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 workers’ 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.

Statistical Results

Stockhammer’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.

Stockhammer’s analysis helps explain the generally poor performance of neoliberal “trickle down” economics for the world as a whole. It also sheds light on Europe’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.

Policy Implications

Stockhammer’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 “race to the bottom” 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 Рpublished in Philip Arestis, Rog̩rio Sobreira, Jos̩ Luis Oreiro (eds): The 2008 Financial Crisis, Financial Regulation and Global Impact. Volume 1 РThe Financial Crisis: Origins and Implications. Palgrave Macmillan.

Stockhammer, Engelbert, 2009. Determinants of functional income distribution in OECD countries. IMK Studies, Nr. 5. Düsseldorf 2009.

Stockhammer, E, Onaran, Ö, 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.



    Yves over at the Naked bunch, points to an add on to what you are suggesting here Erin.

    Not only does the profit- investment route to growth have less of an impact, but it also seems to be centering on “short-termism”- which is a real problem for developing longer-term solutions, which we face, like building a green economy. Good post Erin.

  • The “neoliberal “trickle down” economics” works as intended. The problem is INFLATION trickle down. Word Food prices have soared, leading to massive protests especially in the middle east where the majority of the young who is unemployed continuing to watch prices go up. Other commodities have soared.

    Speculators are pushing prices bidding through extremely low borrowing cost. Paul Vockler had too knock interest rates too 20% nominally to create Positive Rates of Interest. Speculators could not push prices up at all. Paul Vockler policies are soarly needed.

    FED Thomas Hoenig has, over his term dissented. Asked in a interview on inflation.

    “TH: Think about it this way: The inflation of the 1980s started in the mid-’60s. It is a slow process along the way, but if you leave policy easy, then inflation will eventually catch hold”

  • WP:One place where there’s not any inflation is in wages. Can you really have an inflation problem without wages rising?

     TH:Not initially. But people are losing real purchasing power, and that changes how they’re going to negotiate. People want this lost purchasing power back in time. In negotiating, they’ll say, “Prices have been rising, we deserve more.” We’re already seeing it in some of the surveys that we run. Businesses are telling us, “Yes, we had a pay freeze a year and a half ago, but we’re doing some catch up now. We want to make sure we keep our good people

    Here Hoeing articulates what I have been calling for. Wages are just another price, which can be led by & lag inflation. Wages that rise will continue to fail to keep up with the cost of living.

    All I can say, is thanks, to the Central Banks of the world for pumping enough liquidity in at historic interest’s rate that has enabled many to avoid bankruptcy, and push prices higher in every industry.

  • This kind of seems to assume that small(er) economies must necessarily be highly open. Now, I’m not going to say there should be no trade, but I do think that this analysis just underscores the general left-ish intuition that free trade and investment are a bad idea for ordinary people.
    Import substitution, for instance, would seem to be a tactic that both pushes the wage-led strategy and reduces vulnerability to openness effects that might cancel it out.

    Canada may be a relatively small economy due to the size of the Canadian population . . . but on one hand, geographically we’re very large, meaning we have lots of natural resources both in amount and variety, reducing the need to import inputs, and on the other modern technology allows fairly flexible manufacturing; it seems to me that for a given population size there is less need to specialize production than there used to be. Canada is also rather rich, meaning there is less need for foreign capital than in many, even most, countries. All in all, I think Canada probably sees less utility from being an “open” economy than most countries with our population size.

    I’m not advocating autarky, but I think it’s well past time that we stopped just assuming that trade and foreign investment = good, and started having a discussion of just how much and what kind of trade and investment are actually useful to us, just how open our economy ought to be.

  • I don;t think we even have to mention autarky or trade is bad. What we need for our small open economy are an institutionalized vision that other than resource extraction, high value adding is major part of our future.

    We do not need to worry so much about tarriffs and trade barriers, what we need to worry about is developing high value adding jobs. And that must be married to the global economy. We can compete, and we must as we are what I would call one of the front end economies that has the education, the knowledge and the know- how to make it within the global economy on specialized high value production. We need the leadership, and investment that as mentioned in this article is not so profit oriented on the front end.

    This is the future of the Canadian economy- aside from resource extraction- we need to develop these production abilities.

    We cannot just have a revival of manufacturing, as seems to be the case in the USA with their low dollar. Read an Article today put out by the USW, stating some new manufacturing is making a comeback in a couple of states, however- the wages being paid are around $7.50 an hour.

