When the leaders of the world’s most powerful economies meet at the Group of 20 summit in St. Petersburg, Russia, on Wednesday and Thursday, they face an economic puzzle only half-solved. Co-ordinated monetary and fiscal stimulus by the G20 in 2008 and 2009 narrowly prevented a repeat of the Great Depression. However, almost five years after the onset of the global financial crisis, the world economy remains mired in slow growth and high unemployment.
The latest projections from the International Monetary Fund are for weak growth due to the recession in Europe, the weak recovery in the United States, and a marked slowdown in large emerging economies such as China. The conventional view is that growth is being slowed by the need for households and governments in the advanced industrial countries to reduce high debt levels, but will begin to pick up as demand slowly revives and as business regains the confidence to re-invest.
Some G20 leaders, such as U.S. President Barack Obama and Prime Minister Shinzo Abe of Japan, favour greater fiscal stimulus; others, including Chancellor Angela Merkel of Germany, British Prime Minister David Cameron and Canadian Prime Minister Steven Harper, support continued fiscal austerity. Few observers expect any decisive change of direction to be announced in Russia next week.
While a relaxation of fiscal austerity would be welcome, the more important point is that most G20 leaders have failed to fully grasp the underlying cause of stagnation. In a nutshell, this is the fact that there is a large structural gap between the ability of the world to produce goods and services, and the ability of the world to purchase those goods and services.
Earlier G20 statements have flagged the important point that, as stated in London in 2009, “growth, to be sustained, has to be shared.” The Los Cabos Declaration last year stated that “jobs with labour rights, social security coverage and decent income contribute to more stable growth.”
In the Golden Age of postwar capitalism, growth was sustained by a virtuous circle in which rising productivity fed through into rising real wages. Increased demand by households sustained high levels of business investment, which in turn raised productivity, setting the stage for continued expansion.
This virtuous circle has been broken by the large shift of income in most countries over the past 30 years from wages to profits, and from ordinary working families to the very affluent. Household demand became dangerously dependent on an unsustainable growth of debt and financial bubbles.
In an important paper just published by the International Labour Office, University of Ottawa economist Marc Lavoie and Kingston University’s Engelbert Stockhammer argue that global growth is led more by higher wages than by higher profits, since there is generally a higher propensity for wages to be spent than for profits to be re-invested. Today, this is especially the case given that in many countries (including Canada), we see high levels of corporate savings combined with low investment rates, even though profitability is high.
While higher wages could potentially erode profitability and thus undermine investment, the paper argues that higher wages would boost demand and business confidence, and spur businesses to invest in capital and skills so as to raise productivity. The key conclusion is that a global increase in wages (supported by concerted government action to support labour rights, higher minimum wages and enhanced social security) could set the stage for a more significant and longer-lasting economic recovery.
One obstacle to such a strategy is that some economies (Germany and China are the most important examples) can grow by repressing wages in relation to productivity since they run large export surpluses, thus contributing more to global supply than to global demand. But all countries cannot run export surpluses at the same time, meaning that global growth will tend to stagnate in the absence of temporary financial bubbles of the kind seen in the recent past.
The idea that the global stagnation we are still experiencing is deeply rooted in income inequality and the weakness of labour has been cogently argued by leading economists such as Joseph Stliglitz; this notion increasingly influences the analytical work of such mainstream institutions as the International Labour Organization, the International Monetary Fund and the Organization for Economic Co-operation and Development. But the political obstacles to an alternative economic agenda remain immense.
This article originally appeared on the Globe & Mail's Economy Lab.
Photo: Dmitry Lovetsky, AP.