Do Wages or Profits Lead Growth?
Earlier this month, I served as the discussant for a presentation by Engelbert Stockhammer, an economics professor from Kingston University in London. He was speaking at a conference organized by the workersâ€™ representation to the International Labour Organization (ACTRAV).
Stockhammer reviewed two antithetical strategies for economic growth. The pro-labour strategy aims to increase wages by promoting collective bargaining, raising minimum wages, etc. and to redistribute income through progressive taxation, social spending, etc.
Given higher propensities to consume at lower income levels, a larger wage share and more equal income distribution generate more consumption spending. Greater demand for goods and services then prompts more business investment.
The pro-capital strategy aims to increase profits by deregulating labour markets, cutting corporate taxes, etc. Higher profits produce more business investment, and lower business costs increase net exports through greater international competitiveness. More investment and exports then increase demand for labour, which translates into more jobs and higher wages.
In theory, either strategy could propel economic growth and employment. But which effects are stronger? Do higher wages boost consumption more than higher profits boost investment and exports? Whether the economy is actually wage-led or profit-led is an empirical question.
Stockhammerâ€™s major contribution was to put some numbers on this typology of growth strategies. His regression analysis indicates that, for the European Monetary Union as a whole, a 1% rise in wages as a share of Gross Domestic Product (GDP) increases consumption by 0.37% of GDP, reduces investment by 0.07% of GDP, and reduces net exports by 0.09% of GDP. In sum, a 1% rise in the wage share expands Eurozone GDP by 0.21%.
But in Austria alone, a much smaller and more trade-dependent economy, a 1% rise in the wage share increases consumption by 0.36%, reduces investment by 0.15%, and reduces net exports by 0.39%. In sum, Austrian GDP shrinks by 0.18%.
The key insight is that, since the relationship between profits and investment is relatively weak (a point often noted on this blog), the balance hinges on the significance of trade flows. Since net exports are zero for the world as a whole, the global economy is wage-led. Big economies like the Eurozone and United States are also wage-led. But small open economies tend to be profit-led because trade flows loom large.
Stockhammerâ€™s analysis helps explain the generally poor performance of neoliberal â€œtrickle downâ€ economics for the world as a whole. It also sheds light on Europeâ€™s economic policy paradox.
For individual European countries, it seems rational to pursue pro-capital policies to gain a competitive edge. But since the whole Eurozone is wage-led, member countries would enjoy more growth if they all pursued pro-labour policies.
Stockhammerâ€™s main policy implication is that the European Commission should be encouraging collective bargaining, minimum wages, progressive taxation, social spending, etc. rather than promoting competitiveness in terms of unit labour costs. One could easily extend this analysis to the International Monetary Fund and World Bank, given that the global economy has no net exports and is even more strongly wage-led.
The presentation also got me thinking about smaller economies (like Canada), for which the policy implications are less straightforward. Progressives should still support pro-labour policies to achieve a more equal distribution of income and we should not aspire to provoke a competitive â€œrace to the bottomâ€ by pursuing pro-capital policies.
However, simply boosting wages in a small open economy would not add to its growth. More domestic consumption could be more than offset by diminished export competitiveness (unless wages simultaneously rose elsewhere through international coordination).
To me, this analysis underscores the need for progressives to articulate alternative strategies to promote investment and exports, especially in smaller economies that may not be wage-led. Instead of accepting pro-capital policies across the board, we should advocate investment in public infrastructure and targeted support for actual private investment as well as policies focused on higher wages and income redistribution.
Stockhammer, E. (2010). Neoliberalism, Income Distribution and the Causes of the Crisis. RMF Discussion Paper 19 – published in Philip Arestis, RogÃ©rio Sobreira, JosÃ© Luis Oreiro (eds): The 2008 Financial Crisis, Financial Regulation and Global Impact. Volume 1 – The Financial Crisis: Origins and Implications. Palgrave Macmillan.
Stockhammer, Engelbert, 2009. Determinants of functional income distribution in OECD countries. IMK Studies, Nr. 5. DÃ¼sseldorf 2009.
Stockhammer, E, Onaran, Ã–, Ederer, S. Functional income distribution and aggregate demand in the Euro area. Vienna University of Economics & B.A. Working Paper No. 102 – a revised version of this paper has been published in the Cambridge Journal of Economics, Vol. 33 (1): 139-159.