Secular Stagnation?

Secular stagnation, the wage share, and asset bubbles Annamaria Simonazzi1 (Provisional) 1. Introduction: secular stagnation? Slow growth has been usually attributed to supply factors: a decline in productivity which is explained in turn by disincentive effects of welfare systems no longer attuned to the changed environment (globalization, technical change), excessive protection and regulation resulting in a too slow adjustment of labour and wages and a rate of innovation out of step with the rate of technical progress. By calling the supply-side story into question, Summer’s suggestion that “our economy is constrained by lack of demand rather than lack of supply” (Summers, 2014a) stunned the economic profession. In such a situation, increasing capacity to produce will not translate into increased output unless there is more demand for goods and services, and “training programs, reform of social insurance, [greater flexibility] may affect which workers get jobs, but they will not affect how many get jobs. Indeed measures that raised supply could have the perverse effect of magnifying deflationary pressures”. Summers advocates more government spending and employment, to take advantage of the current period of economic slack to renew and build out our infrastructure. Thus, the crisis has returned legitimacy to old discredited explanations based on demand, or lack thereof. Summer’s argument is based on the idea that the short-term real interest rate that is consistent with full employment has fallen to negative values. With the failure of monetary policy to enforce equality between investment and full employment savings in a “liquidity trap”, we may be stuck in a long-run equilibrium with underemployment and we are doomed to economic stagnation. The reasons of the fall of the “natural” or “Wicksellian” real interest rate lie in its standard determinants: (i) the savings-supply schedule, (ii) the investment-demand schedule, with the shift in the curves being explained mostly by demography and IT respectively. Low interest rates, in turn, may foster financial instability: “It may be impossible for an economy to achieve full employment, satisfactory growth and financial stability simultaneously simply through the operation of conventional monetary policy”. Bubbles are an alternative way for society to deal with excess saving when fiscal policy does not take up the challenge: the recent growth is thus “fragranced with hints of new financial bubbles” (Teulings and Baldwin 2014). Among the reasons affecting the propensity to spend and leading to the lack of demand, changes in income distribution, though mentioned, are not given by Summers their full weight. Indeed, the huge increase in inequality over the last three decades has refocused attention on income distribution as a factor affecting demand and growth. Measures to reduce income concentration at the top, so as to sustain effective demand in the rest of the population have been advocated by many unorthodox economists in the past and are now coming from the most unexpected quarters: the IMF (Ostry et al. 2014) now maintains that “lower net inequality is robustly correlated with faster and more durable growth”, and the Central bankers of the richest countries reunited in Jackson Hole have rushed in support of employment and wages2. “From her position as the world’s single most powerful economic voice, the chair of the US Federal Reserve, Janet Yellen, is forcing the financial 11 Dipartimento di Economia e Diritto, Sapienza University of Rome. 2 Appelbaum B. Central bankers' new gospel: Spur jobs, wages and inflation. http://www.nytimes.com/2014/08/25/business/central-bankers-new-gospel-spur-jobs-wages-and- inflation.html?wpisrc=nl-wonkbk&wpmm=1&_r=0; Apparently, even the austere President of the Deutsche Bundesbank, Jens Weidmann, has welcomed higher German wages, though strictly limited to some sectors (Frankfurter Allgemeine Zeitung July 30th, 2014). http://uk.reuters.com/article/2014/07/30/uk-germany-wages- weidmann-idUKKBN0FZ03U20140730 1 markets to rethink assumptions that have dominated economic thinking for nearly 40 years. Essentially, Yellen is arguing that fast-rising wages, viewed for decades as an inflationary red flag and a reason to hike rates, should instead be welcomed, at least for now”. Yellen’s new stance, that echoes that by another former Fed Chairman (1932-48), Marriner Eccles3, has forced Wall Street to re-focus as well. Judging from the articles in the financial press4, finance has become obsessed with a simple, easy-to-understand measure of American household health: wages. The paper argues that, with increasingly unequal distribution in income and wealth and fiscal