Duncan’s Economic Blog

Wages & Investment – An Outline of an Economic Programme for Labour



The medium term challenge for Labour is to design an economic policy that generates sustainable economic growth, which is distinct from that of the Coalition and which is not dependent on public spending.

Policies designed to increase the wage share of GDP and increase the level of investment in the real economy fit with our emphasis on jobs and growth and dovetails neatly with a political focus on the ‘squeezed middle’. 

Such policies represent a post-New Labour, Social Democratic solution to the economic crisis which is not a simple return to Old Labour calls for higher state spending.

The Wage Share and Coalition’s Export Led Growth Model

The share of GDP going to wages, as opposed to profits, has been in long-term decline since the mid 1970s.

One consequence of a declining wage share has been the stagnation of real wages and hence living standards in the Anglo-Saxon world (US median real wages have stagnated since the late 1970s, UK real wages this year will be at 2005 levels whilst productivy gains outstripped wage gains from the late 1980s onwards). Another consquence has been the growth in debt fueled consumption as workers are forced into borrowing to meet rising aspirations.[1]

The coalition’s export-led growth model is premised on a further squeeze in living standards. The OBR’s November forecasts show the wage share of GDP declining through out 2011 and remaining at a low level until 2016.

Given that a second large depreciation of sterling seems unlikely in an era of more managed exchange rates (‘currency wars’) and given that UK Trade & Investment is already rated as the best export-promotion agency in the developed world, it is hard to see any driver for net exports other than increased competitiveness – competitiveness that will bought at the cost of higher unemployment and lower real wages[2].

Reversing the trend of a falling wage share, according a recent IMF paper[3], would make future financial crises less likely and help the banking sector recover from the latest crisis:

“For long-run sustainability a permanent flow adjustment, giving workers the means to repay their obligations over time, is therefore much more successful than a stock adjustment, unless the latter is extremely large… But without the prospect of a recovery in the incomes of poor and middle income households over a reasonable time horizon, the inevitable result is that loans keep growing, and therefore so does leverage and the probability of a major crisis that, in the real world, typically also has severe implications for the real economy.”

It would also provide an important boost to domestic demand and allow a recovery based on growth in the home market rather than hoping for external demand.[4]


A related issue is the question of the low level of investment in the UK economy, despite the rising profit share of GDP since the mid 1970s, much of this profit has not been transformed into investment.

The chart below shows investment as a % of GDP across the G7 since 1980.

The low level of investment is a contributing factor in the falling wage share of GDP.[5]


All things being equal a higher level of investment means higher wages and higher growth.

One long term problem for British industry[6] is that historically the banks have preferred not to lend to industry and instead concentrated on the more profitable business of lending to finance property and asset speculation.

For decades in Britain the safest bet for a bank manager to make, and the easiest way to “fail conventionally” as Keynes might have put it, has been to lend against property, either commercial or residential. Between December 1997 and December 2007, the pre-recession decade, UK banks advanced £1.3 trillion to UK residents as loans. Of this lending, 46 per cent went to financial companies, another 12 per cent to commercial real estate companies, and 23 per cent to mortgages for households. Very little found its way into the productive economy.

The abnormal returns on UK property, coupled with the British public’s belief in the attractiveness of “bricks and mortar” as an investment opportunity, have helped to create an environment in which the savings of the British public are channeled not into future productive capacity but into inflating property prices.

Policies designed to channel savings into more productive uses (uses that also generate jobs) would help lessen the UK’s dependence on the City and financial services without attacking the city itself. (Which will always be important, not least for its positive balance of payment effect).

