Sunday, April 11, 2010

Wage-Productivity Gap Caused Crisis

Economist, Boris Anisimov argues that there is more to the world economic crisis than meets the eye. In fact, stagnating wages are impacting upon demand, with ramifications for economies the world over. 

By Boris Anisimov

Many speak of the current crisis as a financial one, which means that the source of all the problems is believed to be in the way the financial system is functioning. I have joined the ranks of those who are of an opinion that the roots go deeper than the financial sector. In fact, an analysis from the standpoint of political economy reveals that there is much more to the crisis than meets the eye. A different set of disparities than publicly acknowledged is becoming more obvious.

The “Global Wage Report: 2009 Update” issued by the International Labor Organization on November 3, 2009 mentioned years of stagnating wages relative to productivity gains as one of the reasons for the current economic crisis. This echoes conclusions by Dr. Ravi Batra (an economics professor at Southern Methodist University), Mikhail Khazin (a Russian economist and publicist), William I. Robinson (a sociology professor at the University of California) and Karl Marx himself.

“Productivity” and “wages” are not financial concepts – they deal with the economic situation rather than financial markets and banking regulations. The above mentioned sources point out that the current crisis is an economic one first of all. Let’s look into this more closely.

The wage-productivity gap concept is rarely brought up in modern textbooks on economics, but in fact it should be because the economists I have mentioned see this disparity as the main cause of the crisis. The wage-productivity gap is the gap between the real wage and labor productivity, the real wage being the purchasing power of an average salary. Productivity is the main source of supply, whereas wages are the main source of solvent demand. If productivity rises faster than the real wage, then supply rises faster than demand, the result being a crisis of over-production. Some economists prefer calling it “over-accumulation”, but that does not change the essence of the problem.

In other words, wages are only part of the costs that a capital owner has to incur. The ultimate cost of a good or service will be higher than the wage that the business owner pays to his/her employee to have that good or service produced. Let me simplify it even more - if all the employees in a particular country put their wages and salaries together, they will not have enough money to buy all the goods and services that they have produced. The same principle applies when we talk about the entire world economy.

Each time the wage-productivity gap widens, the economy has no other choice but to contract because of overproduction. This occurs on a regular basis in the form of crises (the Great Depression is a perfect illustration). A long-term solution would be to find new markets and boost demand thereby. Thus, availability of new external markets becomes vital for the stability and predictability of profit-making, but when that availability is limited for any reason, finding new markets can be quite costly and troublesome.

That is why back in the 1970’s when another depression-like crisis became obvious, a less costly solution was found - it was decided to raise demand to the level of supply by means of more aggressive credit expansion (this applies to both government debt and household debt). The abolition of the gold standard was in line with this logic (the excess of the global money supply over the golden bullion was becoming obvious anyway) thus making it possible for governments to increase money supply and keep interest rates down. In the case of the US dollar, as long as active international involvement was maintained, the excessive money supply could be moved abroad thus reducing inflationary pressure on the US markets.

Debt can temporarily postpone wage-productivity gap problems. As productivity rose, debt had to increase as well unless wages were to rise. An exponential global increase of debt puts the entire global economy (not just its financial sector) in jeopardy because it is obvious that the credit system will have to explode one day. Household debt grew from $705 billion by the end of 1974 (60% of disposable personal income) to $14.5 trillion by mid-2008 (134% of disposable personal income).[41] During 2008, a typical US household owned 13 credit cards, with only 40% of households able to carry a balance.[42] U.S. home mortgage debt relative to GDP increased from an average of 46% during the 1990’s to 73% during 2008, reaching $10.5 trillion.[43]

In these circumstances, boosting demand any further by means of credit became impossible. The model of economic development based on artificially-boosted demand, constantly-increasing money supply and the lowering of interest rates has collapsed – the credit bubble did explode in our faces. The dependence of manufacturing and the service sector on credit for the last 30 years made them just as vulnerable as financial institutions. The growing interdependence of markets worldwide spilt the problems over to other countries. This is how we got the current global ECONOMIC crisis.

