In the struggle between capital and labor, capital is winning — and that’s hurting the feeble economic recovery. To simplify slightly: Labor (wage-earners and consumers) can’t spend, and capital (businesses and shareholders) won’t spend. Without a powerful growth engine, the economy advances haltingly. I wrote about this last week from labor’s perspective, but the subject deserves deeper treatment.
One way to chart the fortunes of capital and labor is to show how much of the nation’s income goes to each. Labor’s share is straightforward. It covers workers’ wages, salaries and fringe benefits. Capital is more complicated. It includes corporate profits, the income of small businesses and professional partnerships, rents from real estate and net interest on bank deposits, bonds and loans.
Since World War II, labor’s and capital’s shares of income have fluctuated within a narrow band, reports the White House Council of Economic Advisers (CEA). Prosperity boosted both groups by roughly equal proportions. In 1947, labor’s share of nonfarm business income was 65 percent; in 2000, it was 63 percent. Everyone benefits when labor and capital work in tandem, not in opposition. But as I reported last week, labor’s share has plunged in the past decade. In 2013, it’s 57 percent. This shifts about $750 billion annually from labor to capital.
Rampant greed, howl critics. Policies favor the rich, it’s said. Granted, the shift worsens economic inequality, because capital income — dominated by profits — is skewed toward the wealthy. But the explanation is not a simple story of unbridled greed and undue influence.
Actually, there’s no universally accepted explanation. What we know is that the shift to capital is worldwide. In its study, the CEA examined 22 other advanced countries. In this group, labor’s share fell from 73 percent in 1980 to 65 percent in 2011. The trend also occurs in poorer countries, including China, Turkey and Mexico, reportedTimothy Taylor, managing editor of the Journal of Economic Perspectives.
“When a trend cuts across so many countries, it seems likely that the cause is something cutting across all countries, too,” wroteTaylor on his blog. “Looking for a ‘cause’ based on some policy of Republicans or Democrats in the U.S. almost certainly misses the point. The same is true of . . . policies more common in Europe, or in China.”
Broader theories include globalization, new technologies and weaker unions. All tend to beat down wages through intensified competition, the substitution of machines for people and the loss of bargaining power. Meanwhile, financial-market pressures on companies to raise profits have increased. Labor is getting crushed. It’s not fair, say critics.
True. But the more important effect is less visible: It dampens the recovery. Labor’s shrinking share curbs consumer spending. The economy will then falter if the recipients of capital income don’t offset the weakness with increased spending on buildings, equipment, research and new products. Unfortunately, this doesn’t seem to be happening.
Corporate America is husbanding its profits. It invests mainly in the safest projects. From 2007 (the previous business cycle peak) to 2012, domestic corporate profits climbed 35 percent while investment in plants and equipment rose only 2.6 percent. U.S. companies have accumulated a huge cash hoard of $1.8 trillion as of the end of 2012.
A well-functioning economy is a circular process by which one person’s spending becomes another person’s income, which is then spent again. Today, there’s a damaging disconnect between capital’s rising share and its subsequent spending. So the economy sputters.
Of course, it’s not literally true that labor can’t spend and capital won’t. In 2012, U.S. gross domestic product was $16.2 trillion; of that, $11.1 trillion was consumption spending on everything from cars to fast food. But adjusted for inflation, the increase from 2011 in consumer spending was only 2.2 percent, not enough to accelerate the recovery. The economy seems stuck in a self-defeating cycle: Weak consumer spending rationalizes weak investment spending; this keeps economic growth low and unemployment high, while putting downward pressure on labor’s income share.
We need to break this cycle. It’s possible. The gradual reduction in unemployment and improvement in housing might tip the economy into faster growth. But August’s mediocre employment report (only 169,000 jobs added) emphasized the grounds for skepticism. Consumer spending and business investment represent about 80 percent of the economy. The rest is housing investment, government spending and net exports. Each of these also faces problems. In housing, mortgage lending standards have tightened. Government grapples with long-term budget deficits. Exports suffer from sluggish growth abroad.
What would improve the odds is more exuberance from the custodians of capital. CEOs seem content to sit on their profits and invest only when the needs and the returns are indisputable. Careless capital, which fostered the financial crisis, has given way to ultra-cautious capital, which is making a lackluster economy self-fulfilling.
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