NEW YORK – In the ongoing economic debate about what policy to pursue in the face of economic slack and prolonged unemployment, economists can roughly be divided into two groups. Keynesian economists argue for government spending as a temporary substitute for private spending, while supply-side economists call for austerity and structural reforms. But what if the main impediment to economic growth is indeed a shortfall of demand, only one that is structural rather than cyclical?
In 2005 then Fed governor Ben Bernanke, reflecting on the puzzlingly low long-term interest rates at the time, raised the specter of a global savings glut. He singled out emerging economies for their high national savings rates, suggesting that Americans acted as the world’s consumers of last resort. While American consumerism has since dwindled along with home values, the global savings rate is projected to reach a fresh high at 25% of world GDP this year.
Companies instead of households account for most of global savings. In the United States households save on average a meager 2.5% of disposable income. U.S. companies, on the other hand, hold on to $1.7 trillion in cash, which amounts to over 10% of U.S. GDP. Even in China, where households save on average an impressive 30% of disposable income, companies do the bulk of the saving, just as in Canada and the United Kingdom. Moreover, natural resource companies account for a disproportionate share of the world’s corporate cash piles.
Companies’ profits have soared due to the unlimited supply of labor in a world with exhaustible stockpiles of natural resources. As long as the supply of labor exceeds demand, workers are unable to translate productivity gains into higher wages. Employers will only pay the subsistence wage that keeps workers alive and fit to work. The economic rents extracted due to the excess supply of labor accrue to corporations and their shareholders.
The integration of China and India in the global market added more than 2.3 billion consumers and producers to the global economy. They entered as producers of core goods and services and as consumers of food and energy. The labor glut in China and India has put downward pressure on wages in the rest of the world as well because of international trade and the ever-looming threat of offshoring. Even if China’s labor supply eventually dries up, the rise of technologies may still displace large swaths of workers.
Profits as a share of U.S. GDP have doubled since China’s entry to the WTO in 2001. The price of a barrel of oil has tripled. According to Chicago University’s Loukas Karabarbounis and Brent Neiman, companies’ share of private savings rose in aggregate by 20 percentage points between 1975 and 2007 across 51 countries, while labor’s share of GDP shrank by five percentage points in aggregate in countries where corporate savings rose.
The marginalization of labor contributes to the shortfall of demand, which in turn accounts for weak business investment. In the 2000s a massive credit bubble kept consumer spending afloat, offering only temporary reprieve. Now the pressure is on governments to act as spender of last resort.
Henry Ford, the American industrialist, in 1914 introduced the five-dollar day, doubling wages for workers at the Ford Motor Company. The objective was not just to boost workers’ morale and enhance productivity, but also to ensure that workers earned enough money so they could afford the car they produced. Such wage hikes can be feasible if companies are only partially exposed to competition. In a situation of perfect competition, individual companies may not be able to afford the wage increases, even though each company would benefit from greater consumer demand.
Normally it is up to governments to solve these kinds of coordination failures in the economy. An increase in corporate income tax to skim off the rents that businesses extract due to the unlimited supply of labor is entirely appropriate. The government can use the tax revenues to redistribute income in favor of workers, boosting consumer demand, or invest in education, bolstering human capital.
But just like businesses, countries are subject to competition, namely international tax competition. The trend has been to lower corporate income taxes, instead of raising them. Between 2000 and 2011 the corporate income tax rates in OECD countries dropped on average 7.2 percentage points, from 32.6% to 25.4%. In addition, countries have been nursing tax loopholes, to lure the same multinationals that benefit most from the global labor glut. Rather than being the solution, governments are part of the problem.