Economic Growth and the High Wage Economy

Morris Altman

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781136293399
• Edition: 1
• Topic: Negocios y empresa
• Subtopic: Negocios en general

This book provides a theoretical framework to better understand how firms, economies and labor markets have evolved. This is done in a reader-friendly fashion, without complex mathematical arguments and proofs. Economic Growth and the High Wage Economy shows how high wage economies help make firms and economies more productive and why high wage economies can be competitive even in an increasingly globalized environment. It also demonstrates why concerns that labor supply will dry up as wages increase and social benefits rise are largely based on impoverished economic reasoning.

The first chapters provide a theoretical basis for the rest of the book, showing for instance how higher wages are prone to increasing the level of economic efficiency by getting people to work harder and smarter (mainly smarter). Altman also explains that our understanding of technological change can be markedly improved by modelling technological change as a product of higher wages and improved working conditions and other shocks to the economic system. As the book develops, it is shown that increasing and high levels of income inequality are not necessary for growth and development, because the economic 'pie' grows when the economic wellbeing of the lower half and even the middle improves. The evolution of the state can also be better understood by applying this analytical framework. So too can the persistence of inefficient systems of production and cultural traits that appear to be inconsistent with economic prosperity. On top of this, the book examines the implications of Altman's theoretical framework for macroeconomic analysis and policy. Finally, it is shown that labor supply can be better understood by introducing target income into the analytical mix.

The main contribution of this book is providing the theoretical underpinning for why relatively high wages and, moreover, competition with high wages is good for dynamic growth and development. This work establishes why an alternative model of labor supply, based on the notion and reality of target income, does a better job of explaining the evolution of labor supply. The latter also reinforces the view that increasing wage and workers' benefits should not be expected to damage the economy, even in the realm of labor supply. This book will be of interest to public policy experts, trade unions, human rights experts and scholars of behavioural economics, labour economics and globalization.

1 Free to choose or prisoner of market forces

An introduction to high wage growth

The key message of this book is that improving the material well-being of workers, even prior to immediate increases in productivity can be expected to have positive effects on productivity through its impact on economic efficiency and technological change. Improving working conditions and labor benefits can also positively impact on the direction of institution change toward facilitating the productivity increases necessary to offset expected increased production costs. When laborers’ capacity to improve their economic standing in society is repressed, this can be expected to have negative economic consequences not only for labor, but also for society at large.

Furthermore, increasing benefits to workers or the unemployed need not have the negative effects on labor supply predicted by conventional economic theory. For most people, as incomes rise so do wants. And individuals will seek the employment necessary to meet their ever- increasing target income. High wages is a good thing, and not just ex post. High wages present a positive and dynamic prior to the development and growth process. High and higher wages help grow the economic pie. Moreover the modeling narratives presenting in this book are more consistent with many of the stylized facts of economic development and growth than the conventional wisdom, such as the absence of convergence in economic development across nations and long run competitiveness and sustainability of high wage economies. In a nutshell, high wage growth can be a good thing for the economy and society at large. It should not be something to be frowned upon and even feared—which is the default reaction in much of mainstream economics.

There are different types of market economies and the evolutionary path taken by high wage economies is different from those taken by low wage economies. High wages and providing workers and the unemployed with reasonable benefits are vital to energizing capitalist economies. They help spur capitalism forward in a manner consistent with improving the material well-being of the many, not simply of a small self-serving socio-economic elite. To reiterate, high wages can have a dynamic positive effect on market economies. A high wage economy is not simply the end-point—where we get to at the end of the rainbow. High wages and related benefits are engines of economic growth and development where the people (the many, not few) reap the benefits of capitalist development. Low wages have the opposite effect. They hamper and impede the process of development. This was, of course, a core message of Adam Smith (1937) who writes, in the Wealth of Nations:

The liberal reward of labour, as it encourages the propagation, so it increases the industry of the common people. The wages of labour are the encouragement of industry, which, like every other human quality, improves in proportion to the encouragement it receives. A plentiful subsistence increases the bodily strength of the labourer, and the comfortable hope of bettering his condition, and of ending his days perhaps in ease and plenty, animates him to exert that strength to the utmost. Where wages are high, accordingly, we shall always find the workmen more active, diligent, and expeditious, than where they are low.

