The (Self-Chosen?) Limits of Analysis: The Falling Labor Share Chapter 3 in the IMF World Economic Outlook, April 2017
Questions of income distribution have gained increasing prominence since the publication of Thomas Piketty‘s „Capital in the 21st Century“ in 2014. Of course, analysis of income distribution has a long history in economic publications, but only the realization of the dangers to political stability and the rise of so-called „populist“ parties in the rich countries have put these issues more prominently on the research agendas.
In this vain has the IMF – which for decades has ignored this problem – begun to deal with this question and has included a special chapter in its most recent World Economic Outlook. So far so good. The analysis in this long (52 pages) chapter distinguished between Advanced Economies (AE) and Emerging and Developing Economies (EMDE) and states bluntly that labor shares in income have fallen significantly as a trend in both regions. While in AE the IMF shows shares falling from 55% in 1970 to 50.5% in 2014, data for EMDE show a fall from around 39% in 1991 to 37% in 2014, with a low of 35% in 2005. From the fact that in both regions the labor share has been falling, the IMF concludes that this constitutes a world-wide trend, deserving a general analysis (if differentiated by development stage).
The data are analyzed – in a highly competent way – as to the presumed influences of both technological change and „globalization“.The authors conclude that this trend is not significantly influenced by a shift from high-labor-share industries to lower-share-industries, but that it is determined by within-sector influences. They come to the conclusion that both technology and trade developments are able to explain a significant amount of this falling trend. In AE technological change, reflected in a steep decline in the price of investment goods is identified as the key driver, along with high exposure (by sector) to routine occupations. Global integration plays a smaller role (p.140). Integration plays mainly a role with respect to participation in global value chains.These result in major wage share losses for mid-level occupations.
For EMDE as a group, global integration plays a larger role than technology in explaining the falling labor share: the reason is less decreasing prices for investment goods and less routinization of operations. For many EMDE countries, this has increased labor income and employment.
This analysis is highly interesting – as far as it goes. The baffling omission is that this analysis looks only at the supply side of the economy. Not a single line is dedicated to the questions what a falling labor share trend means for the total economy, for growth and – especially – for effective demand. The macroeconomic consequences of significant shifts in the shares of the two major sources of income in an economy – labor income and capital income, aka profit – are ignored. According to this „Weltanschauung“ (world view), it is only the conditions of the supply side of the economy which determine growth and thus employment and income. We need to go back to the investigations of John Maynard Keynes and Michal Kaletsky, the „inventors „ of macroeconomics, to remind the IMF that „supply does not automatically create its demand“, but that the reverse causality holds.
This omission is the more surprising, since growth in the AE economies has been lagging: in many of the OECD countries, unemployment is excessively high, growth low – and the labor share in national income falling. While from a macro-accounting point of view it might be immaterial who earns what, be it workers or entrepreneurs, capital or labor, from an effective demand point of view it matters hugely, especially when as today, the higher share of capital is not reinvested in the real economy, but rather in real estate, shares and other assets. The present state of OECD economies is characterized by a lack of investment rates, private and especially public investment. If the income share of labor goes down, this means that wage income will not be able to absorb the whole national product and make up for the low appetite for productive investment. We incur the topical German situation of savings outpacing investment, leading to low growth.
The pity is that this viewpoint of the economy, i.e. let us only worry about productivity-enhancing structural reforms, let us ignore the conditions of demand, has captured the mainstream of economic thinking. While the OECD has recently begun to expand its (this) narrow view, the IMF as the other, and more important, leading global governance institution, is still locked into its market-radical, supply-side-oriented thinking. And, unfortunately, the European Union and most of its member states, are still following this disastrous mainstream.
Another point worth mentioning is the omission of power relations. It is no surprise that the emasculation of British Labor Unions by M. Thatcher and Ronald Reagan’s fight against air traffic supervisors and the concomitant further weakening of organized labor in the US has had effects on the distribution of income between wages and profits. OECD’s, the IMF’s and the EU’s insistence on “structural reform” in labor markets, on flexibilisation – all these also mitigate against organized labor – and thus help to keep wages down. Looking at Europe, we see that in France and Italy the wage share has increased, in Germany decreased, also as a result of changing power relations.
Let us applaud, where applause is due: that the IMF dedicates a whole chapter of its sacred WEO to the (functional) distribution of income, is good. That it omits the most important analytical question, is bad. But maybe, they will come to their senses.
Let me add another critique: the whole of the WEO, chapters 1 and 2, deal with the global economy only in terms of „lost growth“. Maximization of GDP, as conventionally measured, is the only direction of its analysis and advice. Climate change, its effects on the economies of the world, and distributional effects and their effects, are not mentioned (the latter with the exception of chapter 3). Is it not high time that a wider view of the global economy, including environmental and social aspects, becomes the object of the IMF‘s analysis? In a recent discussion on the WEO in Vienna, this question was answered that the next WEO (in October) would deal with climate change effects. Let us hope it does so in a more integrated way than the above discussion on the falling labor share.