It’s the labor share, stupid!
Japan is attempting to stoke a bit of inflation through its new monetary policy and, unsurprisingly, Paul Krugman is quite pleased. His trademarked solution for getting out of the current depression, after all, is right down these lines: real interest rates, despite being near zero, are still too high because the profitability of new investment spending is even less. The central bank, accordingly, should create inflation so as to lower the real interest rate and the way to do so is to “credibly promise to be irresponsible”. It’s the same policy at the Fed.
The premise that new investment won’t occur unless it’s more profitable than the going rate of interest is one of the few ideas of the original Keynes that Krugman has retained. While there’s some merit to this interest rate differential theory of investment (disregarding the risks of stoking higher inflation), it seems to almost completely miss what’s really going on today and where the focus needs to be.
The problem with mainstream economists is that they can’t go beyond tiny tweaks; if they did, after all, they wouldn’t be mainstream economists. To get real insight, we therefore need to move way beyond the mainstream; and where better to start than Michal Kalecki.
We know, through Kalecki, that in a private capitalist economy, profit is necessarily equal to the amount spent by the capitalists, either for luxury or investment. We also know that we live in a world of massive productivity in which oligopolistic corporations have tremendous power, both in setting prices and in forcing down the wage.
Kalecki, unlike Krugman and the mainstream, stresses the importance of the level of real wages in determining output and employment and we gain great understanding by following his logic. From his analysis, it becomes clearly self-evident that output and employment will expand faster with a higher real wage as every monetary unit spent on investment would have coupled with it the spending power of the higher wage. We note that total global profit is unaffected by the higher wage because the wage is both an expense and a source of income, netting to zero as far as profit.
Here is Kalecki’s simplified formula for total output:
Total Output = Investment / Share of Profit in Value Added
The formula is simple common sense – of course output, and therefore employment, will be determined by both the combination of investment spending and the amount of additional production brought on for worker consumption. But we find it gives us great insight into what’s truly needed to bring us toward full employment. Krugman focuses like a laser on investment, the numerator of this formula, but as we’ll see, the denominator is far more important. Let’s demonstrate.
According to the NBER, the labor share of non-farm business sector output in the United States was just 58% in 2010, its lowest since WW2. Declining worker shares of total income are a global phenomenon and, given the great inequality in wages themselves, the figure is even misleadingly overstated as far as the average worker is concerned. Nevertheless, let’s use this number, a 42% share to capital, and determine the effects on output given a 10% increase in investment versus a 10% increase in the worker share.
If we start at a base investment of 100, then the beginning output would be 238 (100/.42). If we increase investment 10%, then the new output assuming the same labor share would be 262, a 10% increase (110/.42). But if we keep investment at 100 and increase the labor share by 10%, what do we get? A whopping 31% increase in output! (100/.32.) And if we allow labor to capture yet another 10% of income bringing it to 78% of the total, output increases by an incredible 91%! Paraphrasing Bill Clinton, it’s the labor share stupid!
These are incredible numbers and they demonstrate the fundamental falsity and class interest involved in focusing only on investment. It’s even worse, though, as much of mainstream economics and global public policy actually do focus on wages, but, incredibly, they try to reduce them even further, claiming the need for ever greater “competitiveness”! What would happen to output if the labor share dropped another 10% from where it is today? Output / employment would drop 19%!
The global problem is clearly one of a grossly abused workforce and its extremity is one of the foundational aspects of neoliberalism. No proposal should be considered as serious unless it puts the labor share of output fully front and center.