What about the workers … and their share of income?

What about the workers … and their share of income?

10:33am EDT

By Alan Wheatley, Global Economics Correspondent

LONDON (Reuters)- Nothing lasts forever but a global trend that set in 30 years ago shows no sign of ending: a steep rise in the share of income that goes to profits and a corresponding decline in labor’s slice of the economic pie.

The imbalance, which is driven by technical change, the waning clout of unions and the rise of financial markets, raises issues that are primarily political.

At what point will public opinion decide that the pendulum has swung too far towards the owners of capital? Should taxes and transfers be tweaked to redistribute income more fairly?But the trend also feeds into an economic debate over the conventional assumption that modest wages are good for growth because they help productivity gains and hold down inflation.

Jeff Madrick with the New America Foundation in Washington argues that low wages are restraining recovery from the Great Recession and were a root cause of the financial crisis that triggered it.

That is because surplus countries such as China and Germany held down wages to promote exports, thereby eroding growth and wages in deficit economies such as the United States, where consumers racked up debt to sustain living standards.

The International Labor Organisation’s ‘Global Wage Report 2012/13′ says the effects of changes in the labor share on aggregate demand and incomes are ambiguous. But a presumption that wage moderation is always beneficial for economic activity would be misguided.

“The challenge is to strike a balance between wages and profits and between household consumption, investment and exports. The idea that you simply cut wages and growth will follow is a simplistic one,” said Patrick Belser, an economist with the Geneva-based U.N. body.

Indeed, while indebted countries on the rim of the euro zone need to put their house in order, officials are coming round to the view that deep cuts in real wages can be self-defeating.

“If in the name of competitiveness and internal devaluation you just compress wages constantly, you also kill demand and you can kill the recovery,” European Employment Commissioner Laszlo Andor told Reuters.

THE TREND IS NOT THE WORKER’S FRIEND

According to the ILO, labor’s share of national income in 16 developed countries dropped from about 75 percent on average in the 1970s to 65 percent just before the financial crisis.

The mirror image of the decline in workers’ compensation is an increased share for capital, or profit.

Labor productivity has increased more than twice as much as average wages since 1999, the ILO says, and the surplus is going to the owners of capital, notably via much higher dividends.

“This is an enormous upheaval in the distribution of income in the global economy, and it has happened in an almost continuous straight line over the entire period,” Gavyn Davies, former chief economist of Goldman Sachs, wrote in a blog.

What makes the shrinking labor share even more remarkable is that the trend is evident across industries and in rich and poor economies alike. The labor share of China’s GDP dwindled to less than 50 percent in 2008 from nearly 65 percent in 1992.

Globally, the labor share rebounded during the recession due to a slump in profits but the decline has since resumed.

“There are no signs that tell us that anything has changed,” said Andrea Bassanini with the Organisation for Economic Cooperation and Development in Paris.

The OECD attributes 80 percent of the shrinkage in the labor share to growth in productivity and capital deepening made possible by new information and communication technologies.

These have led to unprecedented advances in innovation and production processes that boost productivity. Workers are also being replaced by machines, especially in routine jobs.

BLAME THE FINANCIERS

By contrast, the ILO estimates 46 percent of the fall in the labor share is due to global ‘financialization’ – the increased role played by the financial sector since the 1980s, accompanied by an emphasis on maximizing short-term shareholder returns.

Put differently, capitalists have been calling the shots since Ronald Reagan and Margaret Thatcher championed financial deregulation. Workers have been politically powerless to resist, their bargaining strength sapped by globalization.

One question is whether the post-crisis re-regulation of the financial sector augurs a broader reassessment of how societies distribute income – especially as an ever-greater proportion of falling labor income is going to a few very high earners.

Germany is debating whether to introduce a minimum wage, while Switzerland passed a referendum in March imposing strict controls on executive pay.

“Where has the economic growth gone over the last 15 years?” Belser with the ILO asked. “It’s gone into the remuneration of the top 1 percent of earners and the owners of capital. But you don’t see a big revolt against this distribution at the moment; it’s more frustration.”

That frustration might be reduced if firms were re-investing more of their profits, generating growth and jobs. But companies from the United States to Japan are sitting on huge cash piles.

A QUESTION OF FAIRNESS

Germany’s gross fixed investment spending has fallen steadily as a share of GDP for 20 years and is now one of the lowest among OECD countries, even though its wage share dropped by five percentage points between 1995 and 2010.

Adam Posen, head of the Peterson Institute for International Economics in Washington, said Germany should force companies to distribute reserves that are not invested or handed out as pay. Profit-sharing should be the norm.

“Growth in low-wage jobs and in corporate cash hoardings put pressure downwards on investment and consumption, reinforcing the dependence on exports,” Posen wrote.

Bassanini with the OECD said the issue was one of equity and, as such, a political choice for voters to make. But he cautioned against interfering with market forces to limit the decline in labor income as this might harm long-term growth.

Rather, governments should help workers with education and training to win the ‘race against the machine’ and temper inequality through bold use of taxes and transfers.

“At the end of the day I still believe it’s better to have a bigger pie and to make big slices out of it rather than have a small pie with equal slices,” Bassanini said.