Healing the economy by making it more equal

In the second of three posts on ‘Increasing Inequality: Causes, Consequences and the Great Recession’, Robert de Vries discusses whether we can work our way out of economic crisis while still reducing inequality.

As I said last week, plenty of good stuff came out of the University of Westminster’s recent event; ‘Increasing Inequality: Causes, Consequences and the Great Recession’. One of the most interesting and positive talks I heard was by Özlem Onaran, an economist at the aforementioned institution. She posed the question ‘Is there a way we can get out of this crisis, while still reducing inequality’. Her answer was not only that yes, we can; but actually that increasing equality might be the best way of bringing our economy back to life.

She gives a good summary of her views in this post over at LSE’s European policy blog. However, she spends a little less time than she did in her Westminster talk explaining how increasing equality could help economic growth, and what constitutes the evidence that this would work. Given that we’re all about detail and evidence at Inequalities, I thought I’d focus a bit more on that here.

The key to her argument is that, in almost all economically developed countries over the past few decades, there has been a steady decline in wage shares. This is the proportion of national GDP that is made up of peoples’ wages, as opposed to, for example, corporate profits. You can see this in the graphs below showing wage share trajectories in developed and developing economies (sourced from this United Nations Conference on Trade and Development report):

Declining wage shares in developing countries

This decline in wage share drives up income inequality; but according to classical economics it should be a good thing for economic growth. Labour costs go down, profits go up. These increased profits encourage investment, which creates jobs. Lower labour costs also mean that making things is cheaper, and this helps exports.

But (and this is a big but) falling wages also mean falling demand – workers with less money in their pockets buy less stuff. This means that falling wage share has both positive and negative effects on economic growth. The problem is that it’s difficult to work out what the final effects net out to. Is the drop in demand caused by falling wages outweighed by the positive effects on investment and exports?

Here is where we get to the meat of her talk. What her economic models have shown is that, in certain very specific circumstances, falling wage shares are good for growth. The thing is; this is decidedly not true for countries in the Eurozone. For these countries, who are integrated into a tight economic union, and whose economies do not rely mostly on exports, the negative effects of falling demand seriously outweigh any positives. This makes falling wages a significant drag on growth. Incidentally, this is especially (but by no means only) true if all countries are decreasing their wage shares at the same time, as we have been busily doing for the past several decades.

The natural conclusion from Onaran’s work is that the best way for Eurozone countries to promote growth would actually be to increase their wage shares. Essentially to equalize their way to economic health.

So how do we go about doing that? In her blog post, Onaran offers several solutions:

    1. Increasing the power and coverage of labour unions
    2. Increasing the ‘social wage’ by increasing social security
    3. Establishing a sufficiently high minimum wage
    4. Regulating high pay
    5. Instituting international labour standards (presumably to prevent undercutting of production costs by countries with dubious labour practices)
    6. Shortening working hours, but with wages compensated for the lost time

These are good, specific, objectives; most of which I agree with. The problem is that I just can’t see any of them happening. We’ve talked a lot on this blog about the lack of political will (and indeed popular support) for making social security more generous. The other options scarcely seem any more realistic. So if these are the only ways of raising the wage share and decreasing inequality, then it seems to me that we might be sunk. Can anyone think of any other solutions? Something we might actually be able to get done?

About Robert de Vries

I'm an Early Career Research Fellow in the Sociology department at the University of Oxford. I'm mainly interested in how people are affected by concerns about their social status; how it colours the way they think, feel, and behave. I try and contribute here regularly, but my addiction to writing excessively long posts keeps getting in the way.
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2 Responses to Healing the economy by making it more equal

  1. Pingback: Could inequality have caused the financial crisis? | Inequalities

  2. Pingback: Why more equal societies have more stable economies | Inequalities

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