Wages, profits, growth and political ideologies

With the UK election only days away, it is important to know what one is voting for. Even if some of the parties’ manifesto pledges end up being bargained away in the necessity of them forming a governing coalition with a majority in parliament, one hopes that at least a few promises will be kept. Labour and the Conservatives are more or less neck and neck in the poles, and there is a clear divide between them in terms of philosophy and policy. The Labour leader, Ed Miliband, has claimed that the evidence shows that a nation does better when its working people, including the poorest, do relatively better than they are now. In other words, reducing inequality will benefit us all when it produces a stronger economy. He contrasts this with his characterisation of the Conservative philosophy: that only the rich and powerful do better while the poorest and most vulnerable are penalised. This approach, says Miliband, has failed, since living standards for the majority during the last five years have stagnated. Admittedly, the Conservatives do have some policies which aim to help most people to improve their lives: an improved education system and reforms to welfare which reward work are two examples. But it is clear that the Labour party do believe in more state intervention to reduce inequality, which includes a higher minimum wage, more progressive taxation, and reducing examples of labour market exploitation such as zero hours contracts. They also favour greater government spending on infrastructure funded by borrowing, leaving them only needing to balance the current budget. And why not? While comparing the operation of government and company finances can be inappropriate, plenty of companies borrow to fund investment when interest rates are low and the returns are thought to be high, and the next government will be in the same position.

The contesting policy packages and ideologies of Labour and the Conservatives offer voters a starker divide than for many years. So which is right for the country? As with many political issues, it depends on where you stand. Progressives and conservatives often seem to speak a different language such that the same outcomes of policy can be deemed to have either failed or succeeded depending on one’s own beliefs and values. The right tend not to think of rising inequality as a problem, as long as everyone is doing better. The left favour more social justice in the form of greater equality and an enlarged role for the state in dealing with it. The right may see such intervention as an assault on individual freedom, while the left have no problem with it and might suggest that the state, through its provision of a wide range of public goods including social justice, is enabling and empowering citizens.

The two ideologies described above, those of reducing inequality to improve economic performance, and of neglecting inequality and tending to favour the most powerful, can be boiled down to a long-standing debate on economics, at least in heterodox or non-mainstream circles: the question of whether growth is wage-led or profit-led.

The theory of wage-led growth holds that rising real wages for the economy as a whole will boost consumption spending and thus aggregate demand, which in turn will stimulate investment spending and productivity growth, leading to the possibility of further wage growth. A virtuous circle of rising incomes and employment will be created. Assuming that the poorest workers will spend a larger proportion of their incomes than the richest, measures that reduce wage inequality should boost consumption and, in this theory, growth. Such measures could include higher minimum wages, stronger bargaining rights for trade unions so that wage growth keeps up with productivity and redistribution through the tax system in favour of the poorest earners. This wage-led growth is often advocated by those on the left, especially trade union leaders, and was also put forward by the economist John Maynard Keynes as a potential cure for unemployment. He suggested that wage cuts to boost employment during a recession would tend to be ineffective for the economy as a whole, even if they seemed rational for an individual employer. Widespread falls in wages would lower consumption and thus aggregate demand and growth, and could even aggravate unemployment. An economic regime in which growth is wage-led has been called ‘stagnationist’, and is often favoured by Keynesians, Post-Keynesians and other underconsumptionists the latter including some Marxists.

By contrast, if growth is profit-led, then falls in the share of wages will boost firms’ profits, which will be used to fund increased investment. This will raise output and productivity and from there wages and consumption, even if the latter two categories initially fall. Measures to raise the share of profit in the economy will therefore tend to boost growth, rather than undermine it, as in the wage-led case above. Such measures might include tax cuts for business or more general income tax cuts, weakening trade union bargaining rights and reducing minimum wages as well as deregulation to lower the cost of doing business. As well as such policies being favoured by the political right, they could also represent the inevitable injustices of capitalism as a system driven by the search for profit, as described by some Marxists. The latter group emphasises Marx’s theory of the falling rate of profit and its key role in provoking economic crises (recessions) or growth stagnation, and claim that only right-wing policies, alongside capital scrapping, unemployment and other forms of corporate restructuring, highly regrettable though these are, are the only way for growth under capitalism to be renewed. Of course most of these Marxists don’t like capitalism and would rather it were replaced by socialism. But in terms of policy recommendations for encouraging economic recovery, they form an unusual affinity with the political right. A profit-led economic regime has been described as ‘exhilarationist’.

Thus whether economic growth in a particular country is wage-led or profit-leg matters enormously for policy. In the UK, Labour and their supporters would have us believe that the economy is wage-led, and reducing inequality will improve performance so that we all benefit. The Conservatives, by contrast, would argue that sufficient profits are vital to sustained growth and that we will instead all benefit from a package of policies that favours the share of profits rather than wages.

Empirical studies to determine whether economies are stagnationist or exhilarationist are legion. As quoted by economist Marc Lavoie, the evidence comes down on the side of the stagnationists for many countries. However when the effects of foreign trade performance are included, the results can alter. For an individual country, particularly one with a small economy very open to trade, wage cuts can allow the prices of exports to fall alongside some rise in profits, boosting demand from abroad. However, Lavoie concludes that for the world as a whole, which is clearly a closed economy (not open to trade with other planets!), growth will tend to be wage-led. While cutting wages can boost trade for an individual economy, if all countries attempt to do the same, consumption spending for the world will fall, leading to a fall in global investment and growth.

The determination of whether an economy is wage or profit-led is more complex than the stylized and simplified account given above. There is clearly a limit to both regimes. If wages rise without limit and squeeze profits so that sufficient investment to generate improved productivity and continued growth in the longer term becomes impossible, then clearly policies to restrain or reduce wages and stimulate profits will be vital. If wages fall too low, either domestic stagnation from inadequate demand growth will result, or the stagnation will be exported through an effective devaluation as exports become much more competitive. But as considered already, this is not possible for the world economy as a while. Germany and China are good examples of countries in which household incomes have grown much slower than overall output in the last decade, leading to rising saving and large trade surpluses (an excess of exports over imports), and contributing to equivalent trade deficits and concomitant problems abroad.

The question of whether income inequality needs to rise or fall to improve growth performance has been dealt with from the different point of view of the effect on overall saving and investment in a previous post. What is undeniable is that inequality has risen in many rich countries in recent decades, even in the heartland of social democracy, Scandinavia. It might be desirable to put in place policies which reduce it, even if the effect on growth is neutral. If the effect is positive, then social democratic policies are hard to argue against, at least from an economic point of view. If it is negative, then we need to consider if some growth is worth sacrificing from a left perspective (greens might be happy at this outcome), and if we are on the political right, then we might abandon the aim, and be content with hoping that a rising but more unequal tide will lift most of the boats. These are important questions in economics and politics, and even with a rigorous empirical analysis, value judgements, beliefs and ideology will enter into which set of policies we favour.

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One thought on “Wages, profits, growth and political ideologies

  1. Pingback: Capital and labour: conflict or cooperation? | The Political Economy of Development

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