Should we fear negative consequences in fighting for better wages? No… reply to Yves Smith
Yves Smith at Naked Capitalism showed concern over my last post on rising labor share…
“In reality, it’s even worse than that. I hate criticizing writers whose work I generally like, but as a contrast to this talk, I suggest you look at a new post by Ed Lambert at Angry Bear. In it, a left-leaning blog (and remember, Angry Bear has been vigorous in its defense of Social Security), we see an strong argument against having workers get a better deal. Why? It will lower corporate profits, which will lower asset prices and give the confidence fairy a sad. I am not making that up. This shows the degree to which liberal economists have been intellectually captured by the orthodoxy and/or have been inculcated to live in fear of the Market Gods. If you can’t get parties who are ideologically sympathetic to argue for real remedies rather than a “recovery” only for the top tier, how can you possibly exert any pressure on the minions of the 1%?”
Her concern is that we should not fear negative economic consequences, like a recession, from fighting for better wages.
I was defended by the New Deal Democrat who explained very well what I was saying.
For Yves, I must make a distinction between minimum wages and labor share. Raising labor share is different from raising minimum wages. Minimum wages can rise without a substantive rise in labor share. Yet, rising labor share reflects better incomes more widely across the income spectrum. I am completely in favor of higher minimum wages and I am in favor of a higher labor share. Yet, higher minimum wages will not trigger negative economic consequences like a higher labor share would. Higher labor share directly shows that profit rates are coming down. Higher minimum wages would not show that in my opinion.
So we must fight for the workers who make close to minimum wage. The gains outweigh, if at all, any negative economic consequences.
Yet, we must be sensitive to changes in labor share, which directly effect profit rates and thus asset prices. Keynes implied in his description of effective demand, that the business cycle reaches its end at full employment when profit rates maximize in the eyes of the entrepreneurs. So if rising labor share reflects a maximization or even fall in profit rates, I would conclude that the end of the business cycle is coming.
One issue that I did not bring up in my previous post is this… If labor share starts to rise, the door will open to increase productivity by raising the effective demand constraint upon productivity. So labor hours would not have to be curtailed if labor share rises. However, you get a conflicting situation of rising productivity and rising unit labor costs, as labor share rises. Unemployment can continue to fall in this situation. Eventually the rising labor costs overpower rising productivity and extra labor hours. The result is that effective demand per labor hour will rise faster than output per labor hour. This situation has always been a precursor to a recession in the past.
It is generally accepted, I think, that workers tend to get their biggest gains toward the end of a business cycle. You see more wage inflation and lower unemployment. Yet, a recession will eventually bring this moment to an end. The longer the recession can be avoided, the better it is for workers and their wages. Yet, and I think Yves will understand this, when there is a high degree of financial instability, it is easier to trigger a recession at the end of a business cycle. And there appears to be more financial instability and sensitivity at the moment. Also, rising unit labor costs at the end of a business cycle can be offset by rising inflation. Yet, we have well constrained inflation expectations, so inflation will not likely permit much of a rise in unit labor costs.
So we should not fear negative economic consequences in fighting for better wages for workers. We must eventually overcome any and all obstacles.
Two other points to bring up in this issue…
- Yves’ post referred to a video by Dean Baker and Bob Pollin. At one point they said that they do not understand why unemployment has come down so fast. One explanation points to labor force participation, but another explanation is given through the equation that I gave in my previous post. Profit rate = (1 – unit labor costs/inflation)*productivity * labor hours/Capital Increasing labor hours will increase profit rates when unit labor costs are controlled and productivity is constrained. So there is currently an incentive to increase hiring. Thus we see an acceleration of hiring. But why do we see an acceleration now and not before? Well, labor share was falling after the crisis. This means that unit labor costs were low or falling. So profit rates rose without having to increase labor hours through faster hiring.
Once labor share stopped falling, profit rates had to look for another variable in that equation in order to keep rising or at least not fall. The answer was not inflation because mildly falling inflation cuts into profit rates. Profit rates found increasing labor hours as the answer. Labor hours have been increasing steadily at around 2% annual rate from quarter to quarter. So labor force participation has its effect on lowering unemployment too.