Policies to increase the wage share/investment levels

Practical policies would include:

  • Support for a living wage in the public sector and in public procurement
  • Policies designed to (as the IMF put it) “increase the bargaining power of labour”
  • An increase in housing supply to help alleviate the problem of excessive returns from residential investment
  • A State Owned Investment Bank/Green Investment Bank with the power to raise money on the bond markets and to lend to finance long term investment
  • Higher capital allowances
  • Active regional policy with much stronger RDAs

The Political Narrative

Such policies would allow a narrative to be contructed around the twin issues of living standards and the squeezed middle and the idea of supporting British businesses to grow and invest. It would doubly reinforce Labour’s jobs (and decent jobs at that) and growth message. Furthermore it would mean a step away from the post-1997 Labour model of greater equality based on state redistribution, instead inequality would be tackled in the labour market.

It represents a total rejection of the Coalition’s economic approach (stagnant living standards and higher exports) in favour of a model of a more sustainable, and fairer, domestic led recovery.

[1] Fault Lines by former (right of centre) IMF chief economist R. Rajun and The Credit Crunch by (left wing) city economist G. Turner both agree on this point. As does recent work from the IMF.

[2] As an aside this is exactly the policy pursued by the Lloyd George coalition in the early 1920s (used by Policy Exchange as a case study in how to cut the deficit but achieve growth), the ‘Geddes Axe’ meant huge cuts in the public sector workforce which drove up unemployment, lowered real wages and led to an export boom. (Which was then snuffed by the return to Gold).

[3] Inequality, Leverage & the Crisis, IMF working paper, November 2010

[4] This is entirely consistent with much of the economic thinking of Labour, heavily influenced by Keynes, 1931-1945.  The debate around planning and nationalisation was a concurrent, but separate issue.

[5] As Chris Dillow has written in Investor’s Chronicle:

Let’s start from the basic national accounts identity. This says thatGDPis the sum of consumer spending (C), investment (I), government spending (G) and net trade (X – M). ButGDPis also equal to the sum of wages (W), profits (P) and taxes (T). This gives us:

C + I + G + ( X – M) = W + P + T.

Some trivial rearranging gives us:

W = C + (I – P) + (G – T) + (X – M)

This tells us why wages have been squeezed recently. In recent years – before the crisis as well as after – firms invested less than they made in profits. I – P was negative. This tended to depress wages, by creating unemployment. And after the crisis, consumer spending fell partly because easy credit was no longer available. That too created unemployment. These factors, though, were mitigated by government borrowing, G – T (personally, I think it’s just silly to believe that public spending in 2008-10 had any serious crowding out effect.) It was the rise in the latter that raised the share of wages inGDPin 2009.

[6] Debate on this predates the First World War and has a major source of discussion for Keynes at the 1931 Macmillan Committee hearings.


13 Responses

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  1. Tim Worstall said, on April 26, 2011 at 11:18 am

    “One consequence of a declining wage share has been the stagnation of real wages and hence living standards in the Anglo-Saxon world (US median real wages have stagnated since the late 1970s, UK real wages this year will be at 2005 levels whilst productivy gains outstripped wage gains from the late 1980s onwards). ”

    Mixing and matching a bit aren’t you? That productivity gains have outstripped wage gains explains the change in the labour share of GDP, sure. But the implication you’ve got there, that thus real wages have stagnated, isn’t true. For they haven’t.

    Indeed, we can read the evidence the other way around. The 70s very low share of returns to capital were what caused the lack of investment in the UK economy by the provate sector (yes, I am old enough to remember all that malarkey about where the hell was the investment?). A greater share of GDP in capital returns is exactly what has increased productivity as it has stimulated more productive investment and this is what has meant that real wages have not stagnated…..even as theyr rise falls behind the rise in productivity.

    Oh, and as to US real wages, they haven’t stagnated. You’re being fooled by an artefact of the statistics. It’s household wage income which has, but we should adjust for the fall in household size, plus the ever larger portion of wage compensation which comes not as wages (largely, but not exclusively, health care).

    • duncanseconomicblog said, on April 26, 2011 at 11:27 am

      I don’t mean to mix and match. I merely mean that the fall in real wges of the last few years is a problem but that this isn’t just a recent thing. Although real wages have risen in the UK in the 1980s and 1990s the wage share declined which I (together with some IMF types) think is a problem.

