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.
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.
Reversing the trend of a falling wage share, according a recent IMF paper, 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.
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.
All things being equal a higher level of investment means higher wages and higher growth.
One long term problem for British industry 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.
 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.
 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).
 Inequality, Leverage & the Crisis, IMF working paper, November 2010
 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.
 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.
 Debate on this predates the First World War and has a major source of discussion for Keynes at the 1931 Macmillan Committee hearings.