Growth and distribution from top to bottom

My previous post focussed on the possible mechanisms which could underlie a sustained economic recovery in the UK. In particular, growth in productivity would allow real wages to rise, leading to rising consumption which in turn would allow household debt as a share of national income to fall over time. Rising real wages would also hopefully increase government tax receipts, which would reduce the budget deficit. All this would take place in the best of all possible worlds, and would be helped along by booming foreign demand for UK exports leading to a narrowing in the current account deficit. But in the short term this seems like a tall order. In this analysis, I have assumed that one thing leads to another in terms of the mechanisms of growth in productivity and in national income or GDP. However, this article in Sunday’s Observer newspaper reminded me of how unfair the distribution of any increase in national income has become in recent years:

“Median wages per hour – the hourly pay received by the typical British worker – have been growing below productivity since the early 1990s, and markedly so since the early 2000s”, notes Paul Gregg, an economist at Bath University.

In addition:

“The Resolution foundation has also looked at ordinary workers experiencing growth without gain. Its Commission on Living Standards highlighted distribution changes. In 1977, of every £100 of value generated in the UK economy, workers in the bottom half of the earnings distribution received £16 as wages; by 2010 this share had fallen to £12. Workers in the top 10% increased their share of value from £12 to £14 over the same period.”

So even when productivity does rise, an increasing share of the increased income that it allows flows to the top of the income distribution, particularly in the UK and US. Given that the richer members of society are likely to save a higher proportion of their income than the poorer members, consumption is likely to be constrained by rising inequality, unless the poor fund increased consumption by borrowing, which is indeed what happened in the run-up to the Great Recession. This proved unsustainable. Thus unless investment in economies such as the UK is constrained by a lack of savings, ever-rising inequality of incomes is likely to slow the growth of consumption in the long term, and since consumption is necessary to maintain business profits which both fund and stimulate investment in new capacity and employment, the growth of productivity and national income will be constrained by these developments.

However, while these trends in distribution which the current growth process is creating are clear, it is not so easy to decide how government policy can influence a change in direction. Directly raising wages at the bottom of the income scale by paying many more people the ‘living wage’, which is higher than the minimum wage, may reduce business profits, and hence investment and productivity growth in the medium and longer run. Perhaps changes to corporate governance which change the distribution of rewards in companies so that those lower down the scale share more in the improvements in productivity would help. After all, improvements in business performance are very often down to more than simply the efforts of those at the top. The boost to moral of those throughout the company could be a welcome effect of higher real wages. The theory of ‘efficiency wages’ suggests that this, alongside reduced absenteeism and worker turnover, are among the benefits accruing to various kinds of firms that pay their workers higher wages. But can one legislate for the living wage and other similar schemes? The government could offer tax breaks to firms that do pay the living wage, which would reduce the costs to firms, and also the welfare cost to the government in terms of tax credits, which are an in-work benefit which tops up the wages of the lowest paid. This could be one way forward.

The weakness of trade unions in the UK is one explanation for rising inequality driven by poor wage growth for the lowest-paid. If trade unions had more influence over pay and working conditions across the economy, while making sure that they are an effective social partner participating in the life of business, rather than a militant force determined to overthrow capitalism, the benefits to society could be significant, with the potential to stem the rise in inequality.

Since the Great Recession and the advent of quantitative easing (QE), booming asset markets have certainly contributed to a further rise in inequality, as returns for shareholders and those owning financial assets, as well as CEOs paid bonuses in stock, have soared. High profits in the UK and US may justify high stock market valuations, but the recovery remains lacklustre and may even be running out of steam as I write. As the economy returns to more normal times in the longer term, asset market valuations should come to reflect more the overall performance of these economies. The runaway incomes of those at the top should moderate if QE does come to an end, and also if global economic growth slows again and financial markets react accordingly. I could be wrong.

The need remains to boost the incomes of the poorest, while reigning in exploding incomes at the top. I have suggested a few ways in which this might happen or be promoted. But these issues remain difficult, and even the mild policies suggested here have not yet been put on the table by our political leaders.

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