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  November 2, 2012

Does jobs growth come from higher profits or wages?

Özlem Onaran: Research shows that a decrease in wages leads to lower demand and a decrease in economic growth, while higher profits lead to very little increased investment if demand is low
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Ozlem Onaran is Professor of Economics at the University of Greenwich in the U.K. She regularly publishes research studies on globalization, income distribution, and business investment in publications such as the Cambridge Journal of Economics and Labour. She recently co-authored a major study for the International Labour Organization on the relative importance of decent wages versus high profits as an engine of economic growth in several countries throughout the world.


Does jobs growth come from higher profits or wages?PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I'm Paul Jay in Baltimore. Perhaps the number-one thing being debated in this U.S. presidential election is the question of where will growth come from. How will jobs be added to the economy? One side says government needs to get out of the way, there needs to be cuts in spending. And implicit in that are policies that have to do with lower wages, not higher wages.

Now, the other side of the argument does tend a little bit towards government stimulus. You hear that from the Democratic Party. But you still don't hear the word wages or what to do about real increase of demand. Neither party seems to be offering that up as a solution.

But our following guest thinks that's in fact the only solution. So now joining us from the PERI institute in Amherst, Massachusetts, is Özlem Onaran. She's a professor of economics at the University of Greenwich in the United Kingdom. She regularly publishes research studies on globalization, income distribution, and business investment in publications such as The Cambridge Journal of Economics. She recently coauthored a major study for the International Labour Organization on the relative importance of decent wages versus high profits as an engine of economic growth in several countries throughout the world. Thanks very much for joining us, Özlem.


JAY: So what did your research find? I mean, for some people it sounds counterintuitive, because they say that, well, lower wages makes American companies—or European companies, for that matter, or Canadian—more competitive in a global market. And so, you know, when push comes to shove, lower wages actually leads to growth 'cause it leads to more exports. What's wrong with that?

ONARAN: What you have just formulated is the mainstream neoclassical idea that basically views that wages are only a cost item for businesses. They ignore the crucial fact that wages actually have a dual role. They're not just costs, but they're also a very crucial source of demand and [incompr.] contribution. And once you let this dual role, interesting things start happening. When you decrease wages, from a neoclassical perspective, stimulus to growth basically comes via the expected positive effects of higher profits on investment.

These effects might be true. There might be a direct positive effect of higher profits, lower wages on investments. But there are other important effects as well, and most predominantly, you have for sure a negative effect on consumption. Why? When you redistribute income from wages towards profits so you decrease the share of labor in national income, consumption will decrease, because propensity to consume out of wage income (or you can generalize that also as low income) is for sure higher than this out-of-profit income or the income of the rich households. In absolute amounts, the rich might be consuming a lot, but as a proportion to their income, they do consume a lot less than wage income earners and low-income households. That means when you redistribute from labor to capital, when you cut wages, consumption will decrease.

There is very robust evidence of that in several studies I and my colleagues have done. And a recent study for the International Labour Organization shows that also. It's a very robust [incompr.] Consumption decreases. Investment in some cases may increase, but the increase in private investment is never enough to offset those negative effects on consumption.

And if you have that, there will also be another positive demand boost of lowering wages. That will be via the exports channels. So exports will increase, imports will decrease. Then overall what do you have here? You have a negative effect on consumption, a possible but far from certain direct partial effect, positive effect, on private investments, and an unambiguous positive effect on net exports. If you sum it up, the total effect can be negative or positive. So it depends completely on the differences between the marginal propensity to consume out of wages versus profits, it depends on the positive sensitivity of investments to profits versus sales prospects, and it depends, obviously, on the sensitivity to exports to labor cost.

If this sum was positive, we would call such an economy a profit-led economy. It's the only neoclassical idea. They think all economies are profit-led, which means when you redistribute from labor to capital, growth has to increase and jobs will be created and there will be trickle-down effects. But the sum can as well be negative. And I can show you in a minute that for the majority of the large advanced capitalist countries this is the case.

JAY: Let's dig into some of the numbers, because, you know, what we're hearing in the elections is essentially that if you—first of all, to criticize profits is sacrilegious, it's certainly un-American, and that the reason for that is—as I guess you were getting to, is that people who make more profits take their profits, reinvest in new factories and new plants and stores, and that creates more jobs. So what are the numbers that disprove that?

ONARAN: Let's first start by a simple figure, no particular technical sophistication. That's the figure that shows you what has happened to labor income as a ratio to GDP in the European Union fifteen old countries, fifteen old EU member states. From 1960s to 2011, this is the data we have in the graph. So the blue line is the share of labor, wage share. As you can see in that graph, up until the late '70s there is an improvement in labor's share in income, and then there is a very dramatic turn around the late '70s to early '80s, and there was a similar trend in labor's share ever since.

Now, the red line in the same graph is showing you what's happening to growth along with these trends, these developments in labor share. Indeed, if you look at average growth rates in the '60s and '70s in Europe and compare it with the average growth rates in the post-'80s, growth rates have been much lower, along with this race to the bottom in labor's share, along with that very strong [incompr.] pro-capital redistribution of income. So this is a puzzle from a neoclassical perspective.

From a post-Keynesian perspective, the answer to that is most probably European Union is a wage-led economy. And this is what we try to pin down in our empirical work for the International Labour office. We literally tried to estimate the effects of changes in income distribution between labor share and profit share on consumption, on private investment, and on exports and imports.

