a TouchStone Extra report by Howard Reed (Landman Economics) and Jacob Mohun Himmelweit (research fellow, New Economics Foundation)
Executive summary
This is a report about the share of wages in national income (“the wage share”) in the UK. Over the last 35 years there has been a substantial shift from wages to profits in the UK economy. Data from the Office for National Statistics show that between 1977 and 2008 the wage share fell from 59 per cent of national income to 53 per cent, while the share of profits in national income rose from 25 per cent to 29 per cent. At the same time, average (median) earnings failed to keep pace with growth in national income (as measured by gross domestic product (GDP)). If wages had kept pace with growth in overall UK output between 1980 and 2010, median annual earnings for full-time workers would now be around £7,000 higher than they actually are. The fall in the share of wages in national income accounts for just over a third of this gap, with the other two-thirds due to earnings becoming more unequal.
Taking account of increased employer National Insurance contributions and pension contributions (which form part of employee compensation in the national accounts), the fall in the wage share is even more pronounced. A comparison with other countries using data from the OECD shows that, while most countries have experienced a declining share of wages in national income over the last four decades, the decline in the wage share in the UK is particularly high by international standards.
Empirical research on the determinants of the falling wage share using cross-country
panel data suggests that four different factors are responsible:
- technological change
- globalisation (increased liberalisation of product markets and increased mobility of capital across national boundaries)
- financialisation (the increased role of financial activity and rising prominence of financial institutions in national economies)
- reductions in the bargaining power of labour.
However, the relative importance of each explanatory factor is disputed. Research from the IMF and the European Commission argues that technological change is the primary determinant of the wage share, but more recent academic research that includes financialisation as an explanatory variable finds that increased role of financial activity in the economy is the most important driver of falling wage share.
Further investigation of the factors explaining the increase in the profit share over the last 30 years shows that the share of total profits accounted for by financial sector firms increased dramatically from around one per cent in the 1950s and 1960s to around 15 per cent in the years 2008 to 2010. The whole of the upward trend in the profit share over the last 30 years is attributable to the increased profitability of the financial sector. At the same time, investigation of trends in the wage share by industry show that the overall fall in the wage share over the last three decades has largely been driven by contraction of the industries where wage share is relatively high, and expansion of industries where the wage share is relatively low, rather than falls in the wage share in individual industries. These figures underline the importance of the ‘financialisation’ of the UK as a driver of recent trends in the UK economy, and underline the magnitude of the task facing politicians seeking to ‘rebalance’ the UK economy, with a greater role for the manufacturing industry and non-financial services; over recent decades the UK economy has been heading in the opposite direction – with financial services responsible for an ever-greater proportion of operating surplus.
In terms of the distributional impact of a shift from wages to profits, our analysis of recent data from the UK Family Resources Survey (the most accurate source of survey data on incomes in the UK) shows that income from investments is distributed far more unequally than income from wages. Each pound of family income that comes from investments makes a contribution to inequality among working-age families that is four times greater than a pound of income from gross earnings. This suggests that the falling wage share is likely to be associated with an increase in income inequality. Analysis of UK data on inequality over time confirms this; during the 1980s inequality increased markedly, and the wage share fell at the same time.
Some economists have argued that an increase in the profit share is good for economic growth because increased profitability leads to additional funds for business investment. However, the data for the UK from 1975 onwards show a negative correlation between the profit share and the level of business investment. At the same time, business expenditure on research and development – a key measure of innovation (which is essential for economic growth) – has been falling as a share of GDP since the mid-1980s.
An alternative economic argument is that, because the propensity to consume out of wage income is higher than the propensity to consume out of profit income, a higher wage share should increase growth because demand increases had – hence firms increase their investments in anticipation of being able to sell extra output. This story seems consistent with recent UK evidence, and also with most cross-country empirical work on the relationship between wage share and growth, which shows a positive relationship between the wage share and increases in output.
Full text (PDF 36pp)
