MICHAEL KEATING. Inequality, wages and economic growth

Changes in inequality and in the relationship between wages and productivity help explain the poor economic performance of many advanced economies in this century. Interestingly the Governor of the Reserve Bank indicated that Australia might be facing the same risks of inadequate wage growth, although he felt that ‘Australia’s monetary policy framework is better placed to deal with this world than some others’.

 A few days ago, in a significant and widely reported speech the Governor of the Reserve Bank, Philip Lowe, drew attention to the problems that low wage growth might pose for monetary policy. In some ways, this was a first for a senior economic official in Australia. As Dr Lowe himself put it, ‘In years gone by, the more standard challenge was to keep wages in check’.

In most of the other advanced economies, however, a concern about rising inequality and low wage growth is not new. As is well known to anyone who cares to know, inequality has been rising in almost all the advanced OECD economies since the early 1980s. While part of this increased inequality reflects the huge pay rises that the top one percent of the workforce have awarded themselves, in most countries the increase in inequality mainly reflects a hollowing out in the number of middle-level jobs and widening pay gaps across the wage distribution.

For example, in the United States median hourly compensation (adjusted for inflation) grew by only 9 per cent between 1973 and 2014, while productivity grew by more than 72 per cent.  Furthermore, this increase in US wages was very uneven, and the majority of workers missed out on any wage increase in real terms. Indeed, Stiglitz found that in 2015 ‘the typical American man makes less than he did 45 years ago (after adjusting for inflation)’. Similarly, in Austria, Belgium, Finland, France, Germany, Ireland, Italy, the Netherlands and Switzerland, gaps of more than 100 per cent accumulated between the rate of increase in productivity and real wages over the decade and a half before the Global Financial Crisis (GFC).  Since the GFC real wages are still increasing more slowly than productivity in many advanced economies and have actually fallen in the Eurozone countries most impacted by austerity – Greece, Italy, Portugal and Spain – as they seek to regain competitiveness within the Eurozone.

In our forthcoming book, Fair Share: Competing Claims and Australia’s Economic Future, Stephen Bell and I argue that ‘macroeconomic policy finds it difficult to sustain reasonable rates of non-inflationary economic growth if wages do not rise with productivity’. This is essentially because in that case the incomes of the mass of the population are unlikely to keep pace with potential output, and consequently their consumption and aggregate demand risks falling short of the growth in potential output, resulting in excess capacity and unemployment. The alternative view of neo-classical economists is that the lower wages will increase the profit share sufficiently that investment will respond by enough to more than offset the impact of the decline in consumption on aggregate demand.  Recent experience, however, suggests that investment is unlikely to rise sufficiently to maintain economic growth in the face of a shortfall in consumption. Instead, when incomes don’t rise sufficiently, consumption can only be maintained by households going into debt. That is what happened in the United States in the run-up to the GFC, but the increase in debt was unsustainable and led to the GFC.

The response in the United States and many other countries to this shortfall in demand was first to reduce interest rates to zero or even less in real terms.  Then when there was no further scope to reduce interest rates they embarked on an unconventional policy of quantitative easing where central banks tried to expand the money supply in the hope that would encourage more lending for investment. Neither monetary response has worked at all well, and the quantitative easing presents some real dangers to the longer-term stability of the financial system. Many central bankers (including Dr Lowe) are even calling on fiscal policy to do more to stimulate demand.

Larry Summers, a former Secretary of the US Treasury and Harvard economist, has argued that the increase in inequality has caused greater saving, as the wealthy save more, and that the neutral interest rate that would balance investment intentions and saving is now so low that we are facing a continuing situation of ‘secular stagnation’. In my view, in the long term there are two possible ways out of this secular stagnation, where low wage growth is causing a shortfall in aggregate demand.  The first would be to increase aggregate demand through wage increases, including by better education and training so that more people could get the good jobs that are becoming available through technological change. The second, would be to do nothing, and wait for continuing economic stagnation to erode skills and the capital stock to the point where productivity stagnated and potential output growth fell sufficiently to match the low rate of increase in aggregate demand. In our book, Stephen Bell and I argue that ‘This is already the likely scenario in the United States where employment has been growing strongly, but aggregate demand and productivity have been increasing more slowly than in the past’.

