What do the world's three largest economies have in common? The answer underscores one of the key tensions of globalisation unrelenting pressure on labour income. The corollary of that phenomenon is equally revealing everrising returns to the owners of capital. For a global economy in the midst of its strongest fouryear boom since the early 1970s, this tug-of-war between labour and capital is an increasingly serious source of disequilibrium. It has important economic, social, and political implications all of which could complicate the coming global rebalancing.
My recent trip to Japan was the clincher. As I found in Germany during a series of extensive visits last month, and as has been evident in the United States throughout the current upturn, Japanese labour income remains under extraordinary downward pressure. There is no way this is a coincidence. In all three economies, unemployment has been declining in recent years a 27% drop in the US jobless rate since mid-2003, a 21% decline in Japan since early 2003, and a 15% fall in the German unemployment rate since mid-2004.
Yet in none of the three economies has a cyclical tightening in labour markets resulted in a meaningful increase in real wages and/or the labour share of national income. By our calculations, fully 57 months into the current cyclical upturn, US private sector compensation is still tracking nearly $400 billion (in real terms) below the average trajectory of the past four business cycles. After a glimmer of revival in early 2005, stagnation is once again evident in Japanese real wages. Nor are there any signs of a meaningful upturn in German real wages; to the contrary, inflation-adjusted compensation per worker in the overall business sector has actually declined in four of the past five years.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Get 6 issues free
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
The case of Europe merits special comment. We harbor the illusion that European workers are different that sheltered by a deeply entrenched social contract, they enjoy great success in getting more than their fair share of the pie. That impression is no longer accurate. As Elga Bartsch points out in a fascinating new piece of research, after having spiked up dramatically in the aftermath of German reunification, pan-European real compensation per employee has been basically unchanged since 2001.
Nor does she see this changing as an increasingly tight European labour market now approaches its "speed limit." The structural forces are simply far too powerful namely, globalisation, a shift to part-time and temporary employment, and the diminished power of European labour unions. The coming wage round in Germany will undoubtedly test this view, but Elga does not look for a major breakout. Far from marching to its own beat, the European worker is in the same shape as those elsewhere in the industrial world suffering from the unrelenting pressures of relatively stagnant real wages.
At work are the increasingly powerful forces of globalisation namely, the combination of intensified cross-border competition and a wrenching global labour arbitrage that has given rise to an extraordinary productivity push in the high-wage industrial world. The good news is that the productivity payback is at hand. The United States has recorded a decade of 2.8% productivity growth doubling the sluggish 1.4% gains recorded from 1974 to 1995. Japanese productivity growth has averaged 2.1% over the past three years nearly double the 1.2% trend from 1995 to 2002. Even German productivity has been on the rise expanding at a 1.7% annual rate over the past five quarters more than double the anaemic 0.7% trend over the 1998 to 2004 period.
The bad news is that these breakthroughs on the productivity front have not resulted in any meaningful improvement in labour's share of the pie. Therein lies the puzzle: economics teaches us that real wages ultimately track productivity growth that workers are rewarded in accordance with their marginal product. Yet that has not been the case in the high-wage economies of the industrial world in recent years. By our estimates, the real compensation share of national income for the socalled "G-7 plus" (the US, Japan, the 12-country eurozone, the UK, and Canada) fell from 56% in 2001 to what appears to be a record low of 53.7% in 2006. (Note: Due to a lack of harmonised eurozone data prior to 1996, the compensation share cannot be extended before that period; however, based on BIS calculations, the slightly narrower construct of the wage share of G-10 national income is currently lower than at any point since 1975).
Of course, it is important to distinguish between the transitory results of the business cycle and the structural interplay between underlying trends in productivity and real wages. It may be that productivity strategies are dominated by cost cutting; with labour the largest slice of business production expenses, such tactics lead to constant pressure on the compensation share of national income. It may also be that the improvements in labour market conditions are so recent especially in Japan and Germany that the real wage lags simply haven't had time to kick in.
The US experience draws that latter hope into serious question. Fully ten years into a spectacular productivity revival, real wages remain nearly stagnant and the labour share of national income continues to move lower. If the flexible American worker can't do it, why should we presume that others in the industrial world would be any more fortunate?
This takes us to what could well be the biggest challenge in this era of globalisation the ability of the highwage developed world to convert productivity gains into increases in the labour share of national income. In a recent paper, Richard Freeman of Harvard, long one of the world's most prominent labour economists, underscores the very tough uphill battle that highwage workers in the rich countries face in this era of globalisation. By his calculation, the ascendancy of China, India, and the former Soviet Union has added about 1.5 billion new workers to the global economy essentially equaling the amount elsewhere in the world. With global trade and production increasingly shifting into the low-wage developing and transitional economies, what I have called the "global labour arbitrage" puts inexorable pressure on real wages in the high-wage industrial world.
Some would argue that the worst of the arbitrage is over as wage inflation now takes off in China and India. Don't count on it. Our estimates suggest that even after five years of double-digit wage inflation in China, hourly compensation for Chinese manufacturing workers remains at only 3% of levels prevailing in the major industrial economies.
While labour gets squeezed, the owners of capital have enjoyed far more flexibility in this climate. Facing extraordinary competitive pressures, corporations have redoubled their efforts on the productivity front. And, as noted above, those efforts have indeed borne fruit for over a decade in the US and more recently in Japan in Germany. The fruits of those efforts show up in the form of surging corporate profitability and increased share prices with commensurate gains accruing to those workers / households that are fortunate enough to hold shares.
America, with its growing incidence of share ownership, has led the change in that regard. But this has hardly been a panacea for most US workers. Federal Reserve survey data show that 63% of families in the upper decile of the wealth distribution owned stocks in 2004 nearly four times the average 19% ownership share in the remaining 90% of the wealth distribution; moreover, median equity holdings amounted to $110,000 per household in the same upper decile fully 13 times average holdings of $8,350 in the remainder of the wealth distribution.
Don't get me wrong this is not intended to be a replay of my ill-fated "worker backlash" call of the early 1990s, when I mistakenly believed that labour would exercise its power and demand a larger slice of the pie. Today, courtesy of a doubling of the world's work force and an increasingly potent global labour arbitrage, high-wage workers in the industrial world are all but powerless to act. But their elected representatives are not. Witness the recent surge of protectionist sentiment especially in the United States but also in Europe. Nor do I suspect this political backlash to globalisation will fade in the aftermath of the upcoming mid-term election in the United States especially, as seems likely, if the Democrats garner sizable gains in the Congress. Pressures on high-wage workers in the industrial world are likely to endure for years to come irrespective, or perhaps because of, the push for higher productivity growth. As a result, I suspect the angst of labour will remain high on the political agenda for the foreseeable future.
Contrary, to orthodox "win-win" theory, globalisation is a highly asymmetrical phenomenon. Initially, it creates far more producers than consumers. It also results in extraordinary imbalances between nations with current account deficits and surpluses. And it has led to a widening disparity of the returns between labour and capital. Does this mean that globalisation is inherently unsustainable? Probably not. But it does mean that the most destabilizing phase of this mega-trend could well be close at hand.
As seen through surging corporate profitability, the returns to capital have never been greater. Meanwhile the shares of labour income have never been lower. As day follows night, the pendulum will swing the other way and so will the balance between real wages and business profitability. It's just a question of when and under what circumstances.
By Stephen Roach, global economist at Morgan Stanley, as first published on Morgan Stanley's Global Economic Forum
8 of the best riverside properties for sale
Will “Liberation Day” strike again?