Banks have frozen their lending in fears that the falling consumption will make any investment unprofitable thus lowering the chances of getting their money back. The response from the governments worldwide is quite predictable – they went to save the credit system, the hardest-hit sector of the economy, in hopes to boost credit thereby increasing national debts. It is now estimated that the US national debt is going to hit the GDP level (approx. $14 trillion) in 2010. The national debts of countries like the UK, France and Germany are expected to reach 90% of GDP. Thus, 2010 may see an unprecedented number of government defaults as the debt-to-GDP ratio for some smaller countries has already exceeded 100%.

Until the wage-productivity issue is addressed, no actual recovery is possible. Any financial measures recently undertaken by governments of different countries will temporarily “numb the pain”, but they are of no avail when it comes to addressing the very essence of the problem. Politicians and corporations have been viewing developing markets for growth opportunities, which seems like an attempt to find new external markets now that domestic markets in developed countries are unlikely to be able to boost consumption significantly any time soon. This can also address the wage-productivity issue, but developing markets are not yet ready to lead a consuming lifestyle typical of US consumers. So finding new markets ready to “spend, spend, spend” may take some time.

In the mean time, potential negative economic developments in the near future are still possible. Back in the times of the Great Depression, consumers did not have so much debt, which leads us to a conclusion that we are now in a greater mess. This in fact may turn into a systemic crisis, the possibility of which is deliberately concealed by corporate management, politicians and media for obvious reasons by confusing cause with effect.

It must be remembered that business news that we hear on the radio or watch on TV often reflect only one side of the economic reality, the side that transnational banks and corporations are interested in. That is why the recent rallies on stock and commodity markets thanks to government-boosted liquidity have been presented as signs of an inevitable recovery. In fact, for some companies the increased liquidity is a blessing considering the fact that most developed economies are greatly reliant on financial speculations and debt-driven consumer spending to make profits. Such companies believe (and do their best to convince others including politicians) that the mere availability of liquidity will encourage more credit and pull the entire world out of the economic troubles. The small positive signs that we have seen lately in fact may lift up the spirits of corporations, but as for the common people the situation is still grave. While banks and corporations enjoy protection from the governments, common people’s investments and jobs are in serious danger – they are likely to continue losing both (as for developed countries, savings are meagre anyway).

Since debts are assets for the financial system, writing off household debts will be a scary step to take since massive collapses of credit institutions will be inevitable. Besides, the powerful Wall-Street lobbyists will be more willing to shoot themselves in the head than allow any write-offs to occur. But any measures that do not address the wage-productivity gap will only be beating about the bush and continue to confuse cause with effect. The re-introduction of gold- or silver-backed currencies will be of little help as well. Thus, it is rather difficult to come up with a solution when the entire economic model caves in. This only proves that the existing economic paradigm (including college courses in economics and MBA’s) that serviced that model must change as soon as possible.

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  1. The cyclic wages/productivity crisis Anisimov describes here is certainly going deeper than merely financial analyses of the GFC. But it it deep enough?

    Monthly Review writers have been arguing for some time that the "financialisation" of capital -- the huge growth in paper (and electronic) money transactions -- is a result of the stagnation in the real economy. Capital is running out of new growth areas to invest in so it is creating these house-of-cards financial markets.

    In this view, it is not simply (or even) high productivity (relative to wages) that has caused the balloning in credit and bad credit. It is that this is the only outlet for investment, so it has become a structural part of modern capitalism to have this kind of financial instability.

    I'd be interested in other readers' comments on this, I'm not an expert, just curious!

  2. Dear Boris,

    I think you are right to see this as some kind of overproduction crisis, not a financial one, but I don´t think that it is specifically the gap between wages and productivity that is the problem. This gap does not, necessarily, imply a defficiency of aggregate demand. It means wage earners are getting a smaller slice of the cake; but other may be getting a lerger slice of the cake.

