Adair Turner: Is it Debt Deleveraging or the Fall in Labor Share?

Adair Turner was interviewed by INET about his new book which I have to buy and read. The book came out this week. It is called, Between Debt and the Devil. Here is the interview. (link)

He lays out an exquisite analysis of economics on many layers.

  • How the crisis was not expected due to economic theories that thought they had solved macroeconomic problems.
  • How debt is dragging down the global economy.
  • How debt monetization is the best solution to the current sluggish economic growth.
  • How the rise in the Swedish interest rate a few years ago did not stop speculation in housing but hurt other industries instead.
  • and more

Yet I question him… Is it truly deleveraging debt along side fiscal consolidation that is making some economies sluggish? It is an easy concept to grasp and accept. A larger portion of the economy would rather pay down debt than borrow to invest or consume. So the economy becomes sluggish.

But let me play the devil’s advocate…

I look at another cause for economic sluggishness… the fall in labor share. It is not a concept so easy to accept.  If you pay labor less, business should be able to grow faster right? You have lowered business costs. You have made it easier for firms to project higher profits, right?

Yet, I see the fall in labor share as a fall in effective demand, which has lowered economic potential and the social benefits in the economy. The drying up so to speak of labor share of income has caused firms to seek out profits in other channels where money is circulating. Firms are able to survive, but labor continues to suffer.

We can say that deleveraging debt and the fall in labor share both contribute to the economic sluggishness. But since Adair Turner did not talk about the fall in labor share, I will.

The Channels of Money Flow for Business

Here is a simple diagram of the basic channels of money flows into and out of firms.

firm channels

Let’s say that there are four basic channels for moving money. Firms can make money in each of those four channels. Firms can make money from the financial sector from lower interest rate costs and increased funds for investment. They can make money from the government from lower effective taxes, higher subsidies and higher govt. purchases. They can make money from labor by paying lower wages and increasing sales to labor income. They can make money in the foreign markets by lowering overhead costs overseas, increasing exports and selling more imports.

After the 2001 recession, labor share of income began falling to never before seen lows. Consequently relative sales to labor also decreased because labor had less income relative to production. So overall money flows between labor and firms has been growing slow. Firms have had less ability to profit from labor due to decreased overall money flows with labor. So in response, how did firms compensate for the decreased flows with labor?

Firms began to open up new ways to increase profits through the channels of the Financial sector, government and foreign markets. Interest rates have been falling. Money is cheaper. Effective tax rates have been falling. Outsourcing increased. Sales in foreign countries increased. Firms became less dependent upon domestic labor’s income.

So firms have increased money flows in other channels other than with labor. What has been the result? Firms have been able to increase after tax profits in real terms to new records after the 2001 recession. (link to graph)

after tax profits

Firms do not need labor’s income much anymore to obtain their profits. This is a major problem that is dragging down the social benefits of the economy for labor. Firms have been receiving social benefits, but not labor.

The Lack of Productive Investment

Adair Turner recognizes the lack of productive investment. Is it really due to deleveraging like he says? With all the great respect for Adair Turner that I have, I could also say that the lack of productive investment is due to weak labor income for buying production. A greater percentage of profits is being obtained in other ways besides serving the consumption desires of labor.

Incentive to increase production is weakened when effective tax rates are lowered, when interest rates are lowered, and when sales increase through overseas operations. A firm has less incentive to invest in production when effective demand is lower. Productive investment if done is done elsewhere because foreign countries are competing for production capabilities to serve the US consumer.

Is there Deleveraging?

Households are deleveraging. (link to FRED graph)

household debt to gdp

Are corporations deleveraging? Well, corporations have relatively more of their own funds to finance their activities. This graph “is calculated by using debt as the numerator and capital and reserves as the denominator. It is a measure of corporate leverage the extent to which activities are financed out of own funds.” (link to FRED graph)

debt to equity

It may appear as though corporations are deleveraging since total debt to equity is falling. However,  their level of liabilities with debt securities in real terms is rising. (link to FRED graph)

corp debt securities

(link to next FRED graph)

total noncorp debt

And why not increase debt? Borrowing costs are so low. Why not stock up on cheap cash even if it adds to total debt? You could loan it out at a higher interest rate in the future or just use it to pay back debt liabilities when necessary.

At the same time, let’s keep in mind the possibility that the increase in non-financial corporation debt securities may reflect some businesses on the edge of going out of business. They need debt to stay in business. A depressed Fed rate is essential to keep these businesses alive because they may be stacking debt liabilities. In other words, increasing debt to cover past debt.

Firms are lowering future interest rates by stocking up on cash and increasing debt. It looks as though low interest rates have made money so cheap that the demand for money will be satiated for some time into the future.

The Fed rate being low may fuel more debt. Debt is increasing, even while debt to equity is falling. The Fed rate will stay depressed. Adair Turner recognizes this issue in the interview. I see the Fed rate staying depressed all the way to the next recession. Strange times these are…


Adair Turner says that we need to lean against excesses in lending. But corporations have gathered lots of funds and debt for whatever they may want to do. It is harder to have a regulatory mechanism now.

Corporations are less dependent upon the money flows from labor. They have less incentive to invest in productive activities.

For me, the solution lies in making firms more dependent upon the money flows with labor. That means reversing the policies that increased profits through money channels other than with labor. That means tightening the flows with the financial sector. That means raising the effective tax rates with the government. The result will be to force firms to divert overall money flows into the labor channel. Firms will have to realize that labor share of income must be raised because increased volume of business with labor would allow for better profits.

Firms would be making more of their profits serving the needs of domestic labor. Isn’t this how the economy is supposed to function?

I respect Adair Turner and I need to read his new book. His book may answer the differences that I have with him. (link to book)