The Case for Wage-Led Growth

The share of wages and salaries in Gross Domestic Product (GDP) has declined in most rich nations over the past 20 to 30 years. Over the same period, income inequality has grown in most of these nations, and rapidly in some of the largest of them, resulting in slow wage growth for most consumers. 

The result of wage growth that is persistently slower than the growth of GDP, and a simultaneous shift in distribution towards high-end earners who save more and consume less, has been an inadequate level of aggregate demand needed for rapid, job-creating GDP growth.

Stagnant or, at best, slow-growing standards of living are economic failures in themselves and may well lead to political instability. But they are also harbingers of a more serious crisis. The main theme of this paper is that low-wage policy regimes have resulted in an over-reliance on export-led growth models in nations like Germany and China and debt-led growth policies in countries like the U.S. In export-led economies, there has in turn been pressure to maintain low wages to keep exports price-competitive, especially as newer, even lower-wage economies became integrated into the international system.

Debt-led growth models, particularly in the U.S. and the southern periphery of Europe, are the mirror image of export-led growth in Asia and in the core of the Eurozone. Because wages did not rise sufficiently in the deficit economies, consumers in the U.S. and some European countries borrowed aggressively to maintain their standard of living, in the process purchasing the attractively priced products of countries like Germany and China. China’s and Germany’s surpluses were then recycled back to the U.S. and other debtor economies. Recycled dollars from China enabled Americans to borrow at low rates: similarly recycled euros from Germany to peripheral Eurozone nations enabled those countries to borrow cheaply.

Some European nations did restrain borrowing, but their economies grew relatively slowly in the 2000s as a consequence of inadequate demand in the system. But the U.S. in particular maintained growth by allowing household borrowing to rise rapidly and savings rates to decline to near zero levels.

The relationship between export-led growth and debt-led growth contained other negative feedback loops as well. Excessive manufacturing imports from export-led economies undermined the growth of higher-wage industries in deficit economies, eroding the productive capacity of those economies. This in turn placed further downward pressure on wages. Consumer access to credit at low interest rates tended to ameliorate political frustration over low wages – at least for a while.

Neither export-led growth models nor debt-led growth models are indefinitely sustainable. The debt taken on by importing deficit economies at some point becomes excessive, and when these economies reach their borrowing limits they are forced to pay down debt and curtail their demand for the goods of export-led economies. The result of the pursuit of these two models over the past decade or two has been two major financial crises and the Great Recession. The root of the problem is relatively low wages.

Read the full report, "The Case for Wage-Led Growth," here.




Jeff Madrick