Low Wages Leave Economy Vulnerable to Recession

Low Wages

Capitalism has a flaw in its operating system. Karl Marx called it the problem of “Underconsumption.” He pointed out that each company tries to keep production high and wages low. Therefore, the value of the products produced are always greater than the value workers receive in wages, leaving some products not purchased. The less efficient employers then lose money and either close down or lay-off workers, further reducing the societal value of workers’ wages. Employers can only avoid this slump in sales by continually finding new markets. Marx predicted that low wages would cause capitalist economies to frequently fall into recession.

A few years after Marx wrote these words, the two most advanced capitalist countries, England and France went through what historians call “The Long Depression.” More a period of slow growth with high unemployment, this period lasted for 23 years between 1873 and 1896. It was touched off by a severe recession in the U.S. in the fall of 1873 that lasted for 63 months. At its peak, unemployment in the U.S. reached about 14%. While America finally began growing again, England and France remained stuck with very slow growth, featuring high unemployment and low wages. Searching for new markets for industries that could not sell all they produced, all three countries began acquiring colonies. For example, the U.S. acquired Hawaii, the Philippines, Puerto Rico, and Cuba during the 1890s. (I have a detailed analysis of the U.S. in the 1890s in Chapter Six of my book Perils of Empire: The Roman Republic and the American Republic.)

The Keynesian Prescription for Underconsumption

John Maynard Keynes saw the same issues re-surface during the Great Depression and characterized the problem as a question of “Effective Demand.”  Rather than seeking to sell excess products by forcing other countries to become new markets, Keynes said nations could close the gap in demand for products by having their governments engage in deficit spending. Keynes’ ideas gained wide acceptance after WWII. The U.S. and many other countries borrowed money to spend on social products like health care and on military products like aircraft carriers. These policies produced energetic economic growth for 25 years and (coupled with the spread of labor unions) lifted both workers’ wages and corporate profits.

Unfortunately, by the 1970s, the old flaw reappeared on an international scale. The western European countries and Japan, fully recovered from the devastation of WWII, were again producing more products than their workers could buy. To keep their economies rolling, the most sophisticated industries in those countries concentrated on selling to the U.S. which, in the name of free trade, had few restrictions on imports and ran large trade deficits in the 1960s.

The strain of these deficits led President Nixon, in 1971, to take the U.S. off the gold standard and devalue the U.S. dollar. He was hoping to boost the ability of U.S. employers to sell their products overseas. This and the oil price shocks generated by the formation of OPEC in the 1970s triggered very high inflation rates and high unemployment. This breakdown of the Keynesian method led to the Reagan era and the end of New Deal Democrats. (I discuss this extensively in Chapter Two of my book The Roots of Defeat.)

Wages Stop Rising and Growth Slows

With profits continuously pressured by foreign competition and rising oil prices, in the 1970s U.S. employers began a long process of reducing their wage costs. Breaking the power of unions, blocking increases in the minimum wage, outsourcing production to low-wage third world countries, and other actions have had a big effect. Between 1973 and 2007, the real income (after inflation) of 90% of U.S. households grew by less than 1% per year. To gain even this small increase, the members of families are working more. A husband and wife in an average household are working 10.4 hours more each week than they did in the 1970s. {Steven Greenhouse, The Big Squeeze, P. 6}

As a result of this wage squeeze, inequality has created growing social distress. While most Americans had stagnant wages, income for the top 1% grew by 228% between 1973 and 2007. Recent big data research has shown that, when economic growth occurs in a society with wide disparities in income, the recessions that follow periods of growth are very severe. In the U.S., the Financial Crash of 2008 led to at least 10 million households losing their homes to foreclosure or forced sale. In addition, wages for the bottom 90% of the population didn’t increase at all between 2008 and 2015.

Daniel Alpert, in an overlooked book The Age of OverSupply, shows how globalization has exposed Capitalism’s original operating flaw in the 21st Century. He argues that the rapidly industrializing countries of Brazil, Mexico, India, China, South Korea, Taiwan, Hong Kong, Vietnam, Malaysia, Singapore, and Indonesia have many similarities. Wages are kept low by governments that suppress labor unions. In addition, there is a very weak safety net of services for the population, forcing workers to save for periods of unemployment, poor health, or old age. As a result, the addition of these two billion workers to the global marketplace hasn’t generated anything near the consumer demand you might expect when a country industrializes. “Instead of a balanced rise of both supply and demand, we’ve seen a totally skewed situation of ever-growing supply….” {Alpert, The Age of OverSupply, P. 11.}

Back to the 19th Century Economy

With wages stagnating in advanced economies and supply growing rapidly in newly industrializing countries, the world economy has essentially returned to the low growth economic conditions experienced by England and France in the late 19th century. The value of wages in industrial countries lag far behind the value of things produced. As a result, Europe and Japan have had little economic growth since 2008, U.S. growth has averaged just 2%, and growth rates in Brazil, China, India and other nations are slowing. While social safety nets in western Europe and the U.S. prevent mass poverty, and unemployment has gradually fallen in the U.S., even this year’s trillion dollar U.S. budget deficit has not prevented a slow down this year.

With little growth in markets for their products, U.S. companies are essentially sitting on trillions of dollars in profits that cannot be invested in factories or other goods producing facilities. Corporate managers believe they can make more money investing in stocks, bonds, commodities and other short-term financial vehicles than building more production capacity. In other words, companies are having difficulty finding markets for the goods they produce and economic growth in the global economy is weak. In this situation, disruptions or problems can easily plunge us into a global recession.

In my next post, I will discuss the multiple disruptions currently pushing the world into recession.


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