Winner of the New Statesman SPERI Prize in Political Economy 2016


Tuesday, 9 August 2022

Labour shares, decoupling, real wages and inequality

 

There is still a lot of confusion around about why UK real wage growth has been so low since the Global Financial Crisis and 2010 austerity. Many want to point to what economists call the functional distribution of income, which is the split between wages and profits. This was one of the issues I talked about this in a recent post, but perhaps a more direct approach is required.


The first point to note is that none of the decline in real wages over the last decade or so is about a shift from wages to profits. Here is the labour share of income from the 1970s until 2021.



The labour share has fallen since the 1970s, but all of that fall occurred before the recent period. Furthermore, the share of corporate income in GDP has remained fairly flat during this century. There has been no sustained shift from wages to profits over the last ten to fifteen years according to the data. There are a lot of problems with UK corporations, but decreasing labour’s share of national income isn’t one of them.


As my earlier post makes clear, the main reason why real average labour compensation has grown so slowly over the last ten or fifteen years is that output growth and productivity growth have been so low. It’s not about the distribution of the cake, but the size of the overall cake. It is no coincidence that ever since Conservatives started talking about a ‘strong economy’, the UK economy has been anything but strong. (It is no coincidence because Conservative politicians calling things a success to distract from failure started with Cameron/Osborne and the economy.)


What about this year? In the first quarter of 2022 the picture is very similar to the above. Of course real wages in April were lower than in January, but that is because inflation has been pushed up by higher commodity prices. The only company profits to benefit from that are those of commodity producers, and in particular oil and gas producers. That is why high windfall profits taxes on those companies make perfect sense.


I think some of the confusion on this issue comes from the US, where the story is different. While real labour compensation in the US tracked productivity growth pretty closely in the 1980s and 1990s, this stopped happening at the beginning of this century, with labour compensation growing less rapidly than productivity. This in turn has produced a substantial fall in the US labour share, and a rise in the share of profits. But this has not been happening in the UK, and the picture overseas varies greatly from country to country. Note also that a falling labour share does not automatically imply a higher profit share, but may instead reflect increases in indirect taxation, lower subsidies or higher other income.


Another source of confusion is generated by comparison of productivity and real median wages. I first talked about the decoupling between these two measures in this post back in 2014, based on a study by Pessoa and Van Reenen. That study has recently been updated and extended by Teichgräber and Van Reenen (HT @centrist_phone), which gives me a good excuse to talk about its conclusions once again.


In terms of real median wages and productivity there has been uncoupling in the UK. As there is no decoupling between productivity and average real labour compensation, then why are things different for real median wages? As with the earlier study, Teichgräber and Van Reenen find two major causes. The first and most important is the difference between mean (average) and median due to growing inequality at the top, and the second reflects growth in employers’ non-wage compensation (basically pensions).


Here I want to focus on the inequality cause, which is in large part down to the increasing income share of the 1%. Earnings at the very top have risen more rapidly than the rest (see below), which gets into the mean or average compensation measure but is not part of the median measure. A lot, but by far from all (see also below), of these high and rapidly growing earnings are in the financial sector. If you think that was a thing of the past (pre the Global Financial Crisis), think again, with earnings in the financial sector growing over the last year more rapidly than most. This in turn should make us sceptical about seeing the Global Financial Crisis rather than 2010 austerity being the key turning in the UK economy's fortunes, but that issue is for another time.


The key point I wanted to make in my post 8 years ago was that the growing inequality of the 1% has a big impact on everyone else. Concern about inequality at the top need not be, as much of the media likes to suggest, about envy, but instead can be about there being less income for everyone else. The growing income share of the 1% has not paid for itself in terms of more rapid growth, so their extra income comes from the 99% i.e. other workers.


There is a lot more of interest in the Teichgräber and Van Reenen paper, particularly about the self-employed, but I want to stick to the theme of inequality at the top by moving to a recent IFS paper on top incomes. Here is a chart from the paper.



It shows total income for the 1% and 0.1% over the last hundred years. Their share fell almost continuously from WWI to around 1980 , and it then went back up over the 1980s and 1990s. Over the last decade and a half it has been erratic with no clear trend.


