There is so much to reflect upon with Michael Pettis’ new post, Economic Consequences of Income Inequality. I have been in total agreement with the way he looks at income inequality. Yet, he said some things that surprised me… things I hadn’t realized.
He restates his view of how changes in labor share, which he calls household share, affects national savings. And then how changes in national savings can only be resolved with certain economic reactions. Some reactions are sustainable, some are not.
A brief summary is that a fall in labor share causes a rise in national savings, which can only be resolved by 1) increased investment, productive (S) or non-productive (NS), 2) rising inventories (NS), 3) a rise in credit-fueled consumption (NS), 4) a rise in unemployment (S). … Sustainable = (S), Not-sustainable = (NS)
There are only two sustainable outcomes. A rise in productive investment or a rise in unemployment. The problem with productive investment is that when effective demand is low, there is less incentive to invest in productive activity. Therefore, when labor share falls, and productive investment is not the outcome, eventually unemployment rises on a sustainable basis.
This is in agreement with the equation from my research into effective demand…
effective labor share rate > utilization rate of capital * utilization rate of labor
The labor share rate is the upper bound on the utilization of capital and labor. If labor share falls, we would eventually realize a sustainable fall in the utilization rates of capital and labor. The result is increased unemployment just as Mr. Pettis explains, and explains very well.
But here are two things that surprised me from his post…
- “If Spain leaves the euro, Spanish unemployment will decline sharply, but total unemployment will not, which means that German unemployment will rise.” … Thus, Germany has a selfish reason to fight for countries like Spain and Greece to stay within the Euro-zone.
- “The solution to excess savings, in other words, is not for low-saving countries (Spain for example) to cut back on consumption. This will only increase global unemployment. … What is very clear from this analysis is that there are really only three sustainable solutions to the global crisis in demand. Either the world has to embark on a surge in productive investment, or we need to reduce the income share of the state and of the rich, or we must accept that unemployment will stay high for many more years.”
Number 2 is what I have been writing about here on Angry Bear blog. What surprises me is how clear he has made the case. He has put it into simple terms. You either raise labor share or accept higher unemployment. Take it or leave it. Those are strong words, which give policy makers really no choice.
But think some more… Krugman and other economists are calling for loose accommodative monetary policy to push unemployment down. Yet, high unemployment in the US and other countries is the result of the imbalance in global savings. If we push down our unemployment without raising labor share, that only pushes up unemployment in other countries. We will experience a push-back on this from the other countries. Eventually someone has to be stuck with high unemployment, all due to the fall in global labor shares.
Mr. Pettis says…
“So what are the policy implications? Clearly Europe, the US, China, Japan, and the rest of the world must take steps to reduce income inequality.”
“But redistributing income downwards is easier said than done in a globalized world, especially one in which countries are competing to drive down wages. The first major economy to attempt to redistribute income will certainly see a surge in consumption, but this surge in consumption will not necessarily result in a commensurate surge in employment and growth. Much of this increased consumption will simply bleed abroad, and with it the increase in employment.”
So if a country takes the lead and raises its labor share in order to bring down unemployment, most likely they will just bring down unemployment in another country, not domestically. Wow! The global economy is in a trap. and the only way out looks to be global cooperation to raise labor share. We are doomed because we live in a world of people who think like Milton Friedman. Unions and minimum wages are bad. Maximization of profit to shareholders is the prime goal.
“Less global trade, in other words, will create both the domestic traction and the domestic incentives to redistribute income. In a globalized world, it is much safer to “beggar down” the global economy than to raise domestic demand, and so I expect that there will continue to be downward pressure on international trade.”
The ramifications of his words are staggering. He knows it and others deny it.
“This means that rising income inequality must eventually lead to more productive investment or to more unemployment. There is no other conclusion. Can this argument be attacked? Of course it can.”
He is absolutely right… and I defend his argument.