Financial Times (Leaders & Letters page), 17th January 2007
Andrew Smithers response to Jagdish Bhagwati piece entitled “Ask the expert: US wage stagnation” FT.com 9 January 2007.
Sir, Jagdish Bhagwati has suggested that it is not globalisation but labour-saving technology that puts pressure on the wages of the unskilled (“Ask the expert: US wage stagnation”, Ft.com January 9). Certainly the data do not support the argument for globalisation, and I would like to suggest that the main factor affecting the labour share of output in the US has been currency intervention.
Rapidly growing economies naturally have rising real exchange rates. This has been impeded by currency intervention, notably by China, while so far sterilising the monetary consequences to prevent inflation in China. This has depressed the relative prices of goods and services where China has a comparative advantage, notably manufactured goods. These, as I showed in a response to Martin Wolf, have very high capital/output ratios relative to non-traded goods and services.
The impact on relative prices has had several interesting results. First, the US and the UK have been able to have the lowest investment ratios and faster gross domestic product growth rates over the past 15 years. But only at the expense of large and growing trade deficits.
Second, their economies have been able to operate with narrowing output gaps, without increasing inflationary pressure.
As profit margins move with output gaps, this has allowed them to trend upwards – as they have been doing since the late 1970s. (For work on the connection between the labour/profit share and inflation see Inflation Dynamics and the Labour Share in the UK by Nicoletta Batini, Brian Jackson and Stephen Nickell, published by the Bank of England External MPC unit discussion paper no 2, November, 2000.)
Third, low inflation and falling unemployment are the ideal conditions for high financial profits, notably from consumer lending, particularly with the associated increase in house prices. Financial profits have been the major factor in rising profit margins.
Fourth, the swing away from manufacturing profits has hit the major source of union-supported median wages. Wage data suggest that low and high wage incomes have risen relative to the median, with high wages in finance being readily observed.
Finally, claims that China’s entry on to the world scene has caused profits to rise by increasing labour supply relative to capital do not fit the data. The labour share did not rise sharply ab initio only to fall away over time, and real interest rates have been on a falling rather than rising trend. (The entry of China seems to have boosted the supply of savings rather more than the demand for capital.)