This is total pre-tax income, not just wage income, but income from employment accounts for most of the income of the top 1%. As Chart 3 from the paper shows, around ¾ of the income of the 1% comes from employment: it is only for the top 0.1% that falls to just over half. As the paper points out, only a tiny proportion of the 1% are CEOs. To quote (references to studies omitted)


“Instead, many of the top earners are working in highly profitable industries. 29% of wage earners within the top 1%, and 44% of those in the top 0.1%, work in financial services, compared with just 5% across the top half of the income distribution….This speaks to the increasingly well-documented international trend that increases in income inequality that have taken place since the 1980s have been primarily driven by increases in wage differences between firms rather than within them. That is, the top of the income distribution seems increasingly populated not by the most senior individuals from a wide range of firms, but by the employees of a narrower group of high-paying companies concentrated in, for example, the finance industry.”


The paper includes a lot of interesting detail, and at the end there is a very good discussion of possible ways to increase top tax rates. However I want to return to the theme of low real wage growth since the Global Financial Crisis and 2010 austerity. As the chart above shows, the income share of the top 1% has not been steadily increasing over this recent period. This implies that increasing top incomes do not account for much of the poor growth in median real wages over this recent period. The Teichgräber and Van Reenen paper confirms this (see Figure 3). Figure 5 shows that most of the decoupling for median wages occurred in the 1980s and the first half of the 1990s.


Thus not only has there been no decoupling between productivity and labour compensation in the UK, but the decoupling caused by higher income inequality at the top mostly occurred at the end of the last century, and does not therefore account for the slow growth in median earnings in the last decade and a half. So even for median real wages, the last dismal decade and a half is mainly the result of poor growth in output, rather than any shift to profits or growing inequality at the top. It has been a dismal period in itself, but also in comparison with most other G7 countries (for the US, see here).


This allows a nice characterisation of three political periods in terms of the overall economic cake and how it was distributed. Thatcherism, from 1979 until the mid-90s, was a period of growing inequality at the top as well as widespread unemployment, but because overall growth was reasonably good (compared to other G7 countries) real wages still increased. So under Thatcher we had a growing cake shared more unequally. Under the Labour government inequality at the top grew much less rapidly and unemployment fell, and until the Global Financial Crisis the economy continued to grow well. So under Blair/Brown we had a growing cake, as well as a major improvement in the NHS in particular. The big change under Conservative-led governments since 2010 has been poor growth in GDP and productivity, and a decline in public services. Since 2010 the cake failed to rise.


This is one reason why it makes sense for Labour to focus on the poor growth record since 2010. It also shifts the argument away from alleged (not actual) Labour fiscal profligacy onto what really matters for voters today, which is their stagnant or falling real incomes. When the cake fails to rise, it makes little sense to talk about how what is left is divided between wages and profits, but instead to talk about getting a better recipe. Even if Labour’s recipe for growth is not totally convincing, particularly when the Brexit ingredient is still in there, voters will think they have little to lose by changing the cook. But as this post also makes clear, if Labour gets into government it has to decide whether it wants to improve the post-tax incomes of the 99% by belatedly doing something about the shift in incomes away from most workers towards the 1% at the top.



Thursday, 4 August 2022

Why does the Bank of England appear to be ignoring its mandate?

 

The MPC has raised rates by 0.5%, and forecast both very high inflation and a recession. To many people this will come as no surprise. When inflation is high and expected to go higher, central banks raise interest rates to reduce inflation. It’s what they do. A recession is just an unfortunate consequence of that.


However the Bank of England has a mandate set by the Chancellor. Significantly, that mandate is set out in the eighth paragraph of their summary about today’s decision. It is worth quoting what it says in full:


“The MPC’s remit is clear that the inflation target applies at all times, reflecting the primacy of price stability in the UK monetary policy framework. The framework recognises that there will be occasions when inflation will depart from the target as a result of shocks and disturbances. The economy has continued to be subject to a succession of very large shocks, which will inevitably lead to volatility in output. Monetary policy will ensure that, as the adjustment to these shocks occurs, CPI inflation will return to the 2% target sustainably in the medium term.”


It is an odd paragraph, because its first sentence is (rightly) contradicted by what follows. Every economist knows it would be impossible to hit 2% inflation every quarter or year, and foolish to try, especially when energy prices are rising so fast and unpredictably. For that reason, the key mandate is given by the last sentence, and you could add that the Bank should try and make this return to medium term stability as painless (in terms of excess inflation and lost output) as possible.


