National and global effects Conditions of Work and employment Series No. 40 Özlem Onaran Giorgos Galanis - PDF

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For information on the Conditions of Work and Employment Branch, please contact: Phone: (+41 22) Fax: (+41 22) Is aggregate demand wage-led or profit-led? International Labour Office, Conditions of Work and Employment Branch 4, route des Morillons CH-1211 Geneva 22 Switzerland National and global effects Özlem Onaran Giorgos Galanis Conditions of Work and employment Series No. 40 TRAVAIL ISSN Conditions of Work and Employment Series No. 40 Conditions of Work and Employment Branch Is aggregate demand wage-led or profit-led? National and global effects Özlem Onaran* Giorgos Galanis** * Corresponding author, University of Greenwich, Work and Employment Research Unit, London, SE10 9LS UK, greenwich.ac.uk ** University of Warwick INTERNATIONAL LABOUR OFFICE GENEVA Copyright International Labour Organization 2012 Publications of the International Labour Office enjoy copyright under Protocol 2 of the Universal Copyright Convention. Nevertheless, short excerpts from them may be reproduced without authorization, on condition that the source is indicated. For rights of reproduction or translation, application should be made to the Publications Bureau (Rights and Permissions), International Labour Office, CH-1211 Geneva 22, Switzerland. The International Labour Office welcomes such applications. Libraries, institutions and other users registered in the United Kingdom with the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP [Fax: (+44) (0) ; in the United States with the Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA [Fax: (+1) (978) ; or in other countries with associated Reproduction Rights Organizations, may make photocopies in accordance with the licences issued to them for this purpose. ILO Cataloguing in Publication Data Onaran, Özlem; Galanis, Giorgos Is aggregate demand wage-led or profit-led? national and global effects / Özlem Onaran, Giorgos Galanis ; International Labour Office, Conditions of Work and Employment Branch. - Geneva: ILO, 2012 Conditions of work and employment series ; No.40, ISSN ; (web pdf) International Labour Office; Conditions of Work and Employment Branch wages / income distribution / supply and demand / data collecting / methodology / developed countries / developing countries First published 2012 Cover: DTP/Design Unit, ILO The designations employed in ILO publications, which are in conformity with United Nations practice, and the presentation of material therein do not imply the expression of any opinion whatsoever on the part of the International Labour Office concerning the legal status of any country, area or territory or of its authorities, or concerning the delimitation of its frontiers. The responsibility for opinions expressed in signed articles, studies and other contributions rests solely with their authors, and publication does not constitute an endorsement by the International Labour Office of the opinions expressed in them. Reference to names of firms and commercial products and processes does not imply their endorsement by the International Labour Office, and any failure to mention a particular firm, commercial product or process is not a sign of disapproval. ILO publications can be obtained through major booksellers or ILO local offices in many countries, or direct from ILO Publications, International Labour Office, CH-1211 Geneva 22, Switzerland. Catalogues or lists of new publications are available free of charge from the above address, or by Visit our website: Printed by the International Labour Office, Geneva, Switzerland Preface The Conditions of Work and Employment Research Series is aimed at presenting the findings of policy-oriented research in the area of working conditions from multidisciplinary perspectives such as laws, economics, statistics, sociology and industrial relations. Decent work concerns both the quantity and quality of employment, and indeed, the conditions of work and employment have great impacts on workers well-being and enterprise performance. In recent years, conditions of work and employment have changed significantly in many countries, both advanced and developing, part due to globalization, technological changes, and regulatory shifts. At the same time there has been a growing recognition that improving the quality of work is also an important policy goal. Yet the challenge of what kinds of concrete policy actions need to be developed to improve the every-day reality for workers remains. With this challenge in mind, the Conditions of Work and Employment Series is intended to offer new ideas and insights on improving working conditions. It is also meant to stimulate debates among governments and social partners concerning how to better design and implement policies with the aim of ensuring decent working conditions for all workers. ILO s Conditions of Work and Employment Branch (http://www.ilo.org/travail) is