For my money,the most savvy economist around.---rng
Ravi Batra, "The Crash of the Millennium,"
New York: Random House/Harmony Books, 1999, pp. 66-69
WAGES AND PRODUCTIVITY
Supply and demand for goods are linked to the
workforce through wages and productivity. What
happens in the national labor market is the key to a
country's economic health. Supply and demand for
workers determine wages and employment. Skilled and
motivated workers are the backbone of high
efficiency, but what is perhaps crucial is that
company wages reflect labor productivity. When new
technology raises hourly output, then fairness
demands that workers are properly compensated for
their hard work and skills. This is not only a
question of ethics but of labor peace and social
prosperity as well.
Wages are the main source of demand, productivity the
main source of supply, and if the two are not in sync
with each other, then national supply and demand
cannot be in balance for long, and eventually the
economy runs into major trouble. For a while the
balance between the two forces can be maintained by
raising artificial demand through excessive business
investment, or through the expansion of consumer
debt, money supply, corporate debt, government budget
deficits, and even exports, but these are mere
palliatives that may mask the problem for some time.
Artificial spending is the stuff of which economic
disasters are made. Frequently it culminates in
recessions, but occasionally it has even spawned
depressions and inflation—-even hyperinflation.
Whenever and wherever a country has suffered a major
depression, you will find a persistent and
substantial wage-productivity gap. The bigger the
size of artificial demand, the greater the eventual
trouble.
A SIMPLE ILLUSTRATION
When the labor market is distorted in the sense that
real wages lag behind productivity, the entire
economy behaves irrationally. Let us take a simple
example in a very simple economy. Suppose there are
one hundred workers in a society, and each produces
$5 worth of output. Worker productivity is then $5,
and if everybody is employed, total output or supply
will be $500. U.S. experience of the 1950s and the
1960s reveals that a high-growth economy with
practically no unemployment and inflation requires
that about 80 percent of output go to labor and the
remaining 20 percent to the owners of income-
producing property or capital, which is also an
important resource contributing to productivity.
(Capital owners usually earn incomes through their
labor as well, so the 20 percent share is not their
only source of earnings). Under this rule, wages will
be 80 percent of output, or $400, and profits the
rest, or $100.
Keeping the argument as simple as possible, let us
suppose that initially all wages are consumed and all
profits are invested into new technology and the
replacement of worn-out capital so that consumption
spending is $400, investment spending is $100, and
the aggregate spending is $500. In this case, the
economy functions smoothly, for both national supply
and demand for goods equal $500.
Now assume that owing to new technology, worker
productivity doubles to $10, so the value of output
generated by one hundred workers rises to $1,000. If
wages and consumption also double to $800 and the
profits and investment to $200, again national supply
and demand for products will remain in balance, this
time each equal to $1,000. However, suppose wages
rise only to $600, while profits up to $400.
Consumption now equals $600, and it is clear that
investment spending must now be $400 lest national
demand be short of supply, resulting in
overproduction. Would businesses be willing to put
all their profits into new investment, when consumer
spending grows slowly? The answer is most likely not.
If you are investing $200 when your sales are $800,
you are not likely to increase your investment for
business expansion when your sales go down to $600.
If companies realize that the current demand for
their goods is inadequate, they will trim their
investment even below $200. The purpose of capital
spending, after all, is mainly to meet consumer
demand; you would expand your business only in
proportion to your sales. If sales fail to
materialize, investment will decline. With consumer
demand less than $800, the companies will invest even
less than $200, in which case total spending will
fall way short of supply, businesses will be stuck
with unsold goods, and layoffs will have to follow.
Thus the simple example makes it clear that when
wages lag behind productivity, distorting the labor
market, the product markets will also be out of
kilter.
It is of course possible that, for a while, the
companies may not be aware of the shortfall in
consumer demand; their high profits may convince them
to expand their capital expenditures all the way up
to $400 and to buy more machines. In this case,
demand and supply will each equal $1,000, and the
economy will reveal no signs of the potential
imbalance possible from the slowdown in consumer
spending. The growth process, however, will
continue. With investment skyrocketing to $400, the
use of new technology and worker productivity will
climb even faster.
Suppose in the next round output per employee jumps
to $20, so total supply, with full employment of
labor, soars to $2,000; if wages and consumer demand
rise only to $1,200, then investment must climb to
$800 to maintain the balance between supply and
demand. It is clear that with wages lagging behind
productivity, the growth process will become
explosive, requiring ever-increasing doses of
business investment to maintain high employment and
the living standard.
This process is purely artificial in the sense that
businesses will be selling a large portion of their
goods to each other rather than to consumers to
sustain their prosperity. It's like a Ponzi scheme in
which you have to create sellers to buy your products
and sell them to other sellers. Such schemes always
collapse. When firms raise their capital spending and
buy more machines from other companies, in reality
they sell goods to each other, because consumers
certainly have no use for plant and equipment. Sooner
or later, a point will come when the companies are
unable to sell all their output, and a recession or a
depression will result. If the growth process
continues for a long time, then the potential
overproduction becomes so large that a depression
becomes inevitable.
It is noteworthy that the power of this logic in no
way depends on the simplicity of our assumptions. In
the real world, some workers do save, and not all
profits may be invested. Furthermore, there is a
large government sector today in most economies,
which additionally have to reckon with the ills of
inflation. Labor income also may not initially amount
to 80 percent of output; these assumptions are not
crucial to the argument. What is critical is that
real wages grow slower than the rate of productivity
resulting from new technology and business
investment.
What could be done to rectify the problem? Since the
fundamental source of the imbalance in both the labor
and product markets is that wages trail productivity,
the solution is clear. Either a law should be passed
that all output be divided proportionately between
labor and capital, or some institutions should be
created such that wages grow in sync with hourly
output. This, of course, has not been done anywhere
in the world, even though the wage-productivity gap,
hereafter called the wage gap, has been soaring all
over the globe for the last three decades. Then how
has the balance been maintained between demand and
supply for products?
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