The table below gives the path of inflation in the two forecasts published today that the Bank traditionally presents: one based on market predictions of future Bank decisions (yet more increases), and the other assuming interest rates remain unchanged at their new level.




22Q3

Q4

23Q1

Q2

Q3

Q4

24Q1

Q2

Q3

Q4

25Q1

Q2

Q3

Market rates

9.9

13.1

12.8

11.9

10.5

6.4

5.0

2.5

1.9

1.4

1.1

0.9

0.8

Flat rates

9.9

13.2

13.0

12.2

10.9

6.8

5.5

3.0

2.5

1.9

1.7

1.5

1.3


Now if the Bank were setting rates so “inflation will return to the 2% target sustainably in the medium term” (see above) then that clearly does not happen in either of these forecasts. In 2025 inflation is well below 2% and falling. I’m used to seeing Bank forecasts after they increase rates where at least one of these forecasts shows inflation nicely settling to close to 2% by the end of the forecast period. Not this time.


While most people will understandably focus on the very high figures over the next year, a comparison of the two rows will tell you something Bank economists always stress, which is that it takes time for changes in interest rates to influence inflation. So raising rates now will have little impact on inflation over the next year, which as the Bank shows is substantially a direct consequence of higher energy prices. What raising rates by 0.5% today does is to prolong the recession the Bank is forecasting, and this is why we see a collapse in inflation in 2024 and 2025 in these forecasts. Unemployment is expected by the Bank to be around 6% in three years time, and rising.


So it looks as if the Bank, by raising rates by 0.5%, is helping the economy stagnate into a prolonged recession with collapsing inflation well below the target and with rising unemployment. In fact it’s worse. Both forecasts above assume that energy prices stay high. The general expectation, and the assumption in futures markets, is that energy prices will fall back considerably over this period. The Bank provides an alternative forecast based on market expectations of interest rates where energy prices follow expectations in future markets. The level of inflation expected in 3 years time is then not 0.8% as above, but 0.3%!


So has the Bank departed from their mandate? That is a very serious charge, so I have been trying to work out what the MPC might say if I put that question to them. The first and obvious point is that MPC members are not bound by the Bank’s forecast. However if MPC members think that the Bank is too pessimistic on the length of the recession and medium term inflation they should really speak out, given how awful the Bank’s forecast is. A second obvious point is that the Bank could cut interest rates over the next year or so, which could avoid the collapse of inflation below target expected in 2025. But do they really believe that kind of very fine tuning works, and shouldn't they be open about what they expect to do? 


I want to go back to that rather odd paragraph that I quoted at the beginning. Why was that first sentence included, given that it was then immediately contradicted? The political explanation for why the MPC might raise rates today, even though they expect that decision to have very negative consequences later, is that with inflation expected to hit double figures they felt they had to raise rates. Hence the first sentence in that paragraph. But I really hope that is not the reason, because one of the justifications of having an independent central bank is that it is not subject to these kinds of short term pressures, although on this occasion our expected next Prime Minister has not been helpful in that regard.


When policymakers make an expected recession deeper and more prolonged through their actions, they need to provide very good justifications for doing so. Current high inflation is not a justification, as there is little the Bank can do about that. Their own forecast suggests that they are either raising rates excessively today, or they expect to reverse course fairly soon. Someone should really ask which of these is the case, or whether there is something else that I have missed.


Postscript 05/08/22

I missed one additional explanation for this inflation overshoot, which is that the Bank assumes current fiscal policy. Perhaps the MPC are assuming that the government will introduce a large additional degree of fiscal support for those on lower incomes, which isn't in their forecast, and this will stop the excessive inflation and output collapse they are showing. But the tax cuts promised by Truss, which go to the better off or corporations, provide much less stimulus. Excessive monetary tightening based on a guess of fiscal loosening is a dangerous game to play. 









Tuesday, 2 August 2022

Brexit supporters constantly deny that that problems caused by Brexit have anything to do with Brexit. Does this remind you of anything?

 

I hope this will not come as a shock to US readers, but one of the constants of UK culture is to laugh at the ability of so many in the US to believe nonsense. The number of Americans who believe the Moon landings were faked is a widely quoted example. More recently we have the QAnon conspiracy theory, where 17% of Americans believe “a group of Satan-worshiping elites who run a child sex ring are trying to control our politics and media”. We laugh because it’s assumed that the British are far too level headed to fall for such nonsense.


