Paul Krugman on verge of an illumination
Today Paul Krugman wrote a piece (and a blog post) about China’s high level of investment in the face of low domestic consumption. It is obvious to me that he is making headway in understanding the importance of low labor share of income.
Remember low labor share means high capital share. Capital income is dedicated to increasing the means of production, whereas labor income is primarily dedicated to purchasing the finished production. Paul Krugman refers to this directly…
“What immediately jumps out at you when you compare China with almost any other economy, aside from its rapid growth, is the lopsided balance between consumption and investment. All successful economies devote part of their current income to investment rather than consumption, so as to expand their future ability to consume. China, however, seems to invest only to expand its future ability to invest even more.”
“Wages are rising; finally, ordinary Chinese are starting to share in the fruits of growth. But it also means that the Chinese economy is suddenly faced with the need for drastic “rebalancing” — the jargon phrase of the moment. Investment is now running into sharply diminishing returns and is going to drop drastically no matter what the government does; consumer spending must rise dramatically to take its place.” (emphasis added)
For me, he is describing the growth model of effective demand, where an economy in its early stages puts more income into capital investment and then over time must shift income to labor to purchase the production of the earlier investment. The result is an increasing standard of living. Yet, he is also describing the problem with the US economy where labor share of income has backtracked to a lower level below previous normal levels. We too have created a lop-sided balance between consumption and investment in the form of labor and capital incomes.
One can talk all day about monetary and fiscal policy, but at some point you have to talk about labor income to validate the rise in capital income and even the propensity to invest when demand is low. Labor’s share of total output that it receives in the form of income has fallen 5% in the US since before the crisis. In China, labor’s share is much lower, partly due to large exports in relation to their domestic market and partly due to an abundance of labor as Paul Krugman points out in his post. He sees China as “running out of peasants”. Thus wages will have to rise.
What will happen to wages in the US if wages in China change? Many see wages in the US tied to wages in China. Thus if wages rise in China, they would rise here. An associated view was tweeted by Noah Smith on June 17th, 2013…
“If China’s economy crashes or even slows substantially, I predict a sudden rise in labor’s share of income in rich countries.”
It is true. We have seen that labor’s share of income has fallen in advanced countries, whether or not this is due to labor competition with China or a business philosophy to maximize profits. The result is that domestic consumption is weaker. Yet there is an implication that capital needs the extra income to develop infrastructure and more means of production for the future. OK… then at some point labor will have to receive a larger share of income in order to consume the increased production just like in China. Will the United States return to a “standard of living” when labor share of income was 5% to 10% higher?
Paul Krugman is on the verge of connecting the problem of low consumption in China with the problem of low labor share in advanced countries. He is on the verge of an illumination about the dynamics between labor and capital incomes. I have seen him progressing towards this lately.
The realization of the importance of labor’s share of income would signal a wonderful evolution in the thought of Paul Krugman. Back in the late 90’s he undermined the living wage efforts by saying they were not about living standards and economics, but about morality.
Edward:
I will again be the first to hit on this point:
“whether or not this is due to labor competition with China or a business philosophy to maximize profits.”
I am going to suggest it is more the latter than the former. Business is no longer interested in investing in Capital involving Labor. It is all about Capital and return on Capital with little in reserve for TBTF and the Investment Banks such as Goldman Sachs.
How sad is it when PK is only on “the verge of an illumination” , after all this time ?
Wren-Lewis seems to be entertaining some uncomfortable thoughts as well :
http://mainlymacro.blogspot.com/2013/07/unemployment-output-gap-and-wage.html
I guess it’s tough to kick the habit when you’ve been mainstreaming junk your entire life.
At the end of the day ( a decade from now , perhaps ? ) , I think those like Onaran et al will have been proven to be closest to the mark :
http://www.ilo.org/travail/whatwedo/publications/WCMS_192121/lang–en/index.htm
Even without the benefit of 80 years of additional economic “science” , FDR moved rapidly in the right direction and set us up for the Golden Age of Capitalism. Most of today’s economists should simply resign , in shame.
An article with some links to various papers on wage-led vs profit-led growth regimes :
http://www.social-europe.eu/2013/04/new-perspectives-on-economic-growth-the-potentials-of-wage-led-growth/
Run has the right of it. Capital is a massive leach, sucking the life blood out of the economy.
PK is not really a liberal, despite the name of his blog.
He just looks like one because there is such a gulf between real conservatism and the intellectual wasteland that people who call themselves conservative have wandered into.
He’s a pretty traditional Keynesian, and Keynes was no liberal either. They both try to make sense of the world and be rational about it. Something no “conservative” has attempted to do in the last 20 years.
Sadly,
JzB
JzB:
“gulf between real conservatism and the intellectual wasteland”
How true. The last couple decades of pols coming up lack in the basics of conservatism. I can not say much more about Liberals either, liberals who sell out their constituents in a time of need seeking political agreement. The student loan agreement coming in a time of student pseudo-bankruptcy (they can not go bankrupt) is a disgrace.
I believe what Edward is pointing to the contnual fall of the middle and lower incomes (as Warren might put it) with Productivity Gains being so heavily skewed towards Capital as opposed to Labor in the form of Wages. Why invest in labor-intensive investments when one can make their Gains (profits) solely from Capital?
“Capital income is dedicated to increasing the means of production,….”
I think it would be more correct to say that capital income is dedicated to both increasing the means of production and increasing the income of the stake-holders through either dividend income or capital gains income, both of which are further enhanced by favored tax treatment relative to income from labor.
There is too much focus on the economy as a monolithic process rather than recognizing that our society has evolved into a bi-modal economic process. The economy incorporating the upper ten percent (?) is dooing fine and probablt growing as though healthy. Then there is the 90% economy represented at its worst by Detroit. And likely the 10% mode is syphoning off income and caital from the 90%. I’m speculating some, but I don’t think I’m far off the validity mark.
Edward
I think you are on the right track, and I hope your way of putting it will help even the economists to understand it.
Meanwhile Marko has it right:
“Even without the benefit of 80 years of additional economic “science” , FDR moved rapidly in the right direction and set us up for the Golden Age of Capitalism. Most of today’s economists should simply resign , in shame.”
MY own ideas are far too radical for the people yet. Maybe when we hit the absolute wall where the production possibilities curve is limited by no-more-resources, folks will wish they had listened (not to me. i am far from the only one crying in the wilderness. crying for the wilderness.)
I have to add..
we are not only in an economy where there are no jobs, and the pay is not adequate..
but we have entered an economy where the preferred business model is to defraud your customers. and in this the government far from offering the people any protection, aids and abets the criminals.
i keep thinking this can’t last. but it has lasted for thousands of years in some cases. America’s two hundred years or so was a brief shining light that is about to go out.
Coberly,
Radical ideas are good. The standard ideas are not working very well. It’s because economists are missing a real model for labor share.
And effective demand comes along and says that labor share actually puts a constraint on the economy…. a binding constraint at that.
The bottom 90%, like Jack puts it, are getting caught in the constraint.