Andrew Gawith and Susan Guthrie: Subsidising incomes stunts growth

Professor Paul Krugman wrote that the Great Compression of the 1930s and 1940s energised the US economy. Photo / Bloomberg

In 2007 Nobel prize-winning economics professor Paul Krugman identified the post-1980s as resembling the "gilded age" of the 1920s - one characterised by a high and rising concentration of income in the hands of a narrow elite. (1)

In contrast, the era of the 1930s and 1940s has been labelled the "Great Compression" because the gap in incomes between the haves and have-nots narrowed significantly.

The policies that delivered this compression - including a strengthening of collective bargaining, regulations which provided a floor to wages and high tax rates on capital - were followed by unprecedented income and output growth which persisted until the 1970s.

As Krugman stated it, "the Great Compression, far from destroying American prosperity, seems if anything to have invigorated the economy".

Krugman's book was published before the current global crises fully unfolded. However, others that have examined the recent crisis have identified the importance of policies that enhance the bargaining power of workers and address the effects of having heavily concentrated capital ownership.

In December the IMF published a report titled "Leveraging Inequality".

Its main premise was that a widening disparity in incomes in the United States (as pronounced before the current crisis as it was before the Great Depression) led to low-income households being saddled with high levels of debt.

Not only did workers need to borrow more to maintain their standard of living at a time when real wages were being eroded; an ever-increasing concentration of wealth in the hands of a few led to lower real interest rates (and a recycling of capital via debt towards those on low incomes).

This debt burden made the US economy (and others with similar trends) vulnerable to crisis. Among the policies suggested to prevent a recurrence was strengthening the bargaining power of workers and switching from labour income taxes to taxes on capital such as taxing land, natural resources and excessive profits in the financial sector.

The question is, do our current labour market laws and institutions deliver the wage "floor" Krugman and the IMF see as valuable to lifting output and incomes?

The fact that we have had to introduce a significant income subsidy - Working for Families (WfF) - suggests not.

The Employment Contracts Act 1991 undermined the bargaining power of workers, which probably goes some way to explaining why from 1992 to 2009 average real output per worker rose on average by 2 per cent a year but real wages (labour's reward from the output produced) rose at less than half that pace. That lower-wage workers have fared poorly is indicated by the fact that a declining share of the country's wage bill (from full-time work) goes to the bottom 50 per cent of workers.

The Labour Government recognised that wages were too low to live on and so it introduced WfF to top up the incomes of low-wage workers with families, but note, not all workers. In some cases WfF effectively doubles family take-home pay.

While WfF has definitely alleviated financial stress among low-income families, like most subsidies it has distorted market signals. Low-paid jobs are a traditional route for younger workers to get more experience. However, under WfF, low-paid jobs are more likely to be accepted by older workers with dependents: their living costs are higher and not normally covered by a low wage, but unlike younger workers their take-home pay (thanks to WfF) can far exceed what the employer pays.

The result is that relatively inexperienced youth get locked out of the labour market, contributing to the high rate of youth unemployment.

Experienced workers are employed in jobs that do not use their full potential (detracting from productivity growth). Furthermore, these workers are employed at artificially low wages thanks to WfF, to the detriment of those they are competing with (workers without dependents).

Rather than chasing the dream of matching Australian incomes, let's first make sure workers with families can live with dignity from the wages their employers pay them instead of having to rely on selective income subsidies from the Government.

That may involve giving workers more bargaining power to negotiate an increase in their share of national income.

That would be a step towards narrowing the distribution of income and wealth in New Zealand which has broadened over the past three decades and may be cramping our ability to grow. As Joseph Stiglitz (another Nobel Prize-winning economist), writing this month for Vanity Fair, states: "... growing inequality is the flip side of something else: shrinking opportunity. Whenever we diminish equality of opportunity, it means we are not using some of our most valuable assets - our people - in the most productive way possible."(2)

* 1) Krugman, Paul. The Conscience of a Liberal, W. W. Norton, New York. 2007

* 2) Stiglitz, Joseph E. 'Of the 1 per cent, by the 1 per cent, for the 1 per cent', Vanity Fair May 2011.

* Andrew Gawith is executive director of Gareth Morgan Investments and Susan Guthrie is a finance writer and economist.