September 18, 2014 7:30 pm

Pay pressure

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Economists from across the political spectrum offer their ideas to jump-start wage growth

The middle class in rich countries is living in the age of the stagnant wage. While precise measurements are difficult and disputed, there is no doubt that incomes for ordinary families in the US, Japan and across Europe barely increased faster than prices in the decade before the financial crisis – and have fallen in many countries since.

The result is sending tremors through politics as a lack of progress breeds resentment, populism and, sometimes, extremism.

Increasingly, economists also fear the stagnation in advanced economy wages is holding back the global recovery. The OECD warned this week that although real wage cuts at a time of still rising productivity had limited job losses, “it is now holding back a stronger recovery in consumer spending”.

If recent trends persist, the wonderfully accurate 1930 prediction of John Maynard Keynes that rich societies could expect far less toil and greater leisure – with hindsight through longer retirement – was strictly time-limited.

The global trends are stark. Stefano Scarpetta, director for employment, labour and social affairs at the OECD, says “almost all advanced economies have seen labour’s share of gross domestic product fall over the past 20 years”. Prof John van Reenen, director of the Centre for Economic Performance at the London School of Economics, notes that average workers have been hit hardest.

“Over time non-manual jobs have found their tasks taken over by computers and robots. Think of bank clerks and ATM machines,” he says.

In Japan, it is the young who have been hurt worst as the traditional salaried jobs in big companies dwindled.

Masahiro Yamada, a sociology professor at Chuo University in Tokyo, says this means young people live longer with their parents, generating a “falling birth rate and an acceleration in ageing [that] cuts economic growth while increasing the ratio of unmarried people in a vicious circle”.

The incomes of rich-country middle classes have done worse than almost any other group globally over the 20 years before the crisis, according to Branko Milanovic of the Graduate Centre, City University of New York and the Luxembourg Income Study, creating a “major political problem”.

To suppose that restricting free exchange makes the poor or the median better off is magical thinking

- Dierdre McCloskey of the University of Illinois

But he adds that when viewed from a global perspective, this has in some ways been a “small price to pay for the massive growth in incomes of much poorer groups in Asia”.

Experts from many different political hues, contacted by the Financial Times, agree on the diagnosis. Solutions are more difficult and contested.

On the political left, top economists such as Nobel Prize-winning professor Joseph Stiglitz of Columbia University, call for an immediate fiscal stimulus to boost demand, more generous minimum wages to improve workers’ bargaining positions and tax incentives for labour-intensive investment.

The other side of the political spectrum also focuses on restoring growth. But Dierdre McCloskey of the University of Illinois sees opportunities for market-tested betterment hindered by regulations.

“To suppose that restricting free exchange makes the poor or the median better off is magical thinking,” she says.

Many economists of all political persuasions think education and retraining is essential. Prof Milanovic says the focus on education should not be just for the elite, or for the post-school period, but spread through working lives.

None of the economists and sociologists contacted by the FT thinks there is a silver bullet. Perhaps the most hopeful assessment came from Bart van Ark, chief economist of the Conference Board, who says some of the weakness in wages is likely to be temporary. “Because of potential labour shortages in many mature economies, wages are likely to start rising anyway,” he says, suggesting that countries focus training on areas likely to suffer skill shortages.

Wage stagnation has been well documented. There is a growing consensus that it is contributing to the weak recovery. During the past 40 years, average worker productivity in the US has roughly doubled, while real wages have stagnated.

There are no easy solutions. An increase in minimum wages would have a trickle-up effect: not only would those at the bottom benefit but so would those further up. The diminution of workers’ bargaining position – both because of weaker unions and asymmetric globalisation – has contributed significantly.

But right now, the single most important policy is to improve the macroeconomy, through a well-designed fiscal stimulus.

Economists chart

Not only is the effectiveness of monetary policy limited, but lowering the cost of capital also induces companies to use more capital-intensive technologies, contributing to a jobless recovery and further weakening workers’ bargaining position.

Instead, we should have an investment tax credit to encourage investment – but one designed to especially encourage more labour-intensive investments, particularly ones that require labour of only moderate skills.

As it is, companies have in effect been encouraged to replace unskilled checkout clerks with machines, contributing further to unemployment of unskilled labour and downward wage pressure.

In Japan, the economy has been stagnant for 20 years. The jobs and wages of middle-aged men are secure and protected but the outlook for new graduates and women is unstable. There is also preferential reallocation towards elderly people in social policy.

As a result, the salaries of young people and families with small children have not risen for a long time.