    These plants are producing either seriously low tech productivity jobs or in serious need of a union or a combination of both.

  • I should clarify something here. I would re-title free trade in my previous comment as fair trade. Labour standards, must be respected and also exchange rates in terms of a level playing field for PPP should be the goal.

    However, in light of the differences in labour composition, there is not a doubt in my mind that Canada can make it on the high productivity high wage strategic choice, in terms of growth strategy.

    Given our small size, and the social and economic infrastructure we have in place, it just take “long termism”, and that goes for both public and private investment. Having a wage strong enough for consumption in terms of this post, is something I do think becomes is part of the pre-conditions of developing this. I think the mid-90’s was a case in point. We were getting close to something magical in terms of economic activity, but then the markets imploded on themselves as the greed became unchecked and destroyed the goose. Wages were making a bid to start climbing in a sustained sense, public revenues were on the rise (although somewhat due to cuts, but undoubtedly revenues were rising.

    Investment, was secondary. It was a develop tech from the public sector that matured and was privatized and commodified. But in stead of controlled growth, investment got out of control. The question I have, how much profit does it take to actually get the profit investment virtuous cycle to initiate itself and can it be sustained given inherent unregulated short termism that seems to be it ultimate undoing.

    Virtuous cycles that are sustainable must include a rising wage that goes with the productivity. Wages turn into profit, without that guarantee of huge profits from the robust wage dynamic within that cycle I do not understand how capital can be coaxed out its own bubble base virtuous cycle. And I tell you what, it may bust now and again, but the rich are the first to get out and the first to get back in again when the bubble starts up! Uncanny ability to predict, or maybe insider knowledge- watch the new documentary “Inside Job” and you make up you mind- however beware, it is quite a gory economic horror movie. Put the kids to bed before you click that sucker on.

  • The empirical calculations for the model were done for the euro-zone so Austria has a fixed exchange rate within the zone and most of its exports are presumably to the eurozone.
    Canada’s case is different. It would be interesting to know what the empirical findings of the model would be for a country with a flexible exchange rate with an economy for which exports are largely driven by exogenously priced resources. Something to do in your spare time, Erin!

    Under those conditions I don’t think it’s so clear supply effects (profits driving investment) would outweigh demand effects (wages driving aggregate demand).

  • Wages essentially: you can get there from Marx or Keynes. Do you think a small open yet advanced economy can grow from declining wages? Who is the relative competition. It is pretty clear that if it is wage competition on solar garden lamps Canadians will never be competitive. And it is pretty clear that on mineral extraction the capital intensity is so high that wages do not really matter.

    I am getting a lower and lower tolerance for such abstract thinking. At some point we ought to kiss the ground we are referencing, no?

  • Keynes for sure, but didn’t Marx conceive of capitalism as being essentially profit-led?

  • For supply side Marxists profits drive growth. But that is a one sided view of things. It is clear from Marx’s heuristic (M-C…P…C`-M`) that it is the hope of a profit that drives capitalist accumulation but the realization of that hope requires sufficient demand. Profits are a necessary but not a sufficient condition for growth. Marx’s position was not that accumulation was profit led but that profits were the raison d’etre of the system. A subtle but important difference that all stripes of supply siders miss.

  • yes I think it is the

    profit-investment- production- wages

    cycle of accumulation

    each could break and bring the system down

    quite a bit of synthesis in my statement, and a many interpretations- I liked and studied the french regulation school’s interpretation. Many ways the system can fail, I guess the question remains, could even a regulation approach save capitalism from itself. (depends I guess on how you define save- if you are a neo con, permanent decline is just fine as long as permanent can be restarted (saved) every X amount of years.)

    After Geitner’s statement yesterday that was leaked, it seems he does not view himself as a regulator and openly admits that the system will fail and need saving once again. So unregulated actually existing capitalism is now openly viewed as a cycle of permanent instability and decline.

    The question I leave you with, what value do we assign to X, how often will it fail.

  • “profit-investment- production- wages”

    Great a lefty with a full on supply side account. Really? Who gave you the right to say what was a chicken and what was an egg? And if the whole thing is circular what is the point of privileging one point on the circumstance of accumulation.

    Do finish your thought.

  • I could translate back into marx if you want me to.

