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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