It's Wages, Stupid
By focusing on supply, economists and policymakers have lost sight of the fact that driving down wages destroys demand.
For a few decades now, American economic policy has focused on keeping inflation low, assuming that the natural rate of unemployment is fairly high. In general, that has led to stagnating wages. Family income today is at 1990s levels. Adjusted for inflation, hourly wages are at levels they last reached in the 1960s. The wage share has been falling.
Some economists claim inequality is the bigger issue due to runaway income at the top. My own view is that a better way to understand America’s dilemma to focus on stagnation for the broad middle and bottom. As I note in my latest piece for the New York Review of Books, the incomes at the top, which account for most of the inequality, are made in finance — much of which is a game Wall Street plays with itself. For this brief piece, I will put that issue aside.
It is time to talk about the importance of high wages to sustainable growth in America and Europe — indeed, in most countries around the world. The precarious circumstances in the eurozone today are widely understood, as was the U.S. financial crisis, as a problem of fiscal and financial discipline. In fact, I’d argue they were mostly a product of economic models based on low wages that were not sustainable. Both Germany and China had models that depended on low wages.
I’d also argue that the U.S. had a low wage policy to fight inflation, which had become public enemy number one in the minds of even the most sophisticated economists since the 1970s. These economists persistently over-estimated the so-called natural rate of unemployment, which gave the Federal Reserve justification to keep rates up to suppress inflation. In practical fact, the Fed under Alan Greenspan was mostly appeasing bond markets, which Greenspan watched very closely as the signal of inflationary expectations.
We can now focus our attention on wage deficiency. You might be surprised to think Europe or even American financial distress is a wage problem, not a financial discipline problem. But it is time to think this through clearly. We are told too often that disciplined Germany must bail out undisciplined Greece, that America is angry at China’s currency manipulation and China at America’s profligate government deficits. We might almost believe this is the heart of the matter.
But at the center of the issue are low wage shares and inequality. And one reason the world’s policymakers, technocrats, and economists don’t think about it clearly enough is that they focus too much on “supply” as the principal source of economic growth — of machinery, ideas, technology, resources, and human capital quality labor. They focus far too little on “demand” as a source of economic growth.