But what does this all mean for Australia? Whether it is by good luck or good management – and I am inclined to believe the latter – the increase in inequality in Australia over the last thirty or more years has been less than in most of the other advanced economies. Equally or even more important for economic and employment growth has been the evolution of the relation between real wage growth and productivity. In Australia’s case, this relationship can be hard to interpret because of the impact of the quite large swings Australia experiences in its terms of trade, and their impact on Australia’s capacity to “afford” wage increases, as measured by the real national disposable income per capita. But if we take the long period of uninterrupted growth since the 1991 recession, we find that the increase in real wages, productivity and real net national disposable income per capita have all been almost the same.  More recently between 2002 and 2012, during the mining boom, real wage growth was faster than productivity, but less than the increase in real net national disposable income per capita. Following the peaking of the mining boom in 2012 these relationships were reversed with real net national disposable income actually falling between 2012 and 2016, and real wages then needed to increase by less than productivity, which it did.

My judgement is that equilibrium between productivity wages and real net national disposable income per capita has now been restored. However, that means that if real wages continue to increase by less than productivity then Australia may begin to face the sort of problems of inadequate demand experienced elsewhere.

The Reserve Bank’s judgement seems to be that wage growth will pick-up as the labour market recovers, but there is little evidence of this yet. Instead over the last twelve months there has been no real wage growth while productivity growth continues, albeit more slowly. If that combination of no wage growth and slowing productivity growth continued then we may find ourselves facing the sort of economic stagnation that the United States is experiencing with very low productivity and wage growth.

That would represent a huge cultural shock in Australia, as it has already in the United States, with major implications for future expectations and politics. And even if income inequality did not further decline under this scenario, it would almost certainly destroy equality of opportunity, unless there were vigorous offsetting government intervention.

Michael Keating was Secretary of the Departments of Employment and Industrial Relations, Finance, Prime Minister & Cabinet from 1983 to 1996. The ideas in this article are the main focus of a book by Stephen Bell and Michael Keating, Fair Share: Competing Claims and Australia’s Economic Future, to be published by Melbourne University Press, early next year.

 

 

 

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5 Responses to MICHAEL KEATING. Inequality, wages and economic growth

  1. Wayne Mc Millan says:

    Hi Michael,
    I am heartened that you have brought this serious problem of inequality to a wider audience within the public arena. Can I say that for myself and others who live at Mt Druitt, we have noticed poignantly the widening gap in income and wealth developing in Australia for over 20 years.
    I look forward to reading your new book “Fair Share: Competing Claims and Australia’s Economic Future” in 2018.
    Summers and even Lowe I notice have failed to understand that unless government intervenes in the economy by stimulating more jobs and investment, the economic conditions will worsen. Continuing federal government fiscal deficits are essential when there is a persistent economic downturn.
    Regards
    Wayne

  2. Thanks Mike,

    Very interesting contribution.

  3. Matt says:

    Hi,
    Interesting post.

    You state that “between 2002 and 2012, during the mining boom, real wage growth was faster than productivity.” I would be interested to know which wages measure, deflated with with price index, you used to arrive at this conclusion.

    I reached a different conclusion, see here: https://www.actu.org.au/media/297315/Shrinking%20Slice%20of%20the%20Pie%202013%20Final.pdf. The wages measure I used was compensation of employees plus the imputed labour portion of gross mixed income; the price index was the GDP deflator. I believe both are the appropriate choices if you’re comparing productivity growth and real (producer) wages.

