Will the return of economic growth mean rising wages for workers?

How effective will advanced economies be at translating economic growth into higher wages for those in the low to middle part of the distribution and is this link weakening over time, reinforcing a ‘trickle-up’ tendency in mature economies?

A great deal depends on these questions, yet they all too rarely are directly addressed. The answers not only shape public attitudes towards a pro-growth agenda but they also dictate how much weight redistributive policies need to bear in an era when public appetite for an extension of redistributive tax and benefit policies is being widely questioned.

In the UK context, the simple ratio of growth in GDP to growth in median wages weakened markedly in the early 2000s (pre-crash) compared with the 1990s and 1980s. The thread between GDP growth and median pay has long since broken in countries like the US and Canada and has frayed recently in some EU countries (Germany, France) but less so in others (Sweden, Denmark).

In simplified economic terms the link between GDP and the wages of the low and middle part of the distribution should depend on three factors: (1) How much of GDP goes to profit rather than the labour share? (2) How much of the labour share or GDP goes on non-wage costs of employment and how much actually gets paid out to workers in wages? (3) Of this wage share, how much reaches low and middle earners i.e. what is happening to wage inequality?

1. Why the link between growth and wages weakened 

For some on the left, it is near axiomatic that we face a long-term decline in the labour share of GDP. This argument follows that more of our national income is being sucked up into corporate profit due to a mix of technology, financialisation and de-regulation spurred in no small part by the impact of big money on democratic politics.

From a UK perspective, there has been a slight shift in this direction over time, though it is often overstated: changes in the UK’s labour share accounted for only a fifth of the cleavage that had opened up between GDP and median pay since the early 1970s. But the decline in labour’s share has been far more marked over recent years in some countries (like the US) than others; overall the labour share declined in the majority of OECD countries from 1990 to 2009.

Another view, more often heard from those on the right, is that workers’ wages have primarily been under pressure because of rising burdens on employers, such as higher national insurance contributions, which have borne down on pay. In the UK, along with a number of countries, these costs have certainly risen. But again, this can be overdone: in the British context it accounts for a bit over a quarter of the gap between GDP and median wage growth since the 1970s.

A more predictable, and potent, explanation of why the bottom half of workers has been losing out involves rising pay inequality: of the total sum paid out in wages, a far greater share is now going to the top half of earners than used to be the case. Rising wage inequality accounted for more than half of the gap that had opened up between GDP growth and median wage growth since the 1970s.

How these three trends are likely to evolve over the next decade and beyond is far from clear.

2. A new era of capital?

The intellectual zeitgeist expects there to be a redistribution of income over time from labour towards capital. Whether it is the rise of the robot, or Thomas Piketty’s argument that ‘r > g’ (returns to capital will exceed the growth rate), there are certainly few countervailing voices anticipating labour will claim a larger share of national economies. This suggests two broad strategies. One is to pursue Piketty’s rallying call for a decisive shift towards the (global or at least European) taxation of capital, despite all the political complexities. The other is for nations to build new institutions that ensure that some of the fruits of capital are spread among the wider population – from mass employee ownership to universal asset stakes. At the moment, it’s difficult to gauge which of these feels more out of reach.

3. Rising burdens on employers?

This challenge is, at least in part, more directly susceptible to policy but it involves difficult trade-offs. A number of countries are facing tricky balancing acts between securing adequate pension savings for ageing societies – which often lead to enforced employer contributions which push up the cost of hiring – and protecting the wages of today’s workers. Ensuring adequate pensions is a vital policy goal but it is likely to give rise to some problematic generational implications: in the UK, young workers are taking a hit in their pay packets to fill historic pension fund deficits, as well as having to save for their own retirement. More generally, any remaining sentiment that raising taxes on employment (as opposed to, say, profit, income or consumption) are a wise, stealthy or progressive way of raising revenue should be put to rest. They are not. The costs of hiring should be cut not increased.

4. The inevitably of higher wage inequality?

The simple tale sometimes heard of ever growing wage inequality does not reflect the complexity of the story. In the UK for much of the decade before the crash the gap between wages at the bottom and the middle fell; while that between the middle and the very top rose. Indeed one of the few tale-winds pushing back against the tendency for a smaller share of GDP to reach the bottom half of workers in the UK has been that increases in the minimum wage have generally outstripped average pay. The evidence on wage inequality is hardly heartening, but neither does it support policy-fatalism.

Various strategies suggest themselves (in ascending order of difficulty). First, in a period of recovery, pursue a more aggressive strategy of raising the wage floor – drawing confidence from growing research about the capacity of buoyant labour markets to absorb steady minimum wage rises. Second, there must be a resolve to turn around perennial weaknesses in education policy in countries like the UK, especially the woeful wage (and productivity) returns to many low and intermediate level qualifications. Third, the timidity that has characterised the stance taken towards the extraordinary rents that have accrued to small numbers working primarily in finance over the last decade – particularly in Anglo-Saxon economies – must, belatedly, be tackled. Finally, and most speculatively of all, is the desperate need for experimentation with new institutions and approaches that could offer employees a voice and at least some form of bargaining power,  but in a manner that is compatible with the realities of relatively flexible, heavily service-dominated, open economies.

The relationship between wages and growth goes to the heart of economic performance as well as democratic legitimacy. In the UK that relationship has not broken down but in the pre-crash years it was certainly weakened. It will take a tighter jobs market, together with bold policy-experimentation in pursuit of higher wages for those at the low and middle part of the distribution, to restore it.