What did we find? We did that for the major advanced capitalist countries and developing countries that formed G20, and here is a summary of our results—and you can find the details of the work in the web page of the ILO in our working paper, in our project report for them.

So let's [incompr.] the euro area first. When you increase profit share by one percentage point, growth will decline, growth of GDP will decline by some 0.13 percentage point. In Britain the effect is also negative. In the United States the effect is quite stronger, at one percentage point pro-capital redistribution of income is damping growth by some 0.8 percent.

So, basically the assumed trade-off between wages and growth or wages and job creation is not empirically validated. It's not empirically validated for Europe, it's not empirically validated for the large economies in Europe, like Germany, France, Italy, or United Kingdom, and similarly, this is the case in the U.S. and Japan. In the developing world, Turkey and Korea also fall into that group of wage-led economies. And then, in isolation [incompr.] only [incompr.] pro-capital redistribution strategy in one single country.

There are several countries who can grow out of that. One example is Canada, for example. Now, why is Canada different from the U.S.? Because Canada is a relatively small, thus much more open economy, much more export-dependent. Thus the effect of a pro-capital redistribution of income, a fall in labor costs, will boost exports, and thereby will have much more important effect on growth in Canada, since it's much more open, much more dependant on exports.

Let me mention one other important background. If it weren't for exports and imports, if you only looked at domestic, private demand, the consumption effect in all these countries is a lot more dominant, thus the negative dampening effect on consumption due to a pro-capital redistribution is a lot more dominant compared to the small positive stimulus to private investments. Thus, if we were closed economies, basically we would never be able to grow out of a pro-capital redistribution strategy. But this is not the case. We are open economies.

However, openness has more to it. It's not just Canada cutting wages and increasing profit share. U.S. is in the same race to the bottom in terms of labor share. Europe is implementing the same story. It's what they have been doing in the last three decades. And with this crisis, basically, antilabor, pro-capital redistribution policies is the twin policy along with austerity policies.

JAY: And the legislation that has to do with unions and union organizing, which would be a force for increasing wages, is not even on the table, in terms of making legislation that more facilitates organizing. If anything, it's going the other way with the attacks in various states in the U.S. on public-sector workers, public-sector rights to collectively bargain. Some of the union leaders I've been talking to think that the already incredibly low numbers of unionized workers in the United States, something like 6 or 7 percent, I believe, in the private sector—a little more in the public, but it could be half that within four to five years. So we're headed in quite the opposite direction of what you think is really the only way to end the crisis.

ONARAN: Yes. The scary thing is it's not only one country doing it. We're all doing it simultaneously. And look what happens. Then [incompr.] the wages redistributes towards capital simultaneously. In our study, in this table I'm showing at the moment, in the second column, you're showing what happens when profit share increases not just in one country but simultaneously in all of these major economies that make up more than 85 percent of world GDP. Obviously, the tremendous effect on growth, and thereby jobs, are a lot stronger. For example, in the euro area, a simultaneous race to the bottom in the global economy will dampen growth by some 0.25 percentage point. In the U.K., again, 0.2 percentage point. In the U.S., the effect on growth is approaching to even 1 percent as [incompr.] 1 percent race to the bottom in the wage share.

And, interestingly, Canada, for example, who could grow out of a pro-capital policy, because in isolation it looks like it's very profit-led, will not be able to grow when the U.S., Mexico, Europe, Australia, all its trade partners are simultaneously beating wages down as part of their international competitiveness strategy. Similarly, there are some other important major developing countries, like Mexico, Argentina, India, who seem to be profit-led in isolation, who could grow out of pro-capital redistribution policies, will never be able to do so when all their trade partners, both in the north and the global south, are implementing the same strategies. So, basically, the punchline is the following. If you have a global race to the bottom in the wage share, decreasing the share of labor in income by 1 percentage point, global GDP decreases by 0.4 percent.

Reverse this argument. If they could have a pro-labor shift in income distributions that could increase the share of labor in national income by 1 percentage point, we would be able to increase global GDP. Why? Because planet Earth is not profit-led. Planet Earth is wage-led. But simply because we are not trading with Mars—not just yet. I'm fond of science fiction, but the truth of planet Earth is that we are in a wage-led context.

Now, to formulate that positively, we could think of a scenario, a wage-led recovery scenario out of this crisis. For example, correcting the loss in labor's income share, reversing that back to its peak levels in the late '70s or early '80s in some major wage-led economies, and making corrections also in some other developing countries like China to maybe a lesser extent at the beginning, we could grow by some 3 percent at the global level out of that strategy. That will be something that would first reverse one of the major causes of this crisis, which is inequality. It would stabilize those patterns. And it will also create more jobs.

JAY: It seems to me, then, given that this point of view is not likely to be adopted by any of the people who are collecting these profits at the moment—certainly not the majority of them, 'cause they all seem to think, après moi le déluge, I'll collect the profits today, and the world can go to hell tomorrow—I guess it's up to ordinary people to kind of get organized and fight for higher wages, 'cause I don't see where higher wages are coming otherwise.

ONARAN: It can only come true empowering labor unions, and, obviously, particularly the unions in the north. If they could manage to improve their [incompr.] reverse the fall in labor's income share, they would be able to create a very large area of maneuver for the southern labor movements to be able to increase their own wages and go for a high-growth egalitarian development strategy.

JAY: Well, thank you very much for joining us today.

ONARAN: Thank you very much.

JAY: And thank you for joining us on The Real News Network.


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