    Same thing as far as I am concerned- this is the french regulation school’s account.


    MCM is not my typical analysis.

    It could have went

    wage (labour power) – profit (expropriation of surplus labour through both absolute and relative) investments ( replenishing the dead labour and regeneration of capital) Production (labour process and production chapter 15)

    which is the chicken and which is the egg, I think you have to go back to the enclosures (controlling the means of production) and figure that one out, or potentially to the small craft cottage industries or putting out systems (formation of production process and investment), or original accumulation theories of imported surplus from plundering and pillaging.

    I will admit I am a bit of a newbie on the terminology but not the theory.

    more important for this thread-

    which is the more efficient for workers – profit or wage led growth when the capitalists system sits where it sits its actually existing form.

    got to go with demand. just think about this- debt is what kept the system floating, mainly consumer and now bulked up by public debt. Housing bubble drove personal assets, to heights which were potentially unsustainable. It would have helped if lenders would not have leveraged that debt many times over and rolled it up into triple A CDOs and sold it through a scheme of a global financial web.

    We are suffering from a global shock to asset deflation that Capitalism was riding upon. Forget business cycles, forget investment, focus on stagnating wages being supplanted by staggering consumer debt.

    We need to kick start wages somehow, without going through the awful process of deleveraging.

    But we are phracked- there is no way out but to sink the ship, unless somehow it can be a staggered deleveraging. But with the mortgage fiascos still ongoing (just check out NakedCapitalism Eve keeps a pretty good eye on that stuff) and now a new sloing of the economy if anything we could see more asset deflation in other countries.

    R. Reich tweeted this today

    ‘Beware stock mkt. P/e ratios too high. Americans can’t buy, govts in US & Europe pulling back, Japn in crisis , China growth slowing.’

    That about sums it up to me- big storm coming again.

    So I take it he is in the wage boat for solutions!

    I will one day finish this thought.

  • To the last post it should have read “circumference.”

    Paul slow things down a bit. The first of your posts which I responded to was supply side determined. Your response to that was demand side driven. My initial response was neither supply nor demand side driven.

    Simply put for Marx and subsequent Marxists (some) it is not a question of profits per se it is a question of the balance between the expectation of making a profit and realizing that expectation. Individually capitalists can be very rational but when aggregated up the outcome can be very, and often is, irrational. With the rationality defined inter alia. It is a basic compositional fallacy.

    “which is the chicken and which is the egg, I think you have to go back to the enclosures (controlling the means of production) and figure that one out, or potentially to the small craft cottage industries or putting out systems (formation of production process and investment), or original accumulation theories of imported surplus from plundering and pillaging.”

    Makes no sense. I will not unwind it. The point I was trying to make was that the historical sequence is not important. But you do touch on something important. Namely, the origins of capitalist accumulation is not about saving and investing. It is about juridical changes which allows peasants to be turned into prols. And it is this social relation which is the origin of profit. But the socio-historical process by which that was accomplished is a separate question from the question of the contemporary functioning of capitalism. The peasants have been converted and it is their purchasing power that determines aggregate demand.

  • yes I think I was getting mixed up in the chicken egg. I personally am trying to find my way through an updated functioning of an economies value chain using the Post fordist approaches that as stated using the French regulation school as my base.

    Expectation of profits- the key to what is wrong right now.

    They don’t expect high enough returns, so they have invented new mechanism inside the finaicalization process to artificially increase those expectations, and seeming given the last bailout, without much risk for the super rich.

    So to get brick and mortar investment, given the cycle of accumulation, how does one either fix capitalism, or find a new pathway out, and I do not believe in fantastic revolutions that magically transform everything. But it does take changed thinking – instead of short termism profit expectations we need a new stick to beat the investment with or a new carrot to make them jump- or alternatively- like you stated, private property has got to start being questioned.

    At some point- without a fix to the current system- you could either get a slow realization in thinking or a radical change and I guess that is where we are caught, a loop of bang and bust in a spasmodic capitalism that the wealthy can now barely through cultural control keep the gates clear. (some part of the world the wealth have failed their position of power and are now being thrown to the lions.

    I do like reading about the french revolution, so many sharp objects highlight the story!

  • Niether wages or profits lead growth.
    Profit-sharing does. Profitsharing over and above wages at a pre agreed-upon percentage (such as 20%) will revolutionize the economy.

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