devoted to developing knowledge and policies and to providing technical assistance in the area of working conditions such as wages, working time, work organization, maternity protection and arrangements to ensure an adequate work-life balance. Philippe Marcadent Chief Conditions of Work and Employment Branch Labour Protection Department Social Protection Sector Conditions of Work and Employment Series No. 40 iii Acknowledgements This paper has received research funding from the International Labour Office. We are grateful to Engelbert Stockhammer, Servaas Storm, Amitava Dutt, Sangheon Lee, Patrick Belser, Marc Lavoie for helpful comments on earlier stages of the research, to Susan Pashkoff for careful language editing, and to Matthieu Charpe, Ricardo Molero Simarro, Uma Rani Amara, Rayaproulu Nagaraj, Juan Graña, Joana Chapa, Araceli Ortega Diaz, Morne Oosthuizen, Claudio Roberto Amitrano, and Kazutoshi Chatani, and Byung- Hee Lee for their valuable support regarding data. All remaining errors are ours. iv Conditions of Work and Employment Series No. 40 Abstract This paper estimates the effects of a change in the wage share on growth in the G20 countries using a post-keynesian/post-kaleckian model, analyses the interactions among different economies, and calculates the global multiplier effects of a simultaneous decline in the wage share. At the national level, a decrease in the wage share leads to lower growth in the euro area, Germany, France, Italy, UK, US, Japan, Turkey, and Korea, i.e. these economies are wage-led, whereas it stimulates growth in Canada, Australia, Argentina, Mexico, China, India, and South Africa; thus the latter group of countries are profit-led. However, a simultaneous decline in the wage share in all these countries leads to a decline in global growth. Furthermore, Canada, Argentina, Mexico, and India also contract when they decrease their wage-share along with their trading partners. Thus the global economy in aggregate is wage-led. The policy conclusions of the paper shed light on the limits of strategies of international competitiveness based on wage competition in a highly integrated global economy, and point at the possibilities to correct global imbalances via coordinated macroeconomic and wage policy, where domestic demand plays an important role. There is room for a wage-led recovery in the global economy based on a simultaneous increase in the wage shares, where global GDP as well as all individual countries can grow. JEL: E21, E22, E25, F43 Key words: wage share, growth, global multiplier, consumption, investment, exports, imports, G20, developed and developing countries. Conditions of Work and Employment Series No. 40 v Contents Page Preface... iii Acknowledgements... iv Abstract... v 1. Introduction Data and stylized facts Estimation methodology Estimation Results Consumption Investment Net exports Total effects Comparison with the literature National and global multiplier effects Conclusions and policy implications References Annexes Conditions of Work and Employment Series No. 40 vii List of boxes, charts, figures and tables Figure 1: Wage share (adjusted, ratio to GDP at factor cost)... 5 Table 1a: Average growth of GDP (%), developed countries... 7 Table 1b: Average growth of GDP, %, Developing Countries... 7 Table 2a: Consumption: dependent variable dlog(c) Table 2b: Consumption: dependent variable dlog(c) Table 3: The marginal effect of a 1%-point increase in the profit share on C/Y Table 4a: Private Investment: dependent variable dlog(i) Table 4b: Private Investment: dependent variable dlog(i) Table 5: The marginal effect of a 1%-point increase in the profit share on I/Y Table 6a: Price deflator: dependent variable dlog(p) Table 6b: Price deflator: dependent variable dlog(p) Table 7a: Export price deflator: dependent variable dlog(px) Table 7b: Export price deflator: dependent variable dlog(px) Table 8a: Exports: dependent variable dlog(x) Table 8b: Exports: dependent variable dlog(x) Table 9a: Imports: dependent variable dlog(m) Table 9b:Imports: dependent variable dlog(m) Table 10a: Calculation of the marginal effect of a 1%-point increase in the profit share on net exports, Table 10b: Calculation of the marginal effect of a 1%-point increase in the profit share on net exports, Table 11: The summary of the effects of a 1%-point increase in the profit share Table 12: Elasticities of C, I, and M with respect to Y Table 13: Summary of the multiplier effects at the national and global level Table 14: Two wage-led recovery scenarios Page viii Conditions of Work and Employment Series No. 40 1. Introduction There has been a significant decline in the wage share in both the developed and developing world along with neoliberal policy reforms following the 1980s. The promise of these reforms was to stimulate private investment and exports, which in turn was expected to generate higher growth, more jobs and trickle down effects. The reasons for this fall have recently been the subject of a growing amount of literature