One of the obvious problems being debated among policy-makers, economists and commentators is the low share of labour income compared to that of the wealthy, property-owning class, or the growing inequality of income, a phenomenon particularly notable in the US and other developed countries. This pattern is typically accompanied by growing wealth for the rich, especially growing equity values.
The first enquiry is to get the facts about wage income. Median wage income is a good proxy for the relative income of middle-class and poor people, because we know rich people’s incomes have been rising in recent decades (as more fully shown below):
Here is a graph showing median wage income in constant dollar terms:
What we see are various fluctuations, including three periods of wage growth, namely1982-88, 1996-2002 and 2014-2018.
For starters, it is clear that the simple narrative that wages and salaries didn’t grow is not correct. There has been overall growth in real income of 14% since 1980. As we will see below, the lion’s share of that went to the rich. But even so, it is useful to see what happened to cause intermittent periods of income growth, as I do a little later.
But first, let’s look at the overall trend of declining income. A major contributor to this has been the growth in true money supply in the US, shown on this chart:
The real money supply (which includes demand deposits with banks, ie “money” that banks’ customers are entitled to demand, even though the funds do not exist, typically 10 times the amount that banks are required by law to hold as cash). The money supply so defined has in recent decades increased in tandem with a decline in US federal Funds interest rates:
Lowered interest rates self-evidently encouraged customers to borrow more from banks. The more money is borrowed, the greater the impact of fractional-reserve banking. That is because borrowers spend more money in the market, which in turn finds its way back to the banks as deposits. That, in turn, enables banks to lend out more money.
It is clear that the early 1980s was the real watershed in this regard. Declining interest rates made it more and more attractive for businesses to borrow money from banks.
This is also the time during which a decline in total factor productivity has been noted:
This also was the period showing a trend for businesses to buy shares in businesses (including their own shares) instead of investing in research and development, training, new technology and new plant. Companies’ buy-backs of their own shares increased from about 5% in 1980 to close to 90% in 2000. The culture that took hold since the seventies has been one where consumption has been fuelled by debt, not productivity.
This is all no coincidence. It is a fundamental principle of economics that production has to precede consumption. Low interest rates effectively open the door to money creation out of nothing. That encourages malinvestment in the form of share buying instead of building factories (to simplify) and fuels consumption. The Mises Institute explains:
“On account of loose monetary policy and the subsequent increase in the money supply, the process of wealth transferring from wealth generators to the holders of the newly created money is set in motion. Since this new money was generated out of “thin air,” nothing was exchanged for it, hence we have here an exchange of nothing for something.
This means the holders of newly printed money have taken from the pool of real wealth without giving anything back in return. Consequently, this puts pressure on the pool of real wealth. Similarly to government, these holders of newly created money are engaged in non-wealth generating activities. (These activities sprang up on the back of money pumping. In the free unhampered environment these activities, which ranked as low priority would not be undertaken.)”
It is hardly surprising, then, that it is precisely the period from 1980 onward that was characterised by declining wages for the middle class and the poor. The reason for that is simply that the relative value of workers’ salaries and wages was watered down because the wealthy drew more dollars as a proportion of the total number of dollars in circulation.
It was also the period during which the different income quintiles parted ways, whereas before their income growth was very similar:
Indeed during the period from 1980 the top 10% outgrew the rest of the economy by a huge margin:
Money supply fuelled by low interest rates is not the end of the story however. An analysis of federal spending in the US also correlates with wage growth and decline, as a comparison of this chart, with the median income chart above, shows:
The pre-1980 era saw rising state spending and declining real wages.
Then the Reagan years (1980-88) were marked by declining spending and an increase in wage income.
Over the next 4 years the trends of both state spending and income growth were reversed.
The Clinton era (1992-2000 – circled on the chart), was marked by deep cuts in government spending measured as a percentage of GDP, and wages growing in response to that.
During the era of Bush (2) (2000-2008), spending rose sharply. Wage income remained largely flat, except for a spike right before the 2008 crash.
Understandably, post-crash wages declined between 2008 and 2012.
Then they increased again as the Obama administration managed to cut federal outlays.
So in most periods wage growth largely formed a mirror image of government spending. The explanation for this seems to be that the more the government spends, the less the private sector is able to spend on productivity-enhancing research and development, acquisition of technology and training of workers.
The exception to some extent is the 2008 year, which seemed to be a blip in this pattern. That was the year in which the Greenspan era reached its zenith. The priming of the economy created a once-off spike, after which it plunged to new depths.
Long story short, in 2008 Greenspan’s effectively negative interest rates and the government policies designed to encourage a national splurge on new mortgage bonds resulted in the biggest financial collapse since the great Depression. For a brief period it seemed as if every indicator – home ownership, employment and income, seemed to hold the line. But it could never last. The plunge in wage income between 2008 and 2014 was a sickening drop.
Now let’s interrupt the monetary narrative for a moment, and consider the impact of economic freedom, ie the degree to which individuals are free to engage in market transactions as measured by institutions like the Fraser Institute.
To help with the comparison, I’ll use the same periods analysed above, namely the respective presidential terms:
1980-88: During this Reagan era US economic freedom increased from 7.92 to 8.40, which, together with the decline in spending, helps to explain why wage income increased handsomely.
1988-92: During this term of Bush (1) economic freedom remained high. This was however offset by significant increases in federal spending, so that in the net result wage income declined during this period
1992-2000 (Clinton): This was a good era in that economic freedom was high, and in fact increased, and spending was cut. It is no surprise that wage income grew.
2000-2008: During this period (Bush (2)), economic freedom declined, and spending rose. Wage income trended downwards.
2008 to 2014: This era (under Obama) saw a significant decline in economic freedom. Despite his reining in spending somewhat, employment income dropped.
2008 to 2014, importantly, was also the period of zero interest rate policies (ZIRP) and quantitative easing (QE), money-printing mechanisms by which the Fed loaded its balance sheet, as this chart shows:
The growth in the Fed’s balance sheet (which was made up by growth in equities and similar instruments) caused an unprecedented surge in buying on the NY stock exchange. This in turn caused massive growth in the value of shares, as the next chart shows:
To summarise then:
The era of relative wage decline for the middle and poor sections of the population was introduced in about 1980, when the decline in the Fed’s interest rates and consequent money supply growth began. The broad trend of declining income for the bottom 90% has continued until now.
But within that broad trend there have been multiple fluctuations that partly correlated with government spending: the higher the spending, the lower the wage growth, and vice versa.
The growth or decline in wage income also correlated with economic freedom. The freer the economy during a particular era, the better the wage growth, all other things being equal.
What the developing world (of which the US is a good prototype) thus needs, is a return to a real (as opposed to a paper) economy, where federal interest rates are a reflection of market demand (and not government fiat), where the money supply is stabilised and where state spending is reduced, making more available for private-sector investment.. That would incentivise private sector firms to spend on real productive capacity, as it will no longer be cheap and easy to buy shares in other companies or one’s own, on credit.
A good dose of economic reform (towards freedom) and reductions in government spending are also crucial.
Together these factors will improve productivity, the only realistic way to turn wage growth around.
One should not hold one’s breath. There are far too many vested interests (central bankers, politicians, wealthy shareholders and pension funds, to name but a few) gorging at the feeding trough.