Yet, we will see an effect to slow down hiring if labor costs rise too much. If labor costs rise, not from higher minimum wages, but from higher labor share, growth in labor hours will slow down to preserve profit rates and asset prices. A recession may not start at that time as long as profit rates can be maintained. - I send out one idea to the New Deal Democrat… who said…
“While a decrease in stock prices would create a negative wealth effect, the increase in consumer spending by Labor would likely more than make up for that (since Labor spends more of its income than the wealthy).”
I do not agree with this, because capital income is now spending over $900 billion (real $) at an annual rate. This is much more than they have spent in the past. Before the crisis, they were only spending $500 billion (real) at an annual rate. So it is conceivable that capital income could cut their spending by $100 to $300 billion (real) at an annual rate without too much trouble. Just slow down stock and asset prices. Make capital income go into preservation mode. So labor share would have to rise from 74% to over 75% (effective rate), just to keep real consumption from falling. Labor share would then have to rise to 76% just to see an increase in consumption. But what if capital income cuts another $100 billion from their consumption? They are still spending more in real dollars than they did before the crisis.
It’s a tricky economic situation at the moment… but we must still fight for higher wages, even if it triggers negative economic consequences. And then we must continue to fight for better wages through the next recession and after. And keep on fighting with the long run goal of getting labor share back up to over 80%.
Ed,
You know how too many (the Fed) thoughtlessly worry much more about 1% more inflation than 1% more unemployment (they don’t think of it that way consciously — I hope). Aren’t you worried a little too much about 1% unemployment compared to several percent shift in labor’s share? Just asking.
I know the biggest task is changing the distribution of labor’s share — and income share in general.
Hi Denis,
Unemployment is a measure of how many people can be put to work.
It does not measure how well they are paid or how many hours they will work.
Total labor hours is still over 2% lower than at the start of the crisis, even though total employed has reached that level.
It is nice to have lower unemployment but the cost is lower pay and lower hours, which get reflected in the lower labor share number and lower capacity utilization numbers.
So I am less worried about unemployment than I am labor share. A higher labor share will lead to lower unemployment, higher wages and more labor hours.
Many say that labor hours are down because the marginal cost of labor is still too high compared to other countries and advances in technology. Be that as it may, the social cost of lower labor share is large.
Why would it be hard for labor to make up the difference in capital share, assuming capital share actually reduced it’s spending?
I’m skeptical they even would reduce their spending all that much as such a shift in share would be across the economy and not isolated to a sector or region, in addition the permanent positive shift in demand would likely make up for any change to profits, especially as it generated a virtuous cycle of economic growth.
Also won’t an increase in the minimum wage create wage pressures across the board leading to likely higher wages for most employees anyways?
Axt113
Minimum wages will pay for themselves in increased sales. Thus higher minimum wages will most likely not raise labor share, since revenue will rise along with it.
Yet, raising labor share reflects direct cuts to the profit share of revenue. Thus labor share represents a very different dynamic.
If profit share (capital share) is reduced, firms have to increase sales to maintain their level of profit. Once firms realize that profits have maximized, and their profit levels may fall, they react by slowing down their consumption, because the consumption is a non-productive leakage from their cash flow which will not be replaced by future increases in profits.
Won’t higher labor share also result in higher disposable income and therefore higher sales?
Axt113
Not necessarily. Disposable income for consumption comes from both capital and labor income. One goes down while the other goes up. We have seen disposable income by capital income increase greatly. It can go down too.
Look at China. Labor share is supposedly rising but domestic demand is getting even weaker. Some are pointing to the fall in spending on luxury goods. So even if disposable income is rising for labor, overall spending can decrease if the rich pull back.
China has a much higher savings rate than the US, implying that their population is less likely to spend any excess share than the US would.
If true, then what may be true in a China would not be necessarily true here in the US as we have less inclination to save compared to China
Axt113,
China has a high savings rate because the rich have a great share of the money. The people, labor, have very little, and actually save very little.
If the people received more money in China, they would spend more. The problem is that China has a very hard time raising their unit labor costs. They treat their workers like slaves, and that will be one of their downfalls.
