Income inequality and the downward wage push

The most dangerous ‘imbalance’ at the heart of the UK economy is the disproportionate bargaining power that firms have over labour

Scott Lavery
Scott Lavery

Over the past thirty years, the ‘wage share’ – the proportion of economic output that accrues to labour – has declined significantly. While in 1982 the wage share in Europe was 72.5%, by 2007 it had fallen to 63.3%.  Successive decades of neoliberal reforms have resulted in these trends becoming particularly pronounced in the UK, which now has one of the most polarised distributions of income and wealth in the OECD. 

Although there has been much talk of the need to ‘rebalance’ the UK economy along sectoral or geographical lines, there has been a marked reluctance amongst the political class to address the question of income inequality. But income inequality is not only socially corrosive – it is also economically damaging.  Highly unequal societies have the tendency to generate serious economic imbalances, which both threaten stability and undermine the pursuit of growth in the long term.  Engaging with the distributional question will therefore be essential to the development of a new sustainable growth model for Britain.

Growing income inequality has been driven by three principal mechanisms which have worked together to generate the imbalanced economy that we see today.

The first driver of inequality has been wage stagnation and, in particular, the declining share of workers’ income as a proportion of overall output. As outlined above, the wage share has dropped significantly over the past three decades.  Business generally argues that lower wages and a higher profit share are signs of a ‘competitive’ economy. The problem, however, is that this position treats labour merely as a ‘cost of production’.  In fact, wages have a dual function: they are also a core component of aggregate demand.  As output increases but wages decline, the capacity of society to consume the new goods and services produced potentially slips away.

The flip-side of the declining wage share, and the second driver of income inequality, has been the growing concentration of wealth at the top of society. As Keynes demonstrated many years ago, when the income share is disproportionately skewed towards asset-holders, the likelihood that speculative, rent-seeking behaviour will de-stabilise the economy is much higher. This happens because the asset-rich tend to consume a lower proportion of their income than those lower down the income scale, meaning that more funds are available for speculative lending.

In the pre-crisis period, the huge surpluses which accrued to corporations and wealth funds were increasingly recycled through high-yielding financial instruments, rather than ploughed into productive investment.  As Stewart Lansley has shown, in the lead up to the crash, banks invested only £50 billion in manufacturing, compared to £1000 billion in property investment. The lesson is clear: a high profit share does not automatically translate into socially useful and growth-enhancing investment.

The third driver of income inequality, and of course a core component of the UK’s pre-crisis growth model, was the deregulation of the financial services sector and the massive boom in credit that accompanied it.  In the absence of domestic wage-led demand, UK household debt rose rapidly from 40% in the early 1990s to 160% in the 2000s.  At the same time, the financial services sector strengthened its position in the UK economy, with the result that, by 2011, levels of private debt in the UK had increased to over 400% of GDP  – more than that of any other comparable economy.

In sum, wage stagnation, wealth concentration at the top and financial deregulation cumulatively contributed to the massive growth of income inequality within the UK over the past three decades. This in turn left the UK particularly vulnerable to financial contagion and crisis.

What does this analysis of the economic consequences of inequality tell us about the current ‘recovery’?  Looked at through a distributional lens, it would seem that George Osborne’s economic strategy is deepening, rather than resolving, the great wage-profit imbalance at the heart of the UK economy’s malfunction. GDP growth may be rising once again and unemployment may be falling – but the distributional disparities of the British economy look likely to intensify over the years ahead.

It is revealing to compare, for example, the recent crisis period with that of other UK recessions.  For example, according to an IFS report, three years after the early 1980s recession, real wages had grown by 5%.  On the same measurement after the 1990s recession, real wages had grown by 10%. Three years after the 2008 downturn, however, real wages had been pushed down by 4%.  This wage stagnation continues today, with inflation still outstripping average increases in earnings for the fifth year in a row.

Significantly, during this current recovery employers have been able to adapt to a depressed market by passing the burden of adjustment onto their workers.  Over 40% of all workplaces have enacted a wage freeze or wage-cutting strategy, a remarkably high proportion when compared with previous downturns.  In addition, job creation has increasingly been secured through the generation of precarious jobs, such that only one in four jobs created in the years following the post-crisis recession have been full-time in nature.

As for the wage share under the current recovery, well, the proportion of output accruing to asset holders and corporations will increase, not least due to the redistributive nature of quantitative easing.  At the same time, the on-going restructuring of the labour market is likely to ensure that median income earners receive an ever declining proportion of output in the years ahead.

The key point is this. The UK is experiencing a recovery achieved by regressive redistribution premised in turn upon wage deflation and asset-price inflation.  In the end, this strategy is likely to contribute to a further drop in the wage share and the re-emergence of the UK’s debt-led growth model.  Going beyond such a recovery will require that progressives take seriously once again the declining wage-profit share and the political environment which has made this possible.