      I think where we disagree (as ever) is that I believe that increasing the wage share of GDP can be accompanied by an increase in the investment share (falling corporate surplus). You think (I assume) that the only real determinant of capital investment is the returns available, I’m not so sure of that and think that you tend (when concentrating on supply side issues) to miss demand side problems.

      To be clear I think an increase in wages that isn’t accompanied by a rise in investment would be a potentially bad thing (macro economically).

      On the US issue, it’s a side point that we don’t especially need to re-debate here but the poijt is controversial.

      • Tim Worstall said, on April 26, 2011 at 11:59 am

        “Although real wages have risen in the UK in the 1980s and 1990s the wage share declined which I (together with some IMF types) think is a problem.”

        I agree that you and some IMF types think this is a problem. However, doing so rather requires one to believe that the very high levels of the 70s were somehow “correct” and that reductions from that correct level are a problem.

        Which, given the problems the UK economy had in the 70s (not least the screams for someone, anyone, to please invest something) is I think quite a hard assumption to have.

        • duncanseconomicblog said, on April 26, 2011 at 12:00 pm

          What about the levels of the 1950s/60s?

          • Tim Worstall said, on April 26, 2011 at 12:02 pm

            We’re round and about there right now. And yes, the 50s and 60s saw large productivity gains, we’re seeing large productivity gains now…..

            • duncanseconomicblog said, on April 26, 2011 at 12:10 pm

              If only we were…

              50s -60s the range was 58% to 61%. We’re below 55% and heading lower. 3-6% of GDP is a lot.

              • Tim Worstall said, on April 26, 2011 at 12:28 pm

                And perhaps 66% in the 70s was too high: my point I think.

                Heading off into nerdy geekdom I do wonder whether there’s not an artefact in those stats as well. I’m arguing by analogy and may well be wrong but bear with me.

                We know that there’s a huge mess over top 1% (and 5%) income stats and corporate income tax stats in the US. Because of the rise of the S Corporation. This doesn’t pay corporation tax (unlike a C Corporation) but is counted as the income of the shareholders.

                In essence, it’s an LLP rather than a Ltd.

                And I do wonder what the rise in the use of LLPs (as well as the rise of the service industry where they’re more likely) has had on such stats in the UK.

                • duncanseconomicblog said, on April 26, 2011 at 2:24 pm

                  I’m all for nerdy geekdom.

                  An interesting point and one i will look into.

                  (I’d also like to see the wage share if we subtract the top 1/5% of earners).

  2. Paolo Siciliani said, on April 26, 2011 at 7:16 pm

    On increasing labour bargaining power.

    It is widely accepted that the reduced role played by unions is one of the main causes of the decrease share of labour income as a share of GDP (alongside, technological progress, globalisation ect.). This is particularly so given the increasing reliance of Western economies on the tertiary sector, both for high-skilled and low-skilled services. It would be very difficult (and probably inefficient) to unionise these industries, as the workforce is very flexible, people change jobs, roles and careers more often than in manufacturing. By the same token, employee-ownership scheme such as coop might have limited application scope.

    Nevertheless, a solution is needed to rebalance the bargaining relationship where prospective employees negotiate their salary and benefits terms individually and with no information on what the prospective employer is paying to prospective peer colleagues. This info asymmetry generates market failures, as the (prospective) employee that knows little of the match surplus gets a lower salary, and this fundamental piece of knowledge is linked to job tenure, which is not necessarily linked to productivity – this aspect could at least partly explain the growing inequality between age cohorts even if with the same education background. In my view, this is what could explain a growing premium for managerial positions, due to exclusive access to business insights rather than actual contribution to the success of the business overall.

    In this respect, back in 1994 Paul Krugman noted that “[t]hat is certainly true is that the growth of inequality in the United States has a striking “fractal” quality: The pattern of widening gaps between education levels and professions is mirrored in the pattern of increased inequality of earnings within professions. Lawyers make much more in comparison with janitors than they did 15 years ago; but the best-paid lawyers also make much more in comparison with the average lawyer.” I believe that this fractal pattern of income inequality is very much at work nowadays.