Very few individuals would object to people being paid more for their work, receiving improved benefits, or being treated better and more fairly by their employers. Nevertheless, the conventional wisdom in economics and business is that such improvements to socio-economic well-being must follow improvements to the economy, not lead the process. There is a very strong bias in conventional economics in favor of this trickle-down philosophy. There are strongly held views that only after economies prosper can they afford to treat their workers better. And, moreover, if workers are treated better prior to economic advancement taking place, economies that behave with such beneficence will cause economic harm, making everyone worse off in the process, in the long run. High wage economies and economies characterized by higher real wage growth rates will become less competitive, and less competitive economies cannot deliver the goods, as it were.

This makes strange bedfellows of “left wing” narratives rooted in the work of Karl Marx and the conventional economic wisdom. In the pessimistic narratives of the anti-market left, efforts to increase wages and labor benefits can only have a limited effect. Such efforts invariably hit a brick wall of competitive pressures, which are today reinforced by the forces of globalization. For Marx, try as they may, workers cannot in the long run increase their real wages by capitalizing on market forces or by engaging in collective bargaining. Marx (1865, p. 78) argues:

the working class ought not to exaggerate to themselves the ultimate working of these every-day struggles. They ought not to forget that they are fighting with effects, but not with the causes of those effects; that they are retarding the downward movement, but not changing its direction; that they are applying palliatives, not curing the malady. They ought, therefore, not to be exclusively absorbed in these unavoidable guerilla fights incessantly springing up from the never-ceasing encroachments of capital or changes of the market. They ought to understand that, with all the miseries it imposes upon them, the present system simultaneously engenders the material conditions and the social forms necessary for an economical reconstruction of society. Instead of the conservative motto, “A fair day’s wage for a fair day’s work!” they ought to inscribe on their banner the revolutionary watch-word, “Abolition of the wages system!”

In the conventional wisdom higher wages and improved working conditions can make significant headway within the framework of a market economy, but only following upon the process of economic growth bearing tangible and sustainable fruit. The expectation is that the tangible fruit will necessarily appear and be there for the picking without the inducement of higher wages and improved benefits.

At the face of it, this makes sense. If higher wages and, more generally, improved working conditions, make firms less competitive, workers will be worse off. Demanding and fighting for improved working conditions sounds like the right thing to do. But this cannot be the case if, at the end of the day, these efforts kill the geese that lay the golden eggs. According to this perspective, best wait until market forces or the state take care of the development process first. Then the good times will invariably start rolling in. One can always legislate minimum wages or minimum safety standards for moral reasons, but one should then expect higher permanent unemployment and higher product costs as a consequence.

This wait and hope for a better tomorrow approach to wage growth and improved worker benefits has informed economic analysis and public policy for generations. It largely stems from a very static perspective on the relationship between changes in wages and labor benefits and labor productivity. This static modeling approach represents a useful, but limited, ceteris paribus analysis. From this vantage point, changes in such immediate costs of labor can be expected to have no affect on productivity. Ergo, direct improvements to labor benefits, prior to productivity increases, are damaging to the economy.

Much of this book builds upon a theoretical frame which I’ve developed over the past 30 years, whose focal points rest upon x-efficiency and efficiency wage theories both, originally pioneered by the late Harvey Leibenstein. I’ve had a longstanding interest in the capacity of market economies to deliver on its promise of increasing standards of well-being to workers, farmers, and peasants. It also seemed to me that conventional theory could not easily explain the lag of convergence across nations and even across regions within the same nation. Moreover, the conventional wisdom’s prediction that higher wages are bad for the economy appeared to be, all too often, contradicted by the facts on the ground and by the early insight of Adam Smith on these matters (see, for example, Chang 2010 and Krugman 1994).

I first formally broached the importance of high wage growth through the lenses of a modified x-efficiency model in my analysis of a Canadian case, where there was a significant and persistent differential between Quebec and Ontario per capita income in the nineteenth century, not easily explicable using traditional economic variables (Altman 1988). The fact that Quebec was not only a relatively low wage economy compared to Ontario, but low wages were also celebrated by both economic and social leaders in Quebec as Quebec’s economic advantage, as Quebec’s “gift,” helped explain Quebec’s relatively poor economic performance in this period. At a more general level, this type of narrative is very much part of the type of economic history advanced by H.J. Habbakkuk (1962) and more recently taken up by Robert Allen (2009, 2011).

