Real wage cuts in the UK recession (a questionnaire of sorts)

2008 and after: -8.5%

That measure of wage decline is from John van Reenen (pdf, useful powerpoints on UK productivity), citing Martin and Rowthorn (2012).

Now I am all for the UK trying ngdp targeting, or for that matter well-targeted fiscal policy, or both.  I never favored their *tax increases*, often misleadingly labeled “austerity” for political reasons.

I would, however, like to get a handle on Keynesian thinking here and thus the questionnaire aspect of this post.  In the traditional Keynesian story, stimulus lowers real wages through nominal reflation.  Is that the Keynesian view here?  If so, why do Keynesians believe that British real wages need to fall more than 8.5%  Why did they need to fall 8.5% to begin with?

I understand this view and accept it in part myself: “Real wages in the UK were way too high to begin with because the country was producing well above potential output.”  Yet Keynesians have been very unwilling to make that argument.

I also have seen Keynesian-style thinkers argue that inflation will make labor markets tighter and raise real wages.  This is either incoherent or at the very least underargued (there is a possible version of the view if you think prices are nominally sticky but wages are not).

In a multiple equilibria view, new information is revealed about the British economy from the financial crisis, and that economy collapses to a lower trust/productivity/risk-taking point, plus it loses some relative weight in its high productivity sectors, such as finance.  That too I understand and also partially accept, though again I don’t see current Keynesians pushing that line (though it need not run counter to Keynesianism, broadly construed).

I also understand what it would look like to mix Keynesianism with an extreme form of a stagnation theory, more extreme than I hold myself.  But again, I just don’t see that view out there.

So what is the current Keynesian view on why British real wages need to be falling so much?  I would like to better understand the alternatives to my views.

I appreciate your help in the comments.

Addendum: Scott Sumner offers very good commentary.

Comments

AFAIK, Keynesians idea of fiscal spending during a recession is about soaking up idle resources (labour and capital). I don't think they believe it will necessarily be inflationary, nor will it accelerate a reduction in real wages. In fact, it is meant to keep real wages higher than they would be otherwise, since the labour market is tighter, and output is higher.

If real wages already have fallen that much, why won't the private sector just hire them? (And why should the real wage be needing to fall more to induce private sector employment?) It is begging the question to call them "idle resources" plus keep in mind that good fiscal policy will accelerate V, at least for some while.

Maybe one first has to ask a question that has an unpleasant answer first: Why did England propel itself into austerity. The unpleasant answer may be that it had to step in and either purchase assets from banks to keep them afloat, or purchase an ownership share of a bank to infuse capital into it. After all these activities used to support banks, guess what: the state's fiscal balance sheet looks out of whack. At that point: aha, we need to practice fiscal austerity, because, look, we have more debt.

So, if we start at the cause of the financial crisis and then later state fiscal crisis, perhaps we should look at reducing the wealth of those whose assets were protected by the state: bondholders, depositors, and shareholders of financial institutions. Perhaps they should face some austerity first before either taxpayers or those who have used or relied upon government services in the past.

Perhaps then we reach a different equilibrium: financial asset managers and bankers are paid less, and rewarded for not putting their institutions at risk.

Oh, I adore surveys. To be difficult though, I am going to answer in the form of a question:

If you believed there was currently a negative output gap (an economy was producing below its potential) in a country for any of a sundry reasons (debt overhang, credit restrictions, pessimism, uncertainty, less trust, less mobility, less family formation, etc., ect.), what would you suggest as an economic policy adviser? (Being mindful of current political and institutional constraints.) Might you end up sounding like a Keynesian? And are lower real wages really the *goal* of any policy?

Why, oh why, Claudia, do economists never mention oil?

UK oil production is down by nearly half since 2007, by more than half since 2006, and by 80% since 2000. UK oil consumption is down 8% since 2007, 11% since 2006. And of course, the OECD consumer is contributing 56% of the non-OECD's increased oil consumption since the beginning of the Great Recession. Oh, and I'd add that all the countries in systemic financial crisis are oil donors (ceding consumption); and all the oil recipient countries are not in financial crisis. Is there some link? Maybe oil consumption? Apparently not, if you ask the 62 economists who responded to the recent Foreign Policy poll.