Economists chart

This has two effects. First, for young people with little chance of higher pay, one of the few choices to prevent a fall in living standards is to stay at home with their relatively affluent parents, and therefore postpone marriage. But the result is a falling birth rate and an acceleration in ageing. That cuts economic growth while increasing the ratio of unmarried people in a vicious circle.

A second effect is people escaping to virtual worlds of games, animation and costume play. Here, even the young and poor can feel as though they are a hero.

Financial resources should be generated by reviewing benefits towards the elderly while imposing heavier taxes on the wealthy elderly in particular. This should allow young people to preserve their living standards after marriage and during child-rearing. In a similar vein, the low ratio of women in the workplace should be increased, and unfair hiring practices for young people should be corrected. We need to restore hope to young people.

Slowly rising or stagnating living standards of ordinary people in the developed world are emerging as one of the key issues of globalisation. From a cosmopolitan perspective, stagnation of wages and incomes among people who are relatively well off may be a small price to pay for the massive growth in incomes of much poorer groups in Asia. Politically, though, it is a big problem.

There is no silver bullet solution. But focusing on better public education could improve the lives of ordinary people. There are at least three reasons for it.

Economists chart

Countries that had good mass education systems, such as the US, have been economically successful . More recent examples include South Korea, Japan and Singapore. Second, an OECD study has found that, for the first time, many children in rich countries have lower educational attainment than their parents.

Third, rich countries have a rising share of low educational performers. Western lower middle classes are losing out to the similarly placed Koreans because the latter are better educated. But they also lose out to the Thais, who have similar skill levels, because Thai workers are cheaper. Simply put, one part of the western middle class has a wage/skill ratio that makes them globally uncompetitive.

Even a casual observer would notice that Europe is in the process of creating, in its cities, an underclass reminiscent of the US in the 1960s. To avoid creating a permanent underclass there needs to be upward educational mobility. That should come about through improvement in the quality of public education and less emphasis on elitist institutions.

What we should not do is focus on inequality. It doesn’t matter, ethically speaking, if the heiress to the L’Oréal fortune has six yachts or none. True, she ought to be ashamed that she spends her wealth on baubles and not on good works. But her wealth is not what made people poor. Taking it will not much improve their condition.

Economists chart

What we should focus on is the absolute condition of the working class, how much food and clothing and healthcare and education the poor have. The real goods and services earned by the poor has risen since 1800 in the OECD countries by a factor of anywhere from 30 to 100 – 2,900 per cent to 9,900 per cent. And, contrary to what you might have heard, it continues to rise, if not at the heady rates of postwar recovery. Ordinary people in the already well-off countries such as Italy or UK have better heating in their flats, better medical care and better televisions than they had in 1975.

What ails the OECD are regulations piled on regulations, slowing market-tested betterment. What, then, is to be done? Let betterment proceed by stripping away the silliest of the regulations, many of them emanating from Brussels, and the rest from special interests, or plain monopoly. To suppose that restricting free exchange makes the poor or the median better off is magical thinking. Give up the minimum wage, the “protection” of jobs, the over-regulation of banking and the support for monopolies from taxis to surgeons. Yes, I know: hopeless politically. But so people said under all the ancient regimes.

To put wages back on to a sustainable growth path, the focus for policy makers should not be on how to deal with too few jobs, but with too few workers. This is a problem which will arise sooner than many may anticipate, mostly due to the significant slowdown in the growth of the working-age population in mature economies. The pace by which unemployment is declining varies hugely by country, but in Germany and Japan, for instance, the unemployment rate is already below its natural rate. In the US, that will happen next year. Other countries, such as France, Italy and Spain will follow at least three years later.

Economists chart

The focus should be on figuring out where labour shortages will be largest and emerging first. An index by The Conference Board on emerging labour market shortages by occupation shows they will not just affect highly skilled professionals (where immigration at least in part makes up for shortages), but also skilled labour middle-income occupations in the transport, construction, utility and mining industries (from which many older workers are retiring) and occupations at the lower end of the distribution such as health carers (for whom demand is up due to ageing).

Education needs to be broadly targeted to all skill levels where labour shortages are likely. Policy makers should also focus on easing labour market mobility and supporting productivity growth. Technology can help ease labour shortages through higher productivity, but there should also be investment in human capital, strategic workforce planning and new tools for human capital analytics. Governments can learn from what many large businesses are doing.

Everybody should have a basic income. It should be paid monthly, not as a lump- sum capital grant, to reduce weakness of will problems.

A basic income is affordable because it would substitute for many forms of transfer, including the ludicrous array of subsidies that go predominantly to upper-income groups and corporations. And it would cut administrative costs of existing social assistance schemes.

