A crisis in the US real economy marked by growing unemployment and failing businesses is not a product of the current financial crisis. In fact, the financial crisis was but a symptom of a long brewing systemic crisis in the real economy. These claims are made separately by economists Richard Wollf (Univ. of Massachussetts, Amherst) and Ravi Batra (Southern Methodist University, Dallas). They propose an alternative diagnosis of the current economic crisis. If their analysis is correct, fixing the financial system might just deal with one of the symptoms but not the root cause of a deeper economic malaise. Given the amount of public money that is being thrown at fighting the economic downturn, it is critical to consider alternative explanations of current economic problems in order to devise strategies that make the best use of scarce resources.
The most widely accepted diagnosis of the current financial and economic crisis is that it started with the housing bubble in the US. This in turn resulted from irresponsible sub-prime mortgage lending coupled with unregulated and reckless financial engineering. When the housing bubble burst, banks found themselves holding heaps of unsecured debts packaged into complex financial products that could no longer find new buyers. Financial institutions suspected each other to be in a precarious financial position similar to their own and inter-bank lending came to a halt. Several of these institutions went bankrupt or would have gone down that route if public money ($2.98 trillion at last count) had not bailed them out.
Wollf and Batra do not deny the role of housing bubble and financial malpractices in triggering the financial collapse. What they seem to suggest is that there is a need to explore the chain of causation further. Doing so in their analysis reveals that a wage-productivity gap since the last three decades in the US created a systemic imbalance between aggregate demand and aggregate supply in the economy. Since the early 1970s wages of employees in the US have not risen at the same rate as their productivity (output per hour). In fact, real wages of roughly 80% of the US workforce have been stagnating for more than three decades. On the other hand, productivity has been increasing rapidly due to technological innovation and improvement in human skill levels. Now wages are a key lever for creating demand in the economy whereas productivity drives the increase in supply. In other words, workers’ wages need to increase in order to absorb the increase in supply of goods that results from increased productivity. Yet, the wage-productivity gap has now existed for nearly 35 years.
The consequence of this imbalance is that demand for goods and services required to keep up with supply is created in the short term by creating new debt. The housing bubble was a product of this demand-supply disequilibrium. Since real wages are not rising in step with productivity, people could only consume the increased supply of goods and services by taking help of cheap and easy credit. But after the housing bubble burst, credit is no longer easily available and levels of debt have been exposed to be unsustainable. Businesses realize that their goods will not be sold, profits will decline and they are laying off people and in many cases closing shop. Due to the wage-productivity gap, this economic decline may have happened even in the absence of a mortgage driven crisis. Then again, the housing bubble may have simply postponed the real economy crisis that was imminent, and in the process exacerbated the systemic tensions between demand and supply in the economy.
Where did the profits go?
So why have wages not kept step with productivity despite what some have called a “golden era of profitability”? Where have the profits from the productivity growth gone? A paper by Gordon and Dew-Becker, economists from Northwestern University, found “that over the entire period 1966-2001, as well as over 1997-2001, only the top 10 percent of the income distribution enjoyed a growth rate of real wage and salary income equal to or above the average rate of economy-wide productivity growth…[whereas] the bottom 90 percent of the income distribution fell behind or even were left out of the productivity gains entirely” (italics in original). Additionally, the wage share of national income is declining in the US, while the share going to corporate profits has increased from 17.7% in 2000 to 20.9% in 2005. The European Trade Union Congress complains of a widening wage-productivity gap in the eurozone as well.
It appears that “the killing fields of inequality” (as Göran Therborn puts it in his recent piece) and the relentless pursuit of profits by many businesses are critically undermining the primary source of demand in the economy – its workers’ wages. As more people lose their jobs in the recession, there is further downward pressure on consumer demand. Making credit available to businesses alone is not likely to reverse the unemployment trend since businesses will invest only when they have confidence in potential returns on their investment. Lack of demand for goods and services in the economy, however, does not give that confidence. It is a vicious cycle but one that can be broken by restructuring the economic system to distribute the wealth more equitably. And unless this fundamental factor is addressed, according to Wollf and Batra, it is hard to see a long term economic recovery.