A friend of mine walks into the office the other day and says to me, "You know, I only know two things to invest in: oil and distressed properties." Bingo.

So, if you'd like an oil and gas take on our malaise, Claudia or Tyler, I am happy to come visit at the DC Fed or GM and give a presentation on oil and the economy--an updated version of the one I made to John Williams and the SF Fed in July 2011. (For GM, I would probably do an afternoon seminar on oil supply and demand forecasting in a supply-constrained world. Might as well do some teaching if I have students.)

And while I'm at it, for you New Englanders, I'll be at the 4th Annual Biophysical Economics Conference at the University of Vermont in Burlington this Saturday. This is something of a granola conference (as opposed to, say, my industry conferences), but it should be fairly interesting for the left of center and is the only one affordable to the mortal (or at least, non-corporate) man.

I'll be presenting something like "When the Oil Industry Hits the Wall". I'll be commenting on

- Goldman Sach's research note of Oct. 17 regarding their reduced oil price outlook ("A cyclically tight, but structurally stable oil market"). This is important because it repositions Goldman as a structural bear in the oil price market--and that has implications for upstream spend; and related to that

- Jefferies note on the OFS companies, specfically noting that Schlumberger and Baker Hughes are looking to cut capex (in a high oil price environment!)

- and relating to these to my April 17th post on Platt's Barrel blog (http://blogs.platts.com/2012/04/17/the_barrel_brin/)

The gist: It looks to me like we've run out of room on the oil price, and with it, industry capital expenditure growth. And that means declining productivity in the field can't be offset with higher oil prices. To put it in words even an economist could understand, that's bad.

This is all my self-promotion for today. As Yogi Berra said, "If you won't do your own self-promotion, who will?"

Stephen, my double etc. was meant to underscore the incompleteness of the list. Thanks for the references. Of course, this is a topic of interest.

I wanted to also note Simon Wren-Lewis post in response. A more coherent argument of what I was trying to hint at in my comment: http://mainlymacro.blogspot.com/2012/10/a-short-answer-to-tyler-cowens-question.html

Woops... sorry for the name misspelling, Steven. Need to get my coffee.

This is very much complicated by the puzzling behaviour of productivity in the UK over the same period (just look at JvR's slide 25). Real wages may have fallen by 8.5%, but the weakness in productivity means labour costs haven't fallen by anything like the same amount. And the strength of employment growth over the past year means that the labour share has actually risen, not fallen.

(As an aside, worth noting that, relative to a pre-crisis trend, productivity in the UK looks remarkably like productivity in the US during the Great Depression, which nosedived until the mid 1930s before recovering spectacularly, alongside demand, in the second half of the decade).

I Tyler is charitable to a fault, and in the case the emphasis is definitely on "to a fault." Just come out and say it: most Keynesians are too dogmatic. They have one hammer in their arsenal (fiscal policy) so everything looks like a nail to them.

(Yes, the same is true of most conservative economists as well, but this post is about keynesianism).

I propose that during recessions the real wages of tenured college professors should decline so as to stimulate the economy.

We can run a test on the effectiveness of this policy on these tenured academic guinea pigs, or, if you do not want to have experimenter form an attachment to them, call them rats.

The marginal value of a worker to an enterprise varies greatly based on the demand for their products. If wages fell 8% and demand was on the status quo path the market would clear.

It sounds like your metal model of keysianism is one of homogenous households without significant nominal debt, (or without borrowing constraints, whether from creditors or personally imposed based on estimates of their employment prospects.) I don't know for sure about the UK, but in the US much of the money from the delta of wages & productivity has ended up sitting in corporate bank accounts.

Also, just because average wages have gone down dies not mean we have actually settled at the new lower wage equilibrium, which should be quite obvious from the unemployment level. Signalling and game theory about this have been discussed on this very blog.