We should recognise that our individual wealth is due far more to the collective efforts of our forebears than anything we do. A basic income should be seen as a social dividend on their efforts. None of us knows whose forebears made the vital contributions to our current status.

Economists chart

It was evident from the 1980s that globalisation and technological innovations, coupled with labour market flexibility policies, were bound to generate a “precariat” – people experiencing declining and volatile real wages and labour insecurities. Social insurance and assistance schemes could not provide them with basic security. Many face horrendous poverty traps.

Only a basic income could provide them with basic security. Unless that happens, there is a danger that more and more will turn to the populist far right. Politically, a basic income is becoming essential. There are standard objections, notably that it would give something for nothing (as does all inheritance) and would reduce labour supply. But our theoretical and experimental research, including extensive pilot schemes in India and Africa, and work in Canada, show that people provided with basic income work more, not less, and work more productively and co-operatively.

Almost all advanced economies have seen labour’s share of gross domestic product fall over the past 20 years. But not all workers have suffered. People at the top of the wage distribution have increased their share by about 20 per cent while everyone else has lost out. We think that is largely because of rapid technological changes: some people have had the skills to harness advances in information and communication technology to their advantage, while people with more routine skills have seen their jobs replaced by software.

So what is to be done? Improve the skills of the workforce so they can beat the race against the machine. That is not just a job for schools. No education system will be able to give you the skills that will enable you to keep a good job for your whole career. You have to adapt and upgrade your skills continuously.

The best way to encourage life-long learning would be through public-private partnerships. Employers are best placed to know which skills are most required, but especially small and medium-sized companies, but they will need support or subsidies from governments to invest in on-the-job training for their workers.

Of course, it is not realistic to pretend everyone will be highly skilled in the future. And in our ageing societies, there will be demand for services such as long-term care that will not necessarily demand high skills. But we should still try to equip everyone with the best skills, and help them adapt these skills during their working life. We need to rethink our tax and benefit systems, too, to make sure that people at the top pay their fair share and those at the bottom of the wage distribution do not fall into poverty.

Tito Boeri, professor at Bocconi University in Milan

Southern European labour markets are a tale of haves and have-nots. For many of those in work, jobs are very secure, supported by legislation that makes it extremely difficult for companies to sack them.

All the turnover, the hiring and firing, is taking place for the have-nots: workers with temporary contracts. They are the first to lose their job as the economy enters a recession as laying them off costs employers virtually nothing.

The youth suffer most. In Spain, more than 50 per cent of young people are without jobs. When they find a job, they are offered minimal workers’ rights. No investment in training is made in these short-term jobs, which in Spain account for almost one-third of dependent employment. This prevents productivity and wages growing.

In Italy the increasing share of temporary, low-paid workers has also depressed both productivity and wages. Even before the eurozone crisis wages were not rising and productivity was already in decline which combined to reduce competitiveness.

The centralisation of pay deals has also limited rises for those in heavily protected jobs.

Italy should follow the lead set recently by Spain and reform labour markets. They did so by lowering barriers to entry and exit from open-ended contracts, and decentralising salary bargaining to encourage efficiency gains by linking more closely wages to productivity in each company.

There are many high-performing businesses that can afford to pay higher wages than those set by national wage agreements.

Professor John van Reenen, director, Centre for Economic Performance

Jobs in the middle of the occupational distribution have been squeezed in all the advanced countries. This is mainly due to technology replacing “routine” jobs but reinforced by offshoring.

Initially, technological trends replaced manual work on production lines but over time non-manual jobs have found their tasks taken over by computers and robots. These workers were not the least skilled (think of bank clerks and ATM machines) but more in the middle of the wage hierarchy.

By contrast, less skilled occupations such as hairdressers, gardeners and cleaners have enjoyed greater protection as their jobs are less routine and harder to automate. Industries that upgraded their IT stocks by the most had the biggest falls in the share of “middle educated” workers.

There is little that policy makers can do to alter these bigger technological trends, but there are ways to adapt. The surest protection against the uncertain demands of the future is a strong base of human capital today.

Essentially, those in the middle part of the skills ladder need to climb to a higher level. To achieve this, higher education needs to become easier to acquire, more flexible and easily available throughout people’s lives.

The development of massive open online courses and online learning is a good start to this process, but more needs to be done to make it easier to open new institutes of higher education and to improve access to the financing of part-time, modular courses throughout people’s lives.


Letters in response to this article:

The class divide reflects badly on American society / From Mr Marc McDonald

The FT still welcomes utopian views / From Mr Guy Wroble

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