Higher — not lower — wages could be the answer

5 April, 2017 at 17:21 | Posted in Economics | 1 Comment


The general view of most policymakers and analysts is that if firms, in aggregate, increase workers’ wages before there has been an increase in national productivity, the result will simply be a damaging burst of economy-wide inflation as too much money chases too few goods and services.

win-win-720x340This is the kind of description of the way the world works that one can find from economic authorities such as the Bank of England and the Office for Budget Responsibility …

But is this story entirely right? What if wage increases for workers did not always need to follow productivity growth, but could precede it, perhaps even cause it? What if the egg came before the chicken? …

Under the dominant economic story, the collapse of productivity growth is the fundamental reason wages are on the floor and to rectify the latter productivity needs first to be fixed. Attempts to bypass this are often criticised as counterproductive. In his summer 2015 Budget George Osborne mandated a chunky hike in the minimum wage. This drew the disapproval of many economists who argued that low wages for those at the bottom reflect their low personal productivity and that significantly increasing their wages by government diktat will merely increase unemployment …

If the chicken follows the egg, 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.

Ben Chu

Intimating that one could solve economic problems by impairing unemployment compensations and cutting wages, in these dire times, should really be taken more as a sign of how low the confidence in our economic system has sunk. Wage cuts and lower unemployment compensation levels – of course – don’t save neither competitiveness, nor jobs.

What is needed more than anything else in these times is stimulus and economic policies that increase effective demand.

On a societal level wage cuts only increase the risk of more people getting unemployed. To think that one can solve economic crisis in this way is a turning back to those faulty economic theories and policies that John Maynard Keynes conlusively showed to be wrong already in the 1930s. It was theories and policies that made millions of people all over the world unemployed.

It’s an atomistic fallacy to think that a policy of general wage cuts would strengthen the economy. On the contrary. The aggregate effects of wage cuts would, as shown by Keynes, be catastrophical. They would start a cumulative spiral of lower prices that would make the real debts of individuals and firms increase since the nominal debts wouldn’t be affected by the general price and wage decrease. In an economy that more and more has come to rest on increased debt and borrowing this would be the entrance-gate to a debt deflation crises with decreasing investments and higher unemployment. In short, it would make depression knock on the door.

The impending danger for today’s economies is that they won’t get consumption and investments going. Confidence and effective demand have to be reestablished. The problem of our economies is not on the supply side. Overwhelming evidence shows that the problem today is on the demand side. Demand is – to put it bluntly – simply not sufficient to keep the wheels of the economies turning. To suggest that the solution is lower wages and unemployment compensations is just to write out a prescription for even worse catastrophes.

wagesDistributional policies that are likely to increase the wage share and reduce wage dispersion include increasing or establishing minimum wages, strengthening social security systems, improving union legislation and increasing the reach of collective bargaining agreements. All of these policies go against orthodox economic wisdom and, under the perceived pressure to reduce public budget deficits, current economic policy seems to be moving in the opposite direction, with calls for government austerity policies, which are most likely to affect the middle class and the poor, and calls for structural reforms, which are a euphemism for more flexible labour markets and reduced wage rates. However, in times of crisis and a lack of effective demand, what economies need is more state involvement, not less. A successful policy package to economic recovery needs to have sustained wage growth as one of its core building blocks. Only when wages grow with productivity growth will consumption expenditures grow without rising debt levels.

Marc Lavoie & Engelbert Stockhammer


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  1. Unless you’re a mathematical economist: http://worthwhile.typepad.com/worthwhile_canadian_initi/2017/04/wages-and-innovation.html

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