Let's just throw this fact onto the pile -

'Dividend payments in the UK hit highest quarterly total of £23.2bn, up 10.4 per cent in the third quarter compared with last year, according to Capita Registrars.

Capita has increased its headline forecast for the full year by £300m, which would push the total dividends for the year to £78.6bn, including additional special dividends. This would surpass the pre-crisis peak of £77bn, the previous record annual total.'

http://www.moneymarketing.co.uk/investments/uk-dividends-hit-new-record-in-q3-2012/1060000.article

Or let's just say, someone is profiting from those pay cuts, it would seem.

I think an older economist, who spent a lot of time in England, might be worthwhile to bring into the discussion.

This isn't about 'austerity.'

Hasn't there been some substantial research showing that some of the typical policy recommendations from Keynesian economics are only effective in large, closed economies? Particularly that multipliers are low in open economies like UK. Might austerity measures being further depressing the economy driving the market clearing real wage further down, a downward spiral so to speak

"In the traditional Keynesian story, stimulus lowers real wages through nominal reflation. Is that the Keynesian view here? If so, why do Keynesians believe that British real wages need to fall more than 8.5%"

I am confused. I don't want to go into the theology of what is traditional Keynesianism, what JMK would have thought, or whatever, but: isn't the basic thesis simply that more nominal demand would create more real output? It is not specifically a statement about real wages, just a belief that we have still enough idle resources that nominal reflation would be significantly real ... I don't quite understand why Sumner has stopped going on about Irving Fisher - he used to far more - but the fact that liabilities are nominal is at least as important as wages being sticky.

Van Reenen is a good economist. His slides make the case that there hasn't suddenly been the discovery of submerged productivity problems. The employment 'paradox' is easily explained by a combination of insufficient demand, very flexible labour markets, difficult credit (the combination of the last two biases firms towards the extra, easy-to-fire employee, not the difficult-to-finance capital that would be productivity enhancing).

I still don't get what the case is against extra AD in the UK economy (or what Sumner's evidence is for structural-problems-from-a-distance). A hypothetical question: can you imagine people saying in 2 years "The problem with the UK economy is they had too much AD"? I can't.

Too much AD?

Is that even a theoretical possibility in a Keynesian framework?

Of course- inflationary gap! (I never said it was a good possibility)

On Sumner's comment, on MR reader writes in to me:

"You can find average hours worked for the UK here, table HOUR01

http://www.ons.gov.uk/ons/rel/lms/labour-market-statistics/october-2012/index-of-data-tables.html#tab-Hours-of-work-tables

According to the ONS, it appears that average hours worked, taking into account full/part-time mix, has stayed surprisingly stable
throughout the recession. As far as I can tell, the proportion of the employed working part-time rather than full-time has increased
slightly (from about c.25.5% to c.27% of all employees, calculated from table EMP01 here

http://www.ons.gov.uk/ons/rel/lms/labour-market-statistics/october-2012/index-of-data-tables.html#tab-Employment-tables),

but not enough to make a big difference. Unless I'm reading this data wrong (or the ONS is wrong, which should always be considered a possibility) then hourly wages must be substantially lower than at the peak."

Simon Wren Lewis has answered this question many times over - http://mainlymacro.blogspot.com/

"In the traditional Keynesian story, stimulus lowers real wages through nominal reflation. Is that the Keynesian view here?"

I would think not. According to Krugman, "The key to Keynes’s contribution was his realization that liquidity preference — the desire of individuals to hold liquid monetary assets — can lead to situations in which effective demand isn’t enough to employ all the economy’s resources."[1], and "Well, the marginal benefit of stimulus is that it adds employment and output.".[2]. Therefore, I conclude that Keynesian stimulus works because there are unused resources, so the government can use them without crowding out private investment, and that the money it spends on it will result in lower liquidity preference.