policy proscribed, advanced economies are bound to stagnate. Monetary policy, conducted within a financially de-regulated setting, is more likely to produce bubbles rather than steady growth. Bubbles thus become the only way in which economies can grow. It is generally maintained that they can produce only short-run, temporary effects on demand, and negative, long-lasting effects on growth through speculative investment ending in waste, deleveraging and balance sheet recession. The paper investigates whether, and in which conditions, booms might activate a process of transformation and growth, and which policies may prevent or mitigate the disruptive effects of deleveraging. In order not to be misunderstood, it is not argued that bubbles are the best way to growth; the aim is simply to compare the disruption following the bursting of a bubble with the wasteland produced by austerity and secular stagnation. Section 2 reviews the literature on the relation between income distribution, demand and growth. It argues that financial deregulation has given rise two ways to exorcise the negative effects of a declining labour share on growth: exports and debt, which are creating cumulative disequilibria, possibly culminating in bubbles. Sections 3 and 4 analyse the need for bubbles and their impact on demand, in the short and in the long-term. The last section briefly compares the experience of three Eurozone countries – Germany, Italy and Spain – which have followed different patterns of growth. 2. Income distribution, demand and growth 2.1 The dual nature of wages. Demand-led growth theory has a long tradition5. In this approach, the dynamic of demand affects the level of output in the short and in the long run, through its influence on the creation of productive capacity (Vianello, 1985). A lower creation of productive capacity prevents insufficient demand from resulting in a sizeble and persistent under-utilisation of capacity, thus covering up the tracks of the lost production (Garegnani 1992). In Summer’s (partial) rediscovery of this tradition: “Perhaps Say’s dubious law has a more legitimate corollary – “Lack of Demand creates Lack of Supply” (Summers 2014b, p. 37) (figure 1). In the European context of the Stability Pact, by reducing the rate of growth of potential output, insufficient demand can impact on fiscal sustainability, as far as the reduction in potential output reduces the output gap, and hence the structural deficit (Boitani and Landi, 2014). 3 “As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth – not of existing wealth, but of wealth as it is currently produced – to provide men with buying power equal to the amount of goods and services offered by the nation’s economic machinery. Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.” (Eccles 1951). 4 M. Phillips, Janet Yellen’s Fed is more revolutionary than Ben Bernanke’s ever was. http://qz.com/247113/janet- yellen-is-a-more-revolutionary-fed-leader-than-bernanke-ever-was/ 5 Keynes (1936) is obviously the leading figure here. 2 Income distribution is regarded as a fundamental determinant of final demand, and, through final demand, of the inducement to invest. Given the Kaleckian assumption that the marginal propensity to save is higher for capital income than for wage income, consumption is expected to increase when the wage share rises6. However, wages have a dual function: they are a cost of production as well as a source of demand. A higher real wage increases consumption but may also reduce investment, in so far as a lower profit share weakens the incentive to invest7. Thus, any exogenous variation in the real wage has contradictory effects on the level of aggregate demand. Bhaduri and Marglin (1990) distinguished between a wage-led demand regime, when an increase in the wage share leads to an increase in aggregate demand in the short run, and a profit led demand regime in the opposite case8. Most empirical studies find that domestic demand regimes tend to be wage-led, i.e. the effect of a pro-capital redistribution of income on demand is negative because consumption is much more sensitive to an increase in the profit share than is investment (Stockhammer 2011). However, in an open economy, external demand can provide a vent for surplus, absorbing the excess savings that would arise when the purchasing power of wages is faltering. Indebtedness can provide yet another support to consumption when the wage share falls. Figure 1 Actual and potential GDP in the Eurozone. Source: Summers (2014b). 6 In the models of Kalecki (1971) and Steindl (1952) an increase in the wage share unambiguously leads to an increase in effective demand.

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