The return of the workers’ economy
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The writer is chief US economist at Morgan Stanley
A big economic trend since 2000 has been the sharp drop in labour’s share of corporate income in the US.
This unprecedented decline has marked a break in the fundamental relationship between real pay after inflation and productivity. While productivity growth continued, real wages flatlined for more than a decade, from 2000 to 2014, spawning a divergence never before seen in the recorded data.
The beneficiaries of the fall in the labour share have been corporations and their owners, with nearly a 50 per cent increase in profit margins relative to their 1990s level. But the tide is turning and investors need to take note.
Economists as far back as Keynes have commented on the stability of the labour share in historical data. This aligns with the theory that labour compensation should rise one-for-one with productivity gains. Otherwise competitive markets would lead to labour being bid away by a company willing to pay higher wages in order to capture the productivity surplus.
Academics have proposed a range of explanations for the shift in income away from labour in the US, including globalisation, technological change, market concentration and the rise of superstar firms, and diminished worker bargaining power.
It is the last of these theories that is most convincing, given that the US is the only developed economy to experience a sharp decline in the labour share of corporate income over this time period.
An acceleration in the decline of labour market institutions such as unionisation, together with long-term erosion in real minimum wages, weakened labour’s hand in negotiations with capital owners. But around 2015, well before the pandemic, things began to change.
The labour share bottomed in 2014-15, followed by a slow reversal, before experiencing a sharp jump higher during the pandemic. Policy support and the rapid recovery from the pandemic have accelerated the return to old norms.
For both fiscal and monetary policymakers, labour market strength has become an overarching policy goal. For example, provisions in the Coronavirus Aid, Relief, and Economic Security Act (also known as the “Cares Act”) are aimed at boosting labour force participation by alleviating the cost burden of childcare. Moves by the Biden administration to curtail market concentration and strengthen workers’ rights will also be supportive.
Up until August 2020, the US Federal Reserve’s mandate to achieve maximum employment had revolved around the unemployment rate. It has been redefined as a “broad-based and inclusive goal” designed to drive tightness in the labour market that reaches the most underserved segments of the working population.
A strong and inclusive labour market is likely to strengthen labour’s bargaining power. History may ultimately attribute upward wage pressure during the pandemic to the Great Renegotiation rather than the Great Resignation.
The Census Bureau projects that population growth will continue to fall through 2050, which should help keep labour markets tight. The rise of prime-age workers as a share of the overall workforce should also support the workers’ economy as companies are forced to align core values with those of their employees. These fundamental changes support the view that the labour share will continue to reverse its long structural decline.
Evidence of this structural shift is increasing. In April, Amazon workers in Staten Island, New York voted in favour of a union. Workers at Apple are expected to hold union votes this year. The number of unionised Starbucks stores has increased and the company has announced it is investing $1bn in its employees and stores, including pay raises.
A full reversal in the labour share of income would reduce pre-tax margins significantly, with outsized effects on smaller-sized businesses.
Larger firms tend to have more pricing power, and firms with less labour exposure and more international earnings could also sustain higher profit margins. Domestically focused and highly discretionary sectors such as hotels, retail, restaurants and leisure stand out as particularly vulnerable.
The outlook for a continued reversion in the labour share toward its historical level implies that wage pressures are not just a temporary phenomenon. Wage growth powered by the rapid recovery from the Covid-19 shock may ease as the economy and labour market loses some steam, but higher wages are here to stay.