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Wednesday, April 5, 2017

Stumblin and Mumblin: Wages and Productivity

Would higher wages boost economic growth? They might, if the marginal propensity to spend out of wages is higher than that out of profits. However, Ben Chu suggests a different mechanism – that higher wages might stimulate growth via the supply-side rather than demand-side:

Perhaps wage increases will prompt higher productivity in firms that employ low-wage labour. Perhaps, in order to protect their profit margins, managements will be spurred into increasing the efficiency of their operations. Perhaps they will invest in more capital equipment to enable their workforce to produce more per hour of their time. Think of a hand car wash installing automatic equipment but retaining the same amount of staff, retraining them to operate the new machinery, and doing more business. This would make minimum wage increases positive for productivity.

Those words "doing more business" are important. Higher wages alone might merely induce capital-labour substitution, leading to unemployment rather than higher output. Which is why Ben is right to say higher wages must be accompanied by fiscal stimulus.

In this, he's echoing Verdoorn's law. This says that faster GDP growth is usually accompanied by faster productivity growth.Verdoorn

I'd like to believe this. But I'm not sure I do. For one thing, whilst the Bank of England research Ben cites finds that higher wages can lead to higher productivity, this is the case for only a minority of industries. And for another, Verdoorn's law hasn't been so strong recently. My chart shows that whilst there was a massive correlation between GDP growth and productivity from the 50s to the 80s, it hasn't been so strong lately; productivity has been weak even relative to GDP.

This draws our attention to the possibility that there are several things that might throw sand into the wheels of the mechanism whereby higher wages might raise productivity, for example:

 - Uncertainty. If the car wash business is to invest in a new machine, it must be confident that the boost to demand will last. This requires something more than just looser policy – be it a looser inflation target, commitment to future easing or whatever.

 - Management quality. Do bosses have the skill to introduce new technology well? Bloom and Van Reenen have shown (pdf) that there's a "long tail of badly managed firms" – but it is in these where productivity is lowest.

 - The fear of future competition. I suspect that one reason why capital spending has been low is that firms fear that their investments will be undercut by future, cheaper ones by their rivals: it's the second mouse that gets the cheese. It's not clear that fiscal stimulus will allay these fears.

 - Credit constraints. Another reason for low investment is that firms don't trust banks to keep credit lines open in future. Again, fiscal policy doesn't address this.

 - Weak profits. The hand car wash is probably only just getting by, and so lacks the means and motive to buy fancy kit. The care home sector, for example, is already teetering: why should it respond to higher minimum wages by increasing capital spending?

Now, I don't say this to dismiss Ben's idea entirely. Given that the Phillips curve is, to say the least, ill-defined in the UK, the cost of experimenting with fiscal loosening is perhaps low. And even if actual productive capacity isn't terribly cyclical, estimates of it might be - and they are worth having even if we don't get a renaissance in productivity. Erring on the side of loose policy seems to me to be better than erring on the side of tight.

The issue here is much bigger than it might seem. The question is: is capitalism cooperative or conflictual? Are the interests of workers compatible with those of capitalists or not? It's this that divides social democrats from Marxists. Historically, the answer has been sometimes yes and sometimes no. I'm not sure which it is today, but I'd like to find out so I'd like to see Ben's suggestion tested.

John Case
Harpers Ferry, WV

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