This illusion is often sustained by the lack of impact most conspiracy theories have on UK politics. The British don’t have an MP who is mad enough to promote conspiracy theories, as Republican Representative Marjorie Taylor Greene has done for QAnon ideas. Further evidence might be the acceptance from the Conservative party leadership, unlike Republican leadership, that man-made climate change is a real threat that requires policy action, although this is a difference in what is said more than what is done.


To see this is an illusion I suggest starting with this post from Chris Grey. It’s about the delays many UK tourists are experiencing trying to go to France. The evidence that Brexit is largely to blame for this is overwhelming, yet Chris notes “the speed with which patently nonsensical arguments about it have been spread, and the sheer bone-headed, brazen obtuseness with which they are clung to despite every effort to correct them.” [1]


This is not an isolated example. Just as the problems caused by Brexit are many, so the list of false claims promoted to make people believe that these problems have nothing to do with Brexit are numerous. These false claims often originate in Brexit supporting newspapers but they are invariably repeated by government ministers.


Most if not all of these problems caused by Brexit were foreseen and discussed by opponents of Brexit during the 2016 referendum, but at that time were rubbished by the Brexit side under the collective heading of ‘Project Fear’. In most cases what was then claimed as fear is now fact, and the general line taken by those on the Brexit side is that these facts are either not facts at all, or that these facts have some other cause that has nothing to do with Brexit. The most common generic claim is that Brexit problems are really just acts of revenge by EU governments who are spiteful that we left.


During the referendum campaign the use of the label ‘project fear’ was extremely successful as a way of dismissing expertise about what would happen after Brexit. But when these expert predictions largely turn out to be correct, continuing denial becomes something even more alarming. As Chris points out, it didn’t need to be this way. It would be quite possible to admit the existence of trade-offs. Brexiters could say ‘yes, Brexit has caused problems, but it also has advantages that outweigh those problems’. So why have most Brexiters decided not to talk about trade-offs, but instead pretend all of Brexit’s problems have nothing to do with Brexit (what I will call Brexit harm denial)?


One argument could be that project fear requires subsequent denial, given the number of Brexiters who denied these problems would occur during the referendum. This argument is unconvincing, because one of the surprising aspects of Brexit has been how little the mainstream media have used previous statements by Brexiters as evidence against what they say now. Being proved seriously wrong in the past seems to be no barrier to the broadcast media allowing the same people to pontificate about subsequent events. Right wing newspapers think nothing of publishing mutually contradictory headlines within weeks, let alone years.


A better explanation for Brexit harm denial is that using the trade-off argument will not cut much ice, once it becomes clear that the benefits of ‘taking back control’ are either close to an empty set, or instead involve doing things that are generally unpopular. In a period where many people are finding it difficult to pay their bills, abstract notions like sovereignty cut less ice.


However I suspect even this explanation does not get to the heart of why Brexiters continue to deny the reality of Brexit harm. Instead we need to recognise Brexit as primarily a populist project, and ask why populists tend to routinely lie. Populism aims to ascribe general feelings of discontent and powerlessness to one or a small number of causes (immigration, the EU, globalisation, liberal social norms etc), and in addition to assert that these causes persist because they benefit a ruling elite. Populists like to draw a dividing line between their supporters (who are true nationalists) and the rest of the population, who are alien in some way (e.g 'woke').


Generally that association between feelings of discontent and the claimed causes is either greatly exaggerated or incredible, and so the only way of convincing people otherwise is by lying. As long as there is a large enough proportion of the population that takes little interest in politics and understands it poorly, lying can be successful. We are programmed to overrate personal confidence, so the populist never shows any doubt, or weakness, or fallibility. Lying becomes bullshitting in the Frankfurt sense. The more confident the populist appears, the more they appear on the side of those to whom they are trying to appeal to.


Brexit appealed to those who felt left behind by advancing social liberalism (see the appendix here), and the locus of that discontent was immigration. EU immigration was blamed for reduced access to public services and low real wages, claims that were greatly exaggerated or incredible and so required the techniques of propaganda or populist bullshitters to successfully persuade enough people of their validity. As real wages continue to stagnate and access to public services has got worse since Brexit, the only hope Brexiters have is to continue in the same manner by denying reality and ascribing any Brexit problem to something other than Brexit. Brexit populists need to appear to be still on the side of their supporters.


