07 July 2011

Gains From Economic Growth No Longer Shared. Why?

The U.S. economy, and European economies as well, have seen a massive increase in the extent to which the gains from economic growth are concentrated in a few, rather than shared widely by all in the economy.  This is mitigated in Europe, and to a much lesser extent in the United States, by a combination of tax policy and social welfare benefit systems.  But, the fact that the new trend has endured for a generation across dozens of countries suggests that it is not simply a matter of policies of particular administrations. 

The folks behind the poster at the top of this post probably have roots in the union movement, and more widely shared gains from growth were found in an era when unions were rather strong.  But, there is room to question the cause and effect relationship in that era.  Were unions strong because workers were in a good bargaining position, or were workers in a good bargaining position because they were unionized?  There is good reason to thikn that the later was true, at least to some extent.

One interpretation is that the technological foundations of our economy have made work traditionally done by less skilled workers more efficient and hence reduced demand for these workers.  For example, e-filing of legal pleadings has gutted the demand for copy room workers and couriers for law firms and reduced postal service volume.  Any one of these changes individually may be insignificant, but one change after the other for decades could have this kind of effect.  Meanwhile, more skilled jobs that are not succeptible to automation have not been eliminated but benefit from the greater productivity that technology has imparted to less skilled workers.  More productive low skilled workers have not been able to reap the full value of their labor in this scenario because the number of people who can do the work greatly outnumbers the number of people needed to do the work.  This hypothesis is behind the characterization of the past few decades as an "information economy" or as an economy where gains are concentrated among "knowledge workers" or a "creative class."

A close variant of this theory suggests that much of the post-war boom was a matter of retooling a wartime economy to meet long unmet domestic demand and shortfalls in the productive capacity of the rest of the war ravaged world, so that not much innovation was required to see record growth at first, but that this situation was exceptional and vanished as routes to greater productivity had to be invented rather than simply being restored or imitated.

Another, somewhat similar analysis would suggest that capital has become a more important factor, relative to labor, in producing economic value.  Physical and monetary capital is much more unequally distributed than human capital, and hence those who have it have benefited greatly, while those who do not have not shared in the wealth.  This fits with the fact that the end of the 1979-2008 time period identified is one where the financial sector had huge profits and much higher compensation levels relative to the "real economy."  But, it also challenges that assumption that efficient markets allocate capital through lending and equity investment transaction to people whose ability to put those assets to work is greatest; an analysis that would seem to mitigate inherited wealth biases.

Of course, it certainly isn't impossible that elite levels of knowledge and skill and great amounts of capital are both necessary for growth and hence share in it, while the relative economic importance of those who are not exceptionally smart or skilled or rich has declined.  Thus, we might have a bifurcated ruling class split between the capable and the wealthy, that leaves out everyone else.

These theories, because they are rooted in economic fundamentals, have the unfortunate tendency to be rather fatalist.  Without further elaboration about what exactly the economy needs in terms of skill sets and how we can broaden the base of people who have those skills, it suggests that there are not any good short to medium term policy fixes to these inequalities in initial market allocations of wealth and that even long term policy fixes rely on assumptions about returns to education and training and other economic policy fixes that are at best unproven and may not work.  If economic value has more to do with IQ and personality than with the value added by education which serves as much as a sorting device as an activity that makes someone more useful economically, public policy may have little capacity to redress gaps in human capital value between the bright and the less bright except through redistributive policies.  Policy may be able to have more impact on the availability of capital, but Americans have historically been skeptical, frequently with good reason, of the returns that result from investment decisions made by government investments in the private sector relative to results produced by the private financial markets.  Government investors tend to be more forgiving of failure than the private sector to a fault.

A third interpretation is rooted in terms of competition both with foreign firms and domestic immigrants.  In this theory, foreign firms in less developed economies have lower labor costs and less costly regulations and taxes, giving them comparative advantage in markets where it is practical for work to be offshored and their less skilled workforces to compete with workers in the U.S., for example, in labor intensive manufacturing enterprises.  Similarly, immigrants to the U.S. from less developed countries, many undocumented, may be willing to work for lower wages on less favorable terms because they are still favorable relative to the labor markets in their homelands, and this competition drives down the market price for all workers, native and immigrant, who compete in the same markets.

A fourth interpretation sees union busting facilitated by weaker labor laws, and pro-big business economic policies as important in this trend.

Both these theories argue that economic policices have promoted cheap labor.  These theories are intuitively attractive, not least of which because their roots in government policy rather than economic fundamentals suggest straight forward solutions to our woes: restrict free trade, limit immigration, and strengthen protections for unions.

But, I am not very comfortable that the cheap labor theories are correct.  Growth in pre-tax, pre-social welfare benefit incomes have not been much more equal in heavily unionized France and Germany than they are in the United States which is much less labor friendly.  Countries like Germany and Japan have continued to have heavily manufacturing oriented economies despite compensation levels of manufacturing workers that far exceed their foreign competitors without having profoundly different international trade regimes than those of the United States.  Econometric studies of the impact of immigration on the wages earned by native born workers have shown the effects to be surprisingly modest and limited to fairly narrow subsets of the workforce.  Economic immigration has been drive to a great extent by the existence of opportunities that native born workers are not filling well for whatever reason.

Economists widely share the view that freer trade in goods and services tends to increase economic output, suggesting that restrictions on free trade and strict immigration laws may do more harm than good.  Unions clearly have some impact on the distribution of profits from enterprises, but it isn't obvious that they have much of an impact for better or for worse on overall economic growth rates.

Japan seemed to be following more of a shared growth model than its competitors, but has been so hard hit by deep recessions that there hasn't been much growth to share in recent decades, so it is hard to confirm that hypothesis.  But, this too could be a product of an economy that, at first, was thriving on imitation rather than invention of more productive technologies and economic institutions, much like the U.S. in the post-war, post-Great Depression era.

Whatever the cause of rising inequality in incomes, there is also the question of what to do about it.  We could follow the European model of redistributing income to make up for the underlying economic trends, or could continue on our current track of treating the market allocation of wealth as presumptively legitimate.  Neither approach seems to be particularly favored empirically in determining the productivity or economic output of a society.  The wealth of nations is indifferent to even significant redistribution of wealth if done well and gradually.

Our future may be that of Japan, a "great stagnation" in which economic growth declines dramatically as all of the low hanging fruit of ideas that could improve productivity are picked, and innovations become more scarce.  The seemingly inevitable end of a global economy based on "cheap oil" is also not very encouraging.  We could move from a regime of unequally shared growth to one in which there is no growth to share.

Is it any wonder that economics is called "the dismal science?"

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