[1] http://krugman.blogs.nytimes.com/2008/11/30/the-greatness-of-keynes/
[2] http://krugman.blogs.nytimes.com/2009/07/11/marginal-thinking-about-fiscal-stimulus/

That's great news. We can just keep building condos anywhere and everywhere and handing out student loans for open-admission colleges and pouring money down bankrupt municipal hellholes and keep those idle resources humming. I'm sure there's no better use for that capital/labor that the market can figure out.

"If so, why do Keynesians believe that British real wages need to fall more than 8.5% Why did they need to fall 8.5% to begin with?"

Because Keynesianism is a political philosophy not a an economic one. Keynes himself wrote the General Theory as an argument to try to get miners to lower their wages.

?? What is the evidence for this? Keynes argues that wage cuts can be destructive, as it sets off a deflationary spiral.

Say UK has a bigger MEC shock, due to oligopolistic banking + shock in finance. So the bad equilibrium unemployment is much higher than the current 8%. The NGDP fall that Treasury + BoE has to fight is bigger.

Now UK manages 8% unemployment (and better employment : population ratio) with worse recovery of GDP. How? With lower real wages.

What's the story of this recession? High corporate cash balances, high corporate profits, and a declining wage share of GDP. This is true of all economies. In the UK this results in lower real wages. In the US it results in lower employment:population ratio (and a worse unemployment rate, relatively speaking). Neither the lower wage nor the higher unemployment is macroeconomically efficient, inter-temporally speaking. Even with the lower MEC. So, we're back to the point where what we want to explain is lower NGDP and lower RGDP, and leave the connection between GDP & employment/unemployment to different degrees of labour hoarding, different labour markets, different part time work etc.

The lower productivity and the lower real wages are both 'choices' that the UK labour market has made. They could easily have the same GDP/price dynamics with different (higher) levels of real wages and unemployment.

A short comment: broader GDP inflation has been about 2 to 3% less than consumer price inflation, largely due to VAT increases. As people do not only produce market goods and services for consumption but als other stuff, like investments and often very highly valued items like education and clean streets wages should not be deflated with the consumer price index, as the article does, but with the GDP-deflator. The gap gets less wide! To me, however, the weird thing is how little British wages increased during the entire last ten years, when recalculated in Euro's. Even less than in Germany. And the British wage level (average (!) hourly wages costs) are only about two thirds of the level in GermanyFranceTheBelgiumsTheNetherlandsIreland.

Might this be what you get when you embrace an economic philosophy which pays more (attention) to mooching managers than to the real inventors, makers and sellers? But that as an aside. The purchasing power of hourly wages is low, real wages are declining but consumption is up, low wage jobs are on the increase and the trade deficit is on the increase. Haven't we seen this before? Spain? The Baltics? Ireland? Is German capital invading the UK? Seems so. I could not track this down at the Bundesbank site as a link to a crucial databank did not work (the Eurostat data do not contain a break down of the financial balance of the balance of payment by country but are consistent with this view: rapidly increasing inflows of money into the UK. Mind, these German banksters (google 'Deutsche bank' and 'fraud') are now even buying diamonds - think of boring second hand garbage instead of risky, exiting, future changing new stuff!). So, I do not exclude however that the present UK non-decline is financed by private borrowing and foreign capital. Which renders your question obsolete. Real wages are down - but people probably keep on spending by financing this with borrowed German capital. Take a long short on the pound...

Bytheway and about these financial institutions: google 'Fisim' and think about what happens to the national accounts when the central bank lowers interest rates and provides LTRO's.

Anyway - we should finally change our institutions in a way that enhances the probability that companies pursue long term thinking and new production instead of short term thinking and confusing inflationary increases in prices of second hand stuff like houses, gold and diamonds with real prosperity.

Question: what do you think of the fallacy of exogenous money?

I agree with Felipe above, when he says,”“In the traditional Keynesian story, stimulus lowers real wages through nominal reflation. Is that the Keynesian view here?” I would think not.”

Plus I think Simon Wren-Lewis answers your questions well.

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