I agree that income inequality is high in China, but the poor and middle class have no safety net
The lack of a safety net meaning even the poor and middle class in China need to save more for ilness, education and retirement.
So even higher incomes will not result in the same consumption patterns as the US since more income will merely mean more opportunities to save for the proverbial rainy day.
Axt113,
Yet, that is the point. Labor has no safety net and little money left over to save.
National savings in China is high due to low consumption in relation to production. That is the rule for savings. Why is consumption low? Because labor has little money to spend. And the rich spend a lot but the rich cannot make up for the huge population of labor that makes very little money.
If you give more money to labor, they will spend it. Savings rates are low. They have needs going unmet because they don’t have enough money.
I read the comments on some blogs that deal with Chinese economy. The ordinary person in China has very little income. They do not save. They simply consume very little which then implies high national savings, because low consumption in relation to production means high savings.
China exports its extra production which reflects its high national savings.
Will they spend though, with no safety net, my opinion is that they will save more, not spend as much, in order to deal with future expenses (they’ll spend some no doubt, but a large chunk will get saved more than would be saved in US)
In US where a safety net exists, people are more likely to spend than save, due to the assumption that they will receive benefits later on.
If they feel confident that the economy is growing, they will most likely spend more. If there is a business contraction, they may try to save more.
But we are talking about labor in China. Their incomes do not rise much. So when you say that a large chunk will get saved, we can’t really be talking about labor.
IN China, their high savings really come from low labor share. Michael Pettis writes about this. So the rich do the saving. If asset prices are starting to collapse in China, the rich will protect their wealth. They will hold more saving or hide the money abroad for instance. Thus, consumption will fall in China. As a nation, their savings will rise. This will cause their trade surplus to rise too, which has just happened. They are importing less and exporting more. So in effect we know that their national savings are growing. Domestic consumption is falling.
Now for the US, the safety net is tenuous. People have lost confidence that the system will watch out for their well-being. If things start to collapse, people will have the initial reaction to preserve what they have. They will save.
No real danger of collapse any time soon in US, no matter what the doomer patrol would have us believe.
Most of the economic news the past two months has been positive and showing signs of a recovery that is finally gathering steam
No, there is no real danger of collapse in the economy but there is concern. The ground is getting shaky. People can feel it.
There is positive news, but wait a few more months. The news will come into a balance.
Even the increase in job openings today is part of a pattern in the Beveridge curve that will balance down.
http://blogs.wsj.com/economics/2014/06/10/an-updated-look-at-the-beveridge-curve-a-step-away-from-normal/
Question?
Are you basing that on data from other recessions caused by financial crises or are you just comparing this recession to other recent US recessions?
As we’ve seen, the aftermath of a financial caused downturn is not directly comparable to a more mundane business cycle downturn.
Does the data from other similar caused downturns reflect a reason for worry? Or is this overreacting by market bears?
My opinion is that this recovery will not reflect other recent US recoveries by the mere fact that it has a different cause than anything since the depression.
Axt113
Recessions are not well understood. Noah Smith is writing about that now. However, if one understands Keynes’ concept of effective demand and has a way to apply it, you can determine the full employment environment that precedes recessions.
So, with effective demand you can determine when a recession will occur, excluding Volcker’s recession, where he manufactured an unnatural recession. This financial recession resisted the effective demand limit for 3 years before it finally caved in. Real GDP did not rise above the effective demand limit for those 3 years. However, financial instability rose during those 3 years.
Now real GDP is pushing against the effective demand limit again. If monetary policy keeps pushing against it now, financial instability will increase.
The problem now is that the economy is so unequal that financial instability is more easily created at the effective demand limit.
The economy is building up tension like a spring. The more tension there is, the more snap we will hear when the tension is released.
So the numbers do not appear as though there is a problem. The yield curve has not inverted. Profit rates have not fallen from their peak yet. Yet, the economy has already hit the effective demand wall. Growth of consumption per labor hour has already fallen to zero.
This recovery is different because of the extreme monetary policy we see. But the monetary policy will not be able to overcome the effective demand limit without a cost of greater and greater financial instability.