Following upon the pioneering work of Leibenstein, efficiency wage theory has been further refined more recently, with George Akerlof, in particular, making significant contributions. A central assumption of both theories, which, in turn, is consistent with the facts on the ground, is that effort (quality and quantity) is a variable input in the production function. This is in contrast to the mainstream view that effort is fixed, invariant to wages, working conditions, employment relations, or managerial and owner preferences with respect to their own effort inputs. I’ve also contextualized my arguments in terms of the institutional framework within which decision making takes place. Therefore, in my high wage, x-efficiency, modeling narratives, institutions matter big time for causal explanations and economic predictions.

The focus of classic x-efficiency theory is on managerial slack in the context of protected markets that, together, yield higher unit costs of production, where these higher costs are a measure of x-inefficiency. This theory was designed to help explain and model differences productivity and average costs across firms that appear to be identical in terms of traditional productivity related variables. The “missing” modeling variable is, according to Leibenstein the x-inefficiency factor, related to effort variability. Different levels of effort input (in their quality and quantity dimensions) yield differences in productivity and costs. Managerial slack is reflected in mangers and owners reducing their level of effort inputs below what they would be in a more competitive economic regime. X-inefficiency economies survive to the extent that they are protected by competitive pressures.

Efficiency wage theory, on the other hand, builds upon the assumption that effort varies as a function of wages and that there is some unique wage rate that is the efficiency wage. This unique wage minimizes unit costs and maximizes profits. Nominal wages are sticky in this model for “rational” profit maximizing reasons. Some refer to this wage as the fair wage, which is a product of reciprocity, gift exchange, and possibly the credible threat of retaliation for unfair treatment by workers against employers. Rational decision makers should not choose any wage that differs from the efficiency wage. Any and every wage should be the efficiency (fair) wage or approaching the unique efficiency wage. Moreover, the efficiency wage need not be associated with any x-inefficiency. The efficiency wage is supposed to yield the maximum of effort inputs. The difference with the conventional model is that since effort is assumed fixed at some maximum in the conventional model, changes in wage have no effect on labor productivity. Also, in efficiency wage theory, the efficiency wage yields relatively high unemployment rates since the efficiency wage is above the conventional economics real wage rate. Wages can’t fall in the efficiency wage narrative because it will cause labor productivity to drop and unit costs to rise. In the conventional narrative, cutting wages will have no effect whatsoever on effort inputs and, therefore, upon labor productivity.

In my elaboration and extension of both theoretical frameworks, I present an overarching modeling framework where the x-inefficiency is a function of a variety of factors inclusive of managerial preferences, human resource management (working conditions, wages, affinity to the firm, voice, etc.), state of the market, and institutional parameters. A unique point of this modeling narrative is that to the extent that effort is variable and technological change is induced by changes in factor costs (such as labor costs), there is no reason for x-inefficiency to coincide with high production costs or with there being a unique wage that minimizes unit production costs. The quality and quantity of effort can change up and down in response to what transpires within the “black box” of the firm. The same can be said of technological change.

To the extent that effort and technology changes offset changes in labor costs there can be a wide range of wage rates consistent with a given unit cost of production and a given rate of profit. There can, therefore, very well be multiple equilibria with regards to sustainable levels of wages and labor benefits and different levels of labor productivity. Cost minimizing firms (decision makers) need not naturally veer toward the equilibrium consistent with maximizing productivity. There could therefore also be a wide array of possible levels of x-inefficiency consistent with equilibrium. But the Golden Rule solution to productivity, that of achieving the maximum output per unit of input and eliminating x-inefficiency in production, would only arise at the higher spectrum of wage rates and working conditions.

Whether the Golden Rule solution obtains is contingent upon a variety of factors; inclusive bargaining power variables, labor mobility, collective bargaining rights, and preferences on the part of firm decision makers in favor of high wage configurations. The latter can amount to what Adam Smith referred to as moral sentiments or empathy on the part of firm owners and managers with preferences of their employees and an overall appreciation of fairness in socioeconomic outcomes amongst the major players of the economic game.

