Let’s start viewing wages as a source of demand

The majority of the working people in the UK have still not recovered from the Great Recession. The inequality regarding the distribution of the costs of the crisis is just a continuation of three decades of rising inequality, which has been one of the root causes of the financial crisis. Real wages have increased slower than productivity for in the post-1980s in the UK; hence the share of wages in national income has fallen. In 2008, the share of wages in GDP in the UK was 8.8 percentage points lower than what it was in 1975.  This trend is not unique to Britain, and has taken place in the major economies in both the Global North and the South. In the UK, the fall in the wage share was further accompanied by dramatic hikes in managerial wages, which makes the fall in the wage share look more modest than it is in reality for the 99 per cent of the wage earners.

Mainstream economic policy tells us that low labour costs are the key to growth and job creation. It is claimed that with the rising international competition from low wage countries, there is no other alternative. However, the strong wage moderation of the last here decades in the UK and elsewhere has not generated a strong performance in terms of investment, growth, and employment. Mainstream economics cannot explain this fact, because it treats wages only as a cost item. In reality, wages are not just costs, but also a source of demand.

Our recent research shows the vicious cycle of global race to the bottom in wages and low growth.  We analysed the effects of a change in the share of wages on growth in the G20 countries. When the share of wages in national income decreases four things happen:  first, consumption decreases, since people earning wage income consume more as a proportion of their income compared to the richer people, who earn profit income. Second, although private investment increases due to higher profits, this increase is not enough to offset the negative effects on domestic consumption. Third, net exports (exports-imports) increase due to a fall in the unit labour costs, but in the majority of the countries, this increase is also not enough to offset the negative effect on domestic demand. Finally, in an environment of the global race to the bottom in the wage share, most of the positive effects on net exports are wiped out as labour costs fall simultaneously in all countries, and their international competitiveness relative to each other does not change much.

Thus, in the vast majority of the developed countries as well as some developing countries a rise in the profit share leads to lower growth; this is what we call a wage-led growth economy. In these economies, the fall in the wage share in the post-1980s has been detrimental to growth and employment. The UK is a typical example of a wage-led economy. Moreover, the effect of the global race to the bottom on overall world income is negative.

The UK or Europe or the global economy as a whole nevertheless grew in the last three decades until the Great Recession despite a falling wage share. However this was made possible by two equally risky growth models. Consumption, was driven by that rather than wage growth in the UK as well as the US, Spain, or Ireland. In a second group of countries such as Germany or Japan exports had to compensate for the decline in domestic demand due to the fall in labour’s share. As not all countries can run a trade surplus at the same time, the trade deficits in the UK or the US were the mirror images of the trade surplus in the export-led countries. The Great Recession proved that both are equally risky.

The dilemma of pay vs. jobs is not empirically validated for the UK or the European Union as a whole as well as the global economy at large. A recovery led by domestic demand and increase in the wage share would help to reverse a major factor behind the crisis in the UK and the world, i.e. increasing inequality. This requires policies to close the gap between wages and productivity increases, and address not only low pay or high executive pay but also the distribution of income between wages and profits.

Özlem Onaran is Professor of Workforce and Economic Development Policy at the University of Greenwich.