A choice for profit or for purchasing power? Yes there are alternatives!

Nearly all governments wrestle with a lack of economic growth and the Maastricht obligation to keep the shortage in the public finances budget under 3% of the GDP. Their only answer is a strict austerity policy. They pass the responsibility to Brussels, pretending their inhabitants have no alternative.

"a governance that creates a strong competition in wage incomes is more hampering than stimulating the recovery"

But is this statement true? Is this the only way to get out of this crisis and to safeguard the interests of the upcoming generations? Famous economists like Thomas Piketty, Paul Krugman and Joseph Stiglitz already expressed their doubts. Recently a team of researchers gave evidence that a governance that creates a strong competition in wage incomes is more hampering than stimulating the recovery. On the contrary, they conclude that we need an urgent raise in purchasing power to enhance economic growth. 

Experiences from the past  

It was Margareth Thatcher who, confronted with a strong opposition, introduced 35 years ago the slogan ‘There is no alternative’ during a debate in the British parliament. Today we know the limits of her strong belief in the free market and the power of the individual: at the end of her government term the purchasing power declined, many Britons remained unemployed, the wage gap (Gini coefficient) grew significantly and the budget deficit didn’t shrink.

Experts assessed her deregulation of the financial sector as a major cause for the actual financial crisis. At that time the process of denationalization of public assets seemed not to be the best recipe to remedy the crisis.

In 2009 the US president Obama launched the ‘American Recovery and Reinvestment Act’ to tackle the economic crisis in the US. The enormous capital of 787 billion dollars was put into the economy to create new jobs and to extend the social services by means of strengthening infrastructure, education, health care, renewable energy.

The driving force behind these plans was to raise the integrated demand by raising the purchasing power of citizens, by reducing taxes and increasing the unemployment benefits. The US economy is recovering, while the European stays behind. Obama's plan was an application of the Keynesian theory that was developed during the thirties as an answer to the depression.

ILO research: save on salaries limits economic growth 

On behalf of the ILO[1] two academic researchers examined if economic growth is better off by increasing the wage element (wage-led), or by making more profit on investments (profit-led). In their analysis of the macroeconomic figures of 16 G-20 countries they noticed that economics traditionally focus more on the manufacturing process, hoping that consumption automatically follows the offer of goods, and that the wage level is seen as a ‘cost’ which is not assessed as a crucial element to create demand which can stimulate economic growth.

According to the type of their economic model the 16 investigated countries are awarded in ‘wage-led’ or ‘profit-led’ economies. In the first group the integrated demand is determined more strongly by the purchasing power, whereas in the second one, the profit made on investment was the key economic factor (often small countries or countries with an open economy where focus is on export).

The researchers noticed that countries implementing an austerity policies (decline of wage share in the GDP) during the last decades also had a decline in their economies. This decline is explained by a reduced purchasing power and a lower domestic demand on consumption.

The researchers demonstrate that the raise in wage share in big countries or blocs of countries (such as the EU) with a huge internal market, will stimulate their economic growth because their export is rather small in relation to the GDP. An increase in profit of 1 percent leads in the end to a negative impact of 0.36 per cent in their GDP.

In general, a lower wage share leads to slowing growth. Another remarkable conclusion is that if trading partners apply the same strategy at the time, e.g. by implementing an austerity policy, the seeked competitive advantage will evaporate and will harm all economies at the end. For that reason a competition between EU member states to be the ‘cheapest’ in wage share is a bad idea. 

[1] ‘Is aggregate demand wage-led or profit-led? - National and global effects’ - Özlem Onaran (University of Greenwich, Work and Employment Research Unit) en Giorgos Galanis (University of Warwick)

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