Slow Realization of Low Wages & the Japanification of the US

I remember a couple of years ago, when I was a constant commentator on Mark Thoma’s blog, I said that low wages and rising inequality were damaging the economy. Finding that comment is like finding a needle in a haystack. But Mark Thoma criticized the remark saying that inequality was necessary in the economy. Others on the blog backed me up. Now he is saying… (source)

“Some degree of inequality is needed to provide the incentives that make a capitalist system work, but inequality has risen far past what is needed to induce the effort that makes the system function.”

He is finally saying exactly what we were saying a couple of years ago. He was slow to realize.

Paul Krugman back in the late 1990’s undermined the living wage movement saying that it was a movement more about morality than economics. Time went by and wages continued to get relatively worse. Now Mr. Krugman is certain that wages will increase on their own, without government intervention. (Aren’t many economists writing recently about how government intervention helps capitalism correct its market failures?) Anyway, he seems quite certain that wages will rise when full employment is reached, so he encourages loose monetary policy to keep pushing toward lower and lower unemployment. He seems to think this strategy is safe. Yet, what if wages don’t rise enough and soon enough? because, you know, they really aren’t rising so much.

Mr. Krugman says that monetary tightening would trap the US into low inflation. (Wages of Fear, Paul Krugman) He says that this would lead to the Japanification of the US.  However, he is slow to realize that low wages are the key.

“I believe wages hold the key,” Tokyo University Prof. Hiroshi Yoshikawa told The Wall Street Journal recently. “Japanese wages started to fall in 1997-98, and that has caused deflation to take hold.” (source WSJ)

I fully agree with Prof. Yoshikawa. and Today is the big day for Prime Minister Abe’s push for higher wages. His push is not direct government intervention, but an indirect plea to firms to raise wages.

“The next big test for Abenomics comes Wednesday when Japan’s major companies decide whether to raise base salaries for the first time in years. Shinzo Abe, Japan’s prime minister, has cast a spotlight on the question, with his unusual public campaign pressuring executives to lift worker pay.”

Our own contributor here at Angry Bear, run 75441 aka Bill, is signalling a concern for deflation, even as central bankers expect inflation to rise. I think his concern is very valid. It is very possible to have falling inflation as we hit full employment. One reason I agree with him is because consumption by capital income could pull back too much as financial instability increases. Consumption by capital income has recently reached levels far beyond those seen before the crisis. I estimate that capital income is consuming around $900 billion (real 2009 $). The highest level reached before the crisis was around $600 billion. So even if wages were to increase now, the effect could be more easily neutralized by capital income backing off some of their own consumption.

The real problem with Mr. Krugman’s strategy is that wages will not rise enough and soon enough. The transmission mechanisms from monetary policy to labor income are extremely weak, which wasn’t the case back in the 1970’s. Besides, monetary policy is making corporate profits easier to come by without the need for enticing labor with higher wages. As well, the high unemployment rate weakens wage demands.

As I read Mr. Krugman, underneath his words is an undying belief that the natural rate of unemployment is well below 6%. That delusional belief colors his strategy and makes it dangerous. Why dangerous? Financial instability is increasing… and you know the old saying, “The bigger they are, the harder they fall.” Increased financial instability will crash harder when wages start increasing on the other side of the safe and sustainable full employment level. Yet, Mr. Krugman likes the idea of breaking on through to the other side..

“And to get wage gains up to where they should be, we need a period of overfull employment.”

He is tempting fate…

Governments must intervene and implement a long term policy of carefully raising wages, here in the US, Japan and Europe. The guiding principle of policy to heal the economy should be… Economic power needs to be transferred back into the hands of labor. Long-term loose monetary policy works against this principle because transmission mechanisms to labor are weak, and capital income receives undue benefits.

Mr. Krugman would have you think that loose monetary policy works in favor of labor. Yet, a stronger capital income base and increased financial instability do not work in favor of labor thank you very much.

Update note: Assuming the economy at full employment, if capital income decided to cut back consumption by one-third, $300 billion, labor share would have to rise roughly 2.5% just to keep consumption stable. I don’t see labor share rising that much without a reaction from business. Business worked hard to get labor share down.