This amended approach to x-efficiency and efficiency wage theories is consistent with and helps explain historical and contemporary socio-economic reality—market forces do not force convergence in wages and labor benefits and productivity across firms and economies. Nor can one expect forced convergence by market forces toward Golden Rule solutions to productivity. Economies can end up being trapped in low productivity equilibria. But this can be quite consistent with the preferences of decision makers whose own welfare is maximized under such economic regimes. The rich, the famous, and the oligarchs can prosper even as the many remain impoverished or at best fall behind. For this reason, breaking out of any low productivity trap is in no way inevitable. But the behavioral-institutional approach articulated in this book allows one to model the possibility of a variety of equilibria and their causes and how to break out of low-level equilibrium traps.

This book is very much rooted in the traditional of behavioral economics, underlying the importance of the realism of simplifying assumptions to analytical rigor, causal analysis, and practical value added of theory. Building and judging theory based on its ability to predict analytically or based upon the logical consistency of its basic premises does not meet the litmus test of good or useful economic theory. I certainly reject, in this book, what Deirdre McCloskey refers to as axiomatic economics. Simply proving that one’s conclusions logically follow from one’s axioms, however empirically invalid one’s axioms are, does not make for a valid economic argument. Concluding that increasing wages yield increasing unit production costs based on the assumption that effort inputs are fixed is logically valid, but economically false or, at a minimum, inconclusive if effort is in fact positively and causally related to wages and more generally to working conditions. Concluding that labor supply diminishes with unemployment insurance or social assistance because not working is a normal good (what people really prefer) is logically consistent, but can be economically false when people have ever-increasing target incomes that are not met by such infusions of nonlabor income.

Assumptions matter for constructing robust models that have a worthwhile causal story to relate and sensible economic predictions to make. Arguing that high wages are bad for the economic health of nations, based on misguided and mis- specified economic models is also bad form, highly unscientific, and can result in public policy and public attitudes toward high wage economics that are misguided. (See also, for example, Krugman 1994, for an alternative perspective on the importance of high wages for development.)

My modeling narrative does not rely on the notion that individuals are somehow irrational or error-prone in their decision making, which is very much the mainstream view in contemporary behavioral economics. But in the narratives developed in this book individuals often do not behave according to the prescription of conventional economics. Still, individuals can be rational (and smart) while making decisions that are inconsistent with the conventional economic prescription for rational behavior. Effort is not maximized, nor is it fixed. And, wealth and income maximization is not always the dominating preference of leading economic decision makers. Smart decision makers can make choices that they find satisfying, yet cause economic inefficiencies in the economy as a whole. Some people might end up doing great, while others are doing relatively poorly and are much worse off than they need be.

I am grateful to my editors and editorial assistants at Taylor & Francis, for their patience and gentle prodding. Thomas Sutton was there at the beginning and was critical to the success of this project. Louisa Earls pushed me forward. Many thanks to Natalie Tomlinson for bringing this book into print. Also, thanks to Allie Waite, the project manager of this book and to Sally Quinn, the copy editor for the great job which they've done on this book. This book builds upon previously published peer reviewed articles and book chapters. Many thanks to the many people who’ve offered ins...

Table of contents

• Cover
• Title
• Copyright
• Dedication
• Contents
• List of figures, tables and charts
• 1 Free to choose or prisoner of market forces: an introduction to high wage growth
• 2 Introducing x-efficiency theory, rational inefficiency, and the political economy of the Golden Rule
• 3 A behavioral-institutional model of endogenous growth and induced technical change
• 4 Why increasing income inequality is not necessary to economic prosperity
• 5 A behavioral model of path dependency
• 6 Culture as a determinant of material welfare
• 7 Sens's capabilities approach and economic welfare
• 8 Economic growth, "globalization," and labor power
• 9 Staple theory and export-led growth: constructing differential growth
• 10 Economic freedom and economic growth and development
• 11 A theory of induced institutional change
• 12 Why high wages don't cause unemployment
• 13 When wants are insatiable: a target income theory of labor supply
• 14 Why unemployment insurance can increase economic efficiency
• Notes
• Bibliography
• Index