    Another distortion is that those employees that “search on the job” (i.e., employed workers looking for outside vacancies) get a better pay compared to those that are loyal to their employer. Also it is counterintuitive that employers wouldn’t try to retain employees that get a poaching offer, and that they prefer instead to incur turnover costs and lose a valuable employee. The reason may be that employers do not want to give a signal to the rest of the workforce that they are ready to renegotiate salaries – that is, they prefer to face turnover in order to perpetuate the coordination failure among employees, where only a minority search on the job – again, this skill is not necessarily linked to productivity.

    To rectify this situation full transparency is needed on what employees are paid across the business organisation (privacy concerns should obviously be taken care of). In a nutshell, there is the need for increasing transparency in the labour market to the benefit of workers. This way, not only would employees be able to negotiate on a stronger basis, but also identify those prospective employers that offer better terms & conditions (transposing the advantages of working in a cooperative to corporations in general) – transparency will impede employers to price discriminate employees on the basis of their individual willingness to be paid, or skilfulness in job hunting.

    On the demand side of the labour market, this would allow employers to differentiate themselves according to their equality of remuneration policy that strongly reflects a corporate culture of collaboration vs. inequality and divisive and spurious performance measurements. This source of differentiation in the labour market will be also reflected in a differentiation in the product market to the extent that the attitude of the workforce is a major determinant of product quality (e.g. service/professional firms).

    Moreover, in consumer markets the powerful role that could be played by consumers (who by a large extent are also employees) must be acknowledged. This I believe is very much similar to Corporate Social Responsibility. (Something similar was successfully developed back in the ‘60s by Martin Luther King in Chicago to boycott those companies refusing to employ black people – it was called Operation Breadbasket.)

    How then to raise consumer awareness on this embedded feature of the product or service bought (fair employment terms) on a much wider scale? Something similar to the use of the word “Organic” could be considered, or similar to the brand “Fair Trade”. Intervention to rectify info asymmetry in the labour market would allow the credible and verifiable use of a similar mark or code of conduct in order to lever the power of consumer sovereignty.

    I don’t believe this solution would necessarily turn out to be inflationary, in that the point is that consumers (who for the majority happen to be employees) would favour companies that are relatively less profit oriented and decide to allocate a larger share to their labour force (i.e. a market-based mechanism to redress companies short-termism in a way that is compatible with modern market economies).

  3. Tim Worstall said, on April 26, 2011 at 7:45 pm

    That’s just lovely Paolo:

    “would favour companies that are relatively less profit oriented and decide to allocate a larger share to their labour force (i.e. a market-based mechanism to redress companies short-termism in a way that is compatible with modern market economies).”

    Except, you see, that paying more of the profits to the labour force rather than using a larger portion of the profits to finance reinvestment is the ultimate definition of “short-termism”.

    “Long-termism” means investing, not paying the cash out to current employees, you see?

    • Paolo Siciliani said, on April 27, 2011 at 6:21 am

      You miss the point you see, you fail to grasp the “endogeneity” that links wages to disposable income to demand and finally to investment – you should remind yourself of the original definition given by A. Smith of “animal spirits”, or maybe this other passage should be equally enlightening:

      “Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer. The maxim is so perfectly self evident, that it would be absurd to attempt to prove it” (Adam Smith, WN, 660).

      Lovely, isn’t it.

      • Paolo Siciliani said, on April 27, 2011 at 6:31 am

        And by the way, being favoured by consumers/employees in the market does not necessarily mean that profits overall would be lower – as the firm would overperform those competitors that remain profit oriented and are keen on minimising their labour COST.

  4. Simon Joyce said, on November 12, 2011 at 7:39 pm

    In the hope that someone is still reading this, what is the reason for that pronounced spike in the mid-1970s? It’s been a recent topic of discussion, in my world, and I found this site from a google search.


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