC

Practical Predistribution: Historical Lessons

10 Jul 2013, by in Economics

Last week the TUC published a major Touchstone pamphlet on policies to raise the wage share. As I wrote at the time:

Real wages are currently going through their longest squeeze since the 1870s and living standards have raced up the political agenda. Meanwhile last week’s GDP data suggested the UK’s current recovery is being propped up by a decline in the household savings ratio, rather than income growth.

Our current economic crisis is more than simple crisis of demand. Things started going wrong in the British economy before the crash – and one of those things was wage growth.

Today’s publication is about more than the need for better traditional macroeconomic policy – we do desperately need a fiscal stimulus, but a stimulus along isn’t enough. The aim of policy can’t simply be to return the economy to where it was in circa 2006.

I’ve argued that we need to think about economic reform in terms of changing our national business model. One important aspect of this is looking at how wages are set and how the gains from growth are distributed.

The pamphlet outlines a series of policies – from raising the minimum wage to extending the living wage, and from lowering unemployment through to (crucially) extending collective bargaining coverage. It also notes that much of the work of raising pay will come through restructuring, reforming and rebalancing the wider economy.

The whole report is available here.

To mark the launch the TUC held a seminar featuring a contribution from economist Romain Ranciere. Ranciere is the co-author of a landmark IMF paper – Inequality, Leverage and the Crisis. This paper argued that rising inequality was a major driver of the financial crisis. As the (surprisingly clear!) abstract argues:

The paper studies how high leverage and crises can arise as a result of changes in the income distribution. Empirically, the periods 1920-1929 and 1983-2008 both exhibited a large increase in the income share of the rich, a large increase in leverage for the remainder, and an eventual financial and real crisis. The paper presents a theoretical model where these features arise endogenously as a result of a shift in bargaining powers over incomes. A financial crisis can reduce leverage if it is very large and not accompanied by a real contraction. But restoration of the lower income group’s bargaining power is more effective.

In other words, it identifies how a decline in the bargaining power of labour (as experienced since the early 1980s in the UK) can lead to rising inequality. It then argues that this rise in inequality will be accompanied by a  build up of personal debt (as the lower income groups borrows to maintain their consumption and the higher income group demand new assets in which to storage their wealth, expanding the size of the financial sector). This debt makes the economy more vulnerable to shocks and increases the chance of serious financial crisis.

As the authors note, there are two ways out of this situation – a long and painful deleveraging process or a restoration of labour’s bargaining power. As they write:

But without the prospect of a recovery in the incomes of poor and middle income households over a reasonable time horizon, the inevitable result is that loans keep growing, and therefore so does leverage and the probability of a major crisis that, in the real world, typically also has severe implications for the real economy. More importantly, unless loan defaults in a crisis are extremely large by historical standards, and unless the accompanying real contraction is very small, the effect on leverage and therefore on the probability of a further crisis is quite limited. By contrast, restoration of poor and middle income households’ bargaining power can be very effective, leading to the prospect of a sustained reduction in leverage that should reduce the probability of a further crisis. (My emphasis).

If there is a recognition that boosting labour’s bargaining power is one way out of the crisis, the question then becomes, are there any successful examples in economic history of a restoration of workers bargaining power and a way out of the crisis?

At last week’s seminar Ranciere showed a couple of slides, suggesting the answer is ‘yes’.

The 1920s saw a large rise in inequality and an accompanying build up in household debt in the US.

ranciere 1

In the 1930s to 1940s this process was reversed.

ranciere 2

This was achieved through the New Deal. In particular through active government policies which strengthened labour. As Hirsch explains:

…private sector union density rose from about 12 percent in 1929 to 24 percent by 1940 and to 35 percent by 1947… Passage of the National Labor Relations Act (NLRA) in 1935 provided the legal and administrative framework that facilitated the rapid transition to an industrial U.S. economy in which union governance was the norm. A more fundamental explanation, however, was that the Great Depression was widely viewed as a failure of capitalism and the product of destructive competition. The result was a set of corporatist New Deal policies in which business, labor, and government were economic partners. Major industries—coal, steel, automotive— became unionized over a brief period, a transition encouraged by the Roosevelt administration in the 1930s and later reinforced by the industrial buildup for World War II (my emphasis)

That’s a doubling of private sector union density at a time of high unemployment – with most of the shift coming before the Second World War. A very interesting history of this period is available on the US Department of Labor’s website.

The point of this historical interlude is this: to demonstrate that with the support of a sympathetic government, major change can be achieved and seemingly unstoppable trends reversed.