Global labour supply and inequality

Sometimes overlooked in analyses of the rise in inequality in many rich country economies since the 1970s is the role of global labour supply.

Levels of income inequality across the advanced countries, particularly in the Anglo-Saxon nations such as the US and UK, have been on an upward trend since the abandonment of the Keynesian-social democratic consensus on economic policy in the 1970s. Cuts to the top rates of income tax, deregulation of labour markets, the decline of trade union influence on wages, higher rates of unemployment, increasing ‘financialization‘ and the forces of globalization are cited as the reasons for this development. Pay for those at the very top of the distribution has risen rapidly since then, especially in the Anglo-Saxon economies but also across Europe, although in the latter case, to a lesser degree.

Richard Koo, in his latest book on balance sheet recessions and the response of various economies to the 2008 financial crisis, has put forward an interesting thesis on the rise in inequality in terms of the dramatic increase in global labour supply in recent decades. More specifically, the development of China and India, with their enormous populations and potential labour forces, as well as the transition to capitalism of economies in Eastern Europe since the 1990s, have hugely increased the supply of labour competing for jobs in low to moderately skilled work. As these economies, and particularly China and India, have grown from very low levels of income per capita, their capitalist business sectors have been absorbing huge supplies of surplus labour from rural areas in a classic case of the ‘Lewis model’.

The Lewis model of development, named after the economist Arthur Lewis, posits that in the early stages of development, while industrialization is going on, huge available supplies of labour working at a subsistence or low level of wages and productivity will maintain a downward pressure on wages in the developing capitalist business sector until much of that supply has been absorbed into the latter sector. Once this ‘excess’ supply has been absorbed, wages will tend to rise in the newly dominant capitalist sector as long as economic growth continues.

Koo suggests that in recent decades, Chinese and Indian business has been absorbing this surplus labour which has kept wages in general from rising in line with GDP. He maintains that China has probably now passed the ‘turning point’ of the Lewis model with the result that wages are rising more quickly for the majority of the labour force. But while surplus labour was being absorbed, the downward pressure on wages kept domestic prices and inflation at a low level, influencing global inflation and labour markets in advanced countries trading with these poorer nations. For rich country workers at the lower and middle income segments of the labour force, business sectors in which they would formerly find work have found themselves facing price competition from firms in Asia and elsewhere, forcing them to keep wages low, reduce employment or simply go bust. This has caused wage stagnation for lower and middle class earners, which may well have been encouraged by the aforementioned policies of labour market deregulation et al. But in the absence of the latter, which has enabled wages to fall for many workers, the alternative may simply have been unemployment.

In Koo’s application of the Lewis model, while countries are in the early stages of industrialization and emerging capitalist sectors are absorbing surplus labour at low wages, the capitalists themselves are able to make huge profits, which provide the funds for reinvestment and continued expansion. To the extent that part of these profits can be taken as an income, this must be one cause of the rapid rise in incomes at the top of the distribution.

This is not to neglect the role of government policies in promoting particular development paths. China has forged an industrial strategy enabling a huge share of national income to be allocated to investment, allowing per capita incomes  to ‘catch-up’ rapidly with richer countries. The share of consumption has fallen to a low level, to the detriment of ordinary households. I will not go into too much detail here, but the leadership has now recognised that the structure of the Chinese economy has to change in order for it to continue its successful development. This will at some point require a change in the institutions of governance of the country. For now, China is a more unequal society than the US, but if, as Koo says, it has passed the Lewis ‘turning point’, rising wages in such a large labour force may begin to reduce inequality and will also impact the rest of the world’s workers. In rich countries, there may be less of the downward pressure on wage and price inflation mentioned above, although other poorer economies, particularly India, which overall remains more economically backward than China, has a labour force employed at low wages which will continue to act as a counter tendency. A global Lewis ‘turning point’ has not been reached yet, but when it does pass, the forces making for rising inequality may well diminish.

Thus while the policies of rich country governments have certainly had an impact on income inequality, possibly more important were the forces emanating from developing countries and their integration with the global economy. As mentioned here, simply looking at isolated economies when analysing inequality ignores these larger forces which are key to a fuller understanding of the issue. The outcomes may be unpalatable for many, but governments need to respond to these developments rather than ignoring or working against them.


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