Wage stagnation and the financial crisis

There was a very interesting and well-written article that I read a little while ago about wage stagnation, rising profits and the financial crisis. I can’t seem to find it again, so if any else knows the one, maybe they could point it out to me. It was about the US, rather than the UK. The basic narrative was that the increasing influence of neo-liberalism and the reduction in union power (and collective bargaining) meant that corporations were (from the 1980s onwards) keeping more of their profits than they had in the past. So, basically profits were increasing as a fraction of GDP while wages were dropping as a fraction of GDP.

So business owners, shareholders and investors now have more capital than they’ve had in the past. Of course they want to do something with this capital which, presumably, they will invest in the financial sector. Their consumers (who are also their employees), however, have less disposable income than they’ve had in the past. So what happens? Well, the financial industry sees all these people who could use more credit and who might like to buy houses. Sub-prime mortgages come into existence and credit becomes easier. People buy their houses and spend their credit on the very products made by the companies who’s profits are rising as a fraction of GDP. These people are, however, also the employees of these companies and their wages are dropping as a fraction of GDP.

So, at this stage corporations are winning on multiple levels. They’re keeping more of their profits than they have in the past (by not increasing wages at the same rate). They’re continuing to sell their products because of the easy credit that this extra capital allows, so they’re able to maintain their revenue streams and continue to extract their profits. Since this credit is essentially their money in the first place, they’re also earning interest on the money being lent to their own employees.

However, there’s a fundamental problem. If people’s wages aren’t rising while their debts are, there’s every likelihood that many won’t be able to repay their debts. Hence the credit crunch arrives when this starts to happen and the financial sector finally realises that the risk associated with the sub-prime mortgages and easy credit is much greater than they had initially realised.

Now, I appreciate that this applies to the US, but I recently saw an article on the Liberal Conspiracy website about wages and profits in the UK. It discusses essentially the same trend, which is illustrated in the figure below which I’ve taken from the article on their site. It’s certainly my view that we should be aiming to reverse this trend if we want to reduce the problems we currently have in our economy and possibly also in our society.

Graph showing the variation in wages and profits (net and gross) since 1960.

Graph showing the variation in wages and profits (net and gross) since 1960 (credit : Duncan Weldon, Liberal Conspiracy).

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2 thoughts on “Wage stagnation and the financial crisis

  1. “Well, the financial industry sees all these people who could use more credit and who might like to buy houses. Sub-prime mortgages come into existence and credit becomes easier. People buy their houses and spend their credit on the very products made by the companies who’s profits are rising as a fraction of GDP.”

    That passage perfectly summarises why the GFC occured. People took out loans, and couldn’t repay them. Part of the fault also lies with the financial institutions who lent money to people who clearly were a credit risk.

    Moving forward, how can we avoid a repeat of the GFC? People need to be encouraged to live within their means. This may mean that they should consume fewer goods and services, perhaps take fewer holidays and have more modest housing. Furthermore, credit providers (Fannie Mae and Freddie Mac and the like) should be more careful about their lending practices. Government should not give them perverse incentives (Bush and Clinton both had a role in these government programmes) to offer loans to risky people.

    • I think there are a large number of things that should be done to avoid a repeat. Certainly, relaxing the regulations didn’t help. Changing expectations would also help. But there are also issues related to income inequality and low-wages that need to be addressed. You can’t live in a consumer society without consumers. Either pay them more so they can spend more, change your expectations as a society, or – I guess – repeat the GFC at some point in the future.

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