Which prompts the question: what difference is there between the way Brexit is currently defended and conspiracy theories? Both deny reality, or ascribe events to incredible causes. Both stress the need to believe in their cause, and dismiss experts as involved in a self-interested conspiracy to dispel their belief. Every problem caused by Brexit is claimed to be part of a conspiracy by the EU to hurt the UK or by ‘Remoaners’ to smear Brexit. Both Brexit and many conspiracy theories have at their heart some emotional feeling, like lack of control or fear of the other (where other can include vaccines). Both are surprisingly resistant to evidence. (Surprising to anyone who understands how science works). In this light it is no coincidence that those who support Brexit are more likely to believe conspiracy theories, and that populists often attempt to appeal to common conspiracy beliefs. (For a more academic take on links between populism and conspiracy belief, see here for example.)


Once we see Brexit as akin to something like QAnon, then any smugness the UK might feel about conspiracy theories in other countries evaporates. [2] Brexit as a reality-denying faith has captured the UK’s party of government. [3] Unfortunately, unlike some conspiracy theories like those about moon landings, Brexit has done great harm, and its proponents seem intent to increase that harm by breaking the treaty they recently signed.


Does seeing Brexit harm denial as similar to a conspiracy theory change anything? [4] Let’s start with those who supply the misinformation. They are not going to give up anytime soon, and their influence on public debate should not be underestimated. For that reason alone it remains important to combat the lies with the truth, because that is one way of preventing more becoming true believers.


But true believers in conspiracy theories are generally unpersuaded by evidence, which is one reason why so many accept Brexit harm denial. (As footnote [2] points out, over a third think Brexit has had a positive impact on the UK). Ridicule is counter-productive, and calling true believers stupid even more so. The starting point with combating conspiracy theories is empathy with the underlying concerns that motivate the false belief. If I’m right that a key underlying concern motivating support for Brexit was a reaction to liberal social change and in particular immigration, then this is very hard for social liberals to do, particularly in the face of policies like trafficking refugees to Rwanda. [5]


The end point is that it will be both hard and will take a long time to significantly reduce the proportion of the population that accept Brexit harm denial. Because of our FPTP voting system that proportion will have an oversized influence on at least the next election. This realisation may be one reason why a recent poll showed 51% believing Starmer was right to commit Labour not to rejoin the Single Market or Customs Union, and only 24% disagreeing. That should never mean Labour joining in Brexit harm denial, but when a combination of the government, much of the media and over a third of the population accept what is akin to a conspiracy theory, those of us who like evidence led policy have to be realistic about our current predicament and recognise the importance of getting back a government that deals with reality rather than its own fantasy.



[1] The main cause of these delays are the requirement that tourists entering the EU from third countries, which the UK is after Brexit, to have their passports stamped. Before Brexit tourists could just wave their EU passport at an official. Multiply that small extra time taken by the number of tourists crossing the Channel between England and France in summer at a few specific points and you get long delays. Chris outlines the spurious stories that Conservative newspapers and ministers (including the two candidates to succeed Johnson as Prime Minister) have promoted in an effort to suggest that these delays have nothing to do with Brexit.

[2] Like most other conspiracy theories, Brexit has a minority appeal, albeit a sizable and currently very powerful minority. In July this year, 48% thought that Brexit had had a negative impact on the country, while 37% thought it had had a positive impact. (Less think the government is handling Brexit well, but this comparison shows that many ascribe Brexit problems to poor implementation rather than reflecting badly on their concept of Brexit.)


[3] If you suspect, following their leadership contest, that Brexit is not the only example where Conservatives are living in an imaginary world divorced from reality you may well be right.


[4] Looking retrospectively, it helps explain the strength of the second referendum movement. Arguing that this movement was very unlikely to succeed, or that its leaders had mixed motives, is really beside the point. Perhaps an analogy would help. Suppose Johnson had declared that Covid was a myth and refused to do anything about the pandemic. Would it have made sense to argue that he had the power and there was nothing people could do about it. Of course not. Suppose he had put that policy to a referendum and won it, would that make any difference. Of course not.


[5] This helps explain why Cameron was the worst possible person to defend EU membership. Not only did he find it difficult to empathise with low real wages or reduced access to public services because he had run the country for six years, not only had he participated in the lies that this was due to excessive immigration, but he had also made a point of ‘modernising’ the Tory image by championing issues like gay marriage.