    • Michael Keating says:

      Matt
      I used the all groups CPI as the deflator to measure real earnings. I believe this is appropriate because I am interested in the purchasing power of those real earnings, not their cost to the employer. When the terms of trade are improving then the GDP deflator will tend to rise faster than the CPI, as the GDP deflator includes fast rising export prices while the CPI includes the slower rising import prices.

  4. Michael Keating is a glutton for punishment. He kick-started the first and only public debate in Australia on neo-liberalism and now he has turned to productivity, the hoary chestnut beloved of economists. Michael’s justification for neo-liberalism can be summarised in one sentence. Making laissez-faire capitalism more laissez increases gross domestic product (GDP). If we accept this is true the best reply comes from Steve Bannon and Michael Anton, two members of the brains trust behind the election of President Donald Trump, and can be summarised in two words. So what?

    The problem with productivity is that productivity is not the problem. This insight came my way circa 1979 when I was in a light aircraft flying at low altitude over the central West Australian wheatbelt with a professional photographer who was taking pictures of an awesome machine called an air seeder. In my youth seeding was a season of cold nights perched on the seat of a tractor wearing warm clothes with a thermos flask of hot soup for company. The combine seeder behind the tractor was a development of Jethro Tull’s seed drill. We loaded the superphosphate and seed grain into bins on the machine by hand from bags weighing 180 pounds. Weary Dunlop recalled that he could lift two such bags, one in each hand, but a man working on his Dad’s farm could lift three — the third with his teeth.

    While the photographer and I watched, the air seeder, manufactured in Perth, cut out a paddock that would have taken me all day and most of the night driving the 1960s rig. One farmer in Western Australia driving a four-wheel drive tractor towing an air-seeder can blow enough seed and fertiliser into the ground in one day to grow enough wheat to grind enough flour to bake enough bread to feed Canberra for a month. Meanwhile teams of robots in the world’s motor vehicle factories can churn out enough cars to have every man, woman and child on planet earth driving around in circles in the local shopping centre car park 24 hours a day.

    If the maintenance of aggregate demand depends on the mass of the people purchasing masses of food, millions of motor cars, electronic gadgets and bits and pieces advertised every night on television then the mass of the people need an income and as Philip Lowe notes it has to be discretionary income, not tied to mortgage repayments. It may be, as Michael suggests. that even more people can be trained to sit in offices in front of computers and send emails to their workmates in the office next door after attending the team breakfast but there is a limit to the volume of horse manure even modern man can digest and it is likely we will have to adopt some form of social or living wage to keep the wheels of industry turning and to head off social upheaval like that seen in Russia 100 years ago. This change in economic policy will have to spring from a more radical, egalitarian change in social outlook propelled by what my anthropological mate Ian Tarrant calls human survival values and completely at odds with the neo-liberal philosophy that has dominated our political and economic thinking for a generation.

    As far as they go, the analysis here from Michael Keating and the points included from Lowe and Larry Summers are logical and true enough but Michael is missing the larger point. The general public never liked or accepted the four horsemen of the Apocalypse who have been riding over the commons for the last 30 years but they had little choice because the entire governing class was infatuated with the fraudulent ideology of neo-liberalism, the phony theories known as neo-classical economics and the associated international swindles of financialisation and globalisation.

    Now the voting public is so desperate to get out of this loop that they are electing anything on two legs, even such unlikely candidates as Trump and Macron, who have no idea what to do but whose electoral victories are symptomatic of this Gramscian moment when the old ideology — devoted to the welfare of markets — is dead and a new ideology — hopefully devoted to the welfare of people and communities — is yet to be born.

    Productivity is not the problem so what is the problem? It is the same fundamental concern that has occupied the minds of men and women since they first looked up from the Savannah to the stars and contemplated the meaning of life. It is the distribution of the surplus. It is the search for justice, fairness and peace.

    In her rather difficult book, Feminist Amnesia, my philosophical friend Jean Curthoys quotes the French mystic Simone Weil. “Respect is due to the individual as such and is not a matter of degree.” We need some new economics, or some old religion.

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