trying to pin down the effects of technology, globalization, and changes in labor market institutions (e.g., IMF, 2007; OECD, 2007; EC, 2007; ILO, 2011; Rodrik, 1997; Diwan, 2001; Harrison, 2002; Onaran, 2009; Rodriguez and Jayadev, 2010; Stockhammer, 2011). This paper offers a theoretical and empirical assessment of the effects of this pro-capital redistribution of income on growth at a national and global level. Mainstream macroeconomic models emphasize the supply side rather than the demand side of the economy; and assume that demand will follow supply. Most importantly for the purpose of this paper, they treat wages merely as a component of cost, and neglect their role as a source of demand. On the contrary, post-keynesian/post- Kaleckian models, as has been formally developed by Rowthorn (1981), Dutt (1984), Taylor (1985), Blecker (1989), Bhaduri and Marglin (1990), reflect the dual role of wages affecting both costs and demand, and while they accept the direct positive effects of higher profits on investment and net exports emphasized in mainstream models, they contrast these positive effects with the negative effects on consumption. In these models, consumption is expected to decrease when the wage share decreases, since the marginal propensity to consume out of capital income is lower than that out of wage income. A higher profitability (a lower wage share) is expected to stimulate investment for a given level of aggregate demand. Also it is often argued that internal funds are an important source of finance and thus profits may positively influence investment expenditures. Finally, for a given level of domestic and foreign demand, net exports will depend negatively on unit labor costs, which are by definition closely related to the wage share. Thus, the total effect of the decrease in the wage share on aggregate demand depends on the relative size of the reactions of consumption, investment and net exports to changes in income distribution. If the total effect is negative, the demand regime is called wageled; otherwise the regime is profit-led. Whether the negative effect of lower wages on consumption or the positive effect on investment and net exports is larger in absolute value essentially becomes an empirical question. We first estimate the effect of the share of wages in income on aggregate demand in the major developed and developing countries (sixteen G20 countries, for which data is available); these constitute more than 80 per cent of the global GDP. These are rather different countries structurally and the effects of income distribution on consumption, investment, and net exports crucially depend on the institutions in each country. Therefore, we estimate country specific equations to find the effect of income distribution on each component of private aggregate demand (i.e. consumption, investment, and net exports). Based on this global mapping, we compare wage-led demand regimes, where consumption is more sensitive to distribution than investment and domestic demand constitutes a more significant part of aggregate demand, and profit-led demand regimes, where the responsiveness of investment to profits is rather strong and foreign trade is an important part of the economy (as it is the case in small open economies). This comparative analysis and in particular its global focus due to the inclusion of the major developing countries is the first contribution of the paper. Most of the previous empirical work has focused on developed countries (e.g. Onaran et al., 2011; Stockhammer et al., 2011; Stockhammer and Stehrer, 2011; Stockhammer et al, 2009; Hein and Vogel, 2008; Naastepad and Storm, 2007; Ederer and Stockhammer, Conditions of Work and Employment Series No. 40 1 2007; and Bowles and Boyer, 1995) with only a few notable exceptions on developing countries (Molero Simarro, 2011 and Wang, 2009 on China; Jetin and Kurt, 2011 on Thailand; Onaran and Stockhammer, 2005 on South Korea and Turkey). Dutt (1996 and 2010) discusses the relevance of the post-keynesian models for the developing countries, emphasizing the role of aggregate demand and the relevance of income distribution; this is important irrespective of the context of the constraints of capital and infrastructural shortages, balance of payments or fiscal problems, and stagnant agricultural sectors found in these countries. The second and most important contribution of the paper is that it goes beyond the nation state as the unit of analysis and develops a global model to analyze the interactions among different economies. We calculate a global multiplier based on the responses of each country to changes not only in domestic income distribution but also to trade partners wage share; this in turn affects the import prices and foreign demand for each country. Pro-capital redistribution policies have not taken place in isolation at the nation state level. First, neoliberal policies have been implemented simultaneously in many developed and developing countries in the post-1980s