    This productivity wage gap, however, is an indicator of growing inequality and this can be expected to have had an negative impact on demand (it gives more money to rich people who tend to save more).

    I explored growing inequality as a contributer to the current crisis in this article a couple of weeks ago:

    Stuart lansley has put forward a similar perspective here:

    @Ben Courtice: My leftfocus article indicated above was in part a review of the Monthly Review writers. I would be interested to know what you think about it.

  3. Tim: as I said I'm not an economics expert...
    but your article seemed pretty reasonable. I don't necessarily think Monthly Review's editors have everything right; but they make the effort to try and go a bit deeper than the mainstream analysis. I am not sure about your argument regarding savings; savings are eventually put back into the economy when they are spent. For this to represent a consistent drain on the economy, there would need to be an increasing rate of savings for a sustained period, i.e. growth in savings exceeding the spending of savings. This would be a pretty unusual situation I think.
    If there is no such consistent drain on the money in circulation, it will pretty much all find its way back around the cycle. But financialisation causes ruptures (of confidence, even) that disrupt and slow the circulation of money capital. When the system is based on credit it is vulnerable to this disruption, which we see then as the GFC and layoffs and firms going under for not being able to get credit.
    I may have this all arse-about but tell me what you think!

  4. Your right, savings all get spent somehow in all but the very short term.
    There's a huge misunderstanding about what Keynes was actually saying here. Basically, he points out that as employment and average income increase, people tend to consume proportionally less of their income and to save more. This means, all things being equal, that aggregate supply rises faster than demand. Such overproduction cannot be sustained unless investment spending increases to fill the gap, something that is unlikely to happen on its own just when firms are facing a build-up of unsold goods. The likely response of the market to such overproduction is therefore to reduce production, employment, and therefore income, back to their starting level at which general supply is in balance with demand. This explains why economies don't always tend to full employment: they get stuck at a certain level of unemployment because any increase in employment results in overproduction.

    Keynes' answer to persistent high unemployment was hands-on economic management to make sure investment spending (including by the state) does rise to compensate for weak consumer demand. I think this makes sense as a means to promote stability at a time when people's propensity to consume is basically high (as in the 50's and 60's) but I'm less sure if it can work as a long term solution to a declining propensity to consume in an ageing, wealthy society. I worry that in the long term there must be a physical relationship between the amount of consumption and the amount of investment that is financially viable. In other words, investment cannot increase without limit to fill the gap left by a weakening propensity to consume. This is why I think the current long-term crisis can only be resolved by action against inequality that would have the effect of raising the propensity to consume, and is (one of the reasons) why I think there are also basic questions to be asked about the viability of capitalism in "post-industrial" societies.

    That's probably way too short a summary to have made any sense, or not? Maybe I will try to write another article for Left Focus that tries to go into these points a little more clearly.

  5. Whilst it would be a cold day in hell that I would argue for a lower portion of economic wealth to be allocated to wages relative to profit or rent, I question the reasoning that suggests that the global financial crisis could have been averted through such means.

    The GFC, as I have discussed in this 'blog in the past, is primarily due to (a) massive debt in the consumer sector and, even more importantly, (b) massive overinvestment in unproductive, rent-seeking assets (particularly real estate).

    Increasing consumer wages over socially-owned capital infrastructure would not be a sensible approach.

  6. Lev,
    The question you beg is why there has been a) such a massive build up of debt, and b) such asset price inflation?

    My suggestion is that the root of the problem is a historical decline in the "propensity to consume", and that this debt-asset bubble has evolved as a way of sustaining demand (albeit, ultimately, unsustainably).

    I'm not sure that "Increasing consumer wages over socially-owned capital infrastructure" is what I proposed.

    Increasing income equality would raise the propensity to consume, which would make growth less debt-dependent, and more sustainable, creating better opportunities for productive investment.


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