period although the exact timing depended on the national economic and political context. Second, the policy to rely on decreasing labor costs as a core component of international competitiveness in several countries inevitably has had spillover effects to the other countries as countries try to preserve their competitive position in the global markets. Thus we have seen a simultaneous decline in the wage share. So the crucial question is what happens to global demand, when there is a race to the bottom, i.e. a simultaneous decline in the wage share in all major developed and developing economies as has been the case in the post-1980s. A related question is whether countries that are profit-led in isolation, would stop growing, or even contract, if all other countries were implementing the same wage competition policy simultaneously. Although individual countries can be wage-led or profit-led, the effect of the race to the bottom strategy on global demand can be detrimental, since the competitiveness gains will be lost in individual countries if there is a simultaneous decline in unit labor costs in their trade partners. To the best of our knowledge, this paper is the first in the theoretical, as well as the empirical literature to develop a model of the global effects of changes in income distribution as opposed to focusing on isolated single country effects. The policy conclusions of the paper shed light on the limits of strategies of international competitiveness based on wage competition in a highly integrated global economy, and point at the possibilities to correct global imbalances via coordinated macroeconomic and wage policy, where domestic demand plays an important role. There is room for a wage-led recovery in the global economy based on a simultaneous increase in the wage shares, where global GDP as well as all individual countries can grow. The rest of the paper is organized as follows: section two discusses data issues and stylized facts. Sections three and four present the estimation methodology and the empirical results of our model. Section five compares our results with the previous findings in the literature. Section six calculates the national and global multiplier effects of a simultaneous decrease in the wage share. Finally Section seven concludes and derives policy implications. 2. Data and stylized facts Our aim in this paper is to present a representative analysis for the global economy. Therefore, we focus on the sixteen major developed and developing countries, which are members of G20: European Union, Germany, France, Italy, UK, US, Japan, Canada, Australia, Turkey, Mexico, South Korea (henceforth Korea), Argentina, China, India, 2 Conditions of Work and Employment Series No. 40 and South Africa. 1 Instead of the EU, we work with the 12 West European Member States of the euro area, since data for the Eastern European new member states does not exist prior to transition. 2 Estimations are made separately for the UK, which is the largest old member state outside the euro area. Appendix A describes the data sources in more detail. The estimation period is for the developed countries, and for the developing countries ( for China); The period of the crisis, (i.e ), are excluded to avoid the crisis years, since it would be impossible to test for possible structural breaks with only two observations since the crisis. Moreover, 2009 data was still provisional at the time of the analysis. C, I, X, M, Y, W and R are real consumption expenditures, real private investment expenditures, real exports (of goods and services), real imports (of goods and services), real GDP (at market prices), real wages and profits respectively. For econometric reasons all variables are in logarithmic form. 3 Wages are adjusted labor compensation, calculated as real compensation per employee multiplied by total employment. In the national accounts, all income of the self-employed are classified as operating surplus. However, since part of this mixed income is a return to the labor of the self-employed, the simple (unadjusted) share of labor compensation in GDP underestimates the labor share. This is a particular problem for the developing countries that have a significant share of self-employed workers due to the informal nature of employment. Thus the adjusted wage share allocates a labor compensation for each self-employed person equivalent to the average compensation of the dependent employees. 4 R is also adjusted gross operating surplus, calculated as GDP at factor cost minus adjusted labor compensation. 5 Profit share, π, is defined as adjusted gross operating surplus as a ratio to GDP at factor cost. Wage share, ws, is simply 1- π; thus it is adjusted labor compensation as a ratio to GDP at factor cost. There are several data issues regarding the wage share in the developing countries: Due to lack of long time series data for the number of self-employed we link the data for the unadjusted wage sha
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