Understanding economic inequality
Understanding economic inequality

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Understanding economic inequality

4.2.1 How income is shared between labour and capital

The total income generated in an economy is known as national income. Polish economist Michal Kalecki (1954) describes how national income can be split into income earned by labour and income earned by the owners of capital, or capitalists. This is the same as saying that the total income in the economy is split between wages, or labour income, earned by workers and capital income from profits earned by capitalists.

The share of national income going to labour and capital can vary over time and it is this variation which many argue has been a contributory factor to changing levels of income inequality.

Households may earn income from both labour and capital. But it is labour that is the predominant source of income for households, constituting an average of 70% of total household income in the UK (Department of Work and Pensions 2018).

Activity 11 Inequality between labour and capital

Timing: Allow about 40 minutes

Complete the national income equation below by filling in the boxes with the different types of income described by Kalecki.

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Once you have filled in the national income equation correctly, drag and drop the panels below to assign economic agents which are the main recipients of each respective type of income.

Using the following two lists, match each numbered item with the correct letter.

  1. Whole economy

  2. Workers

  3. Capitalists

  • a.Wages/labour income

  • b.National income

  • c.Capital income/profits

The correct answers are:
  • 1 = b
  • 2 = a
  • 3 = c

Figure 17 shows how the wage share as a percentage of national income has fluctuated since 1948.

Described image
Figure 17 The falling wage share, UK 1948–2011. Source: Lansley (2012) ONS data

Briefly describe the trend in the share of wages between the mid-1950s and 1980.

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Answer

The graph shows that from the mid 1950s to 1980 the share of wages in national income was largely between 59% and 61%. The exception to this was a peak in the mid 1970s when the wage share reached over 64%. Since this peak the wage share steadily declined, remaining below 56% over the next 30 years with a lowest point below 52% during the second half of the 1990s.

Listen to an extract from an interview with Duncan Weldon, former senior economist at the Trade Unions Congress, an organisation representing UK trade unions. Answer the questions below to explore the causes and changes in inequality between labour and capital in recent years.

Download this audio clip.Audio player: Audio 1
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Transcript: Audio 1

NARRATOR
The Resolution Foundation is a think tank which focuses on those on low and modest incomes. James Plunkett is the Secretary to its commission on living standards.
JAMES PLUNKETT
This is the thing that's not widely known, that in the lead up to the recession of about '03 to '08, we saw almost no wage growth in the middle and below in the UK economy, despite the fact the economy grew by 11% in that period. Then, clearly, the recession hits and you see people's wages fall. But that fall that has happened post the recession is really a problem on top of a problem.
NARRATOR
Whilst wages for those in the middle and at the bottom of the earnings ladder began to stagnate in 2003, this was just the culmination of a much longer shift in the economy. Since the 1980s, median wages, the wages earned by those in the middle, have been failing to keep up with productivity. That is to say, as the economy has become better at producing output over the last three decades, the gains from this efficiency haven't fed through to those in the middle and below. One way to think about this is to consider the so-called wedge share. Stewart Lansley is a research fellow at Bristol University and the author of The Cost of Inequality.
STEWART LANSLEY
The wage share is basically the share of the total output in the economy that goes to the workforce in the form of wages. And essentially, what has happened over the last 30 years is that share, the wage share, has been shrinking. So the share of the economic pie, if you like, is going to the workforce as a whole. It's smaller now than it was 30 years ago. This is in contrast to what happened in the immediate post-war decades, when that share stayed roughly constant. So the gains from growth in 30 years after the war were divided, more or less, equally since then. Essentially, the workforce have been separated from the process of growth. They haven't shared equally in the process of growth, and at an accelerating rate.
NARRATOR
So what's behind this pressure on wages for most of us, while the rich have got richer? The two most common explanations from economists are globalisation and technology. Many of the gains from increased productivity and economic growth have disproportionately gone into company profits and the pockets of top earners. This challenges those who believe that improving productivity is the best way to ensure higher wages for all.
SPEAKER
It's a fallacy to think that increasing productivity automatically leads to increasing wages. If you look at manufacturing productivity, it's gone up much faster, globally, than service productivity, but that doesn't mean that manufacturing wages have gone up in the West because those jobs are now often done by people earning much less in East Asia.
NARRATOR
Alongside technology, the other major structural change in the economy since the 1970s has been the impact of globalisation.
ROGER BOOTLE
Essentially, what's occurred as a result of the opening up of world economy is that a couple of billion workers have just joined the world economy.
NARRATOR
Roger Bootle is the managing director of Capital Economics.
ROGER BOOTLE
The result of that, not surprisingly, is downward pressure on real incomes. And again, downward pressure on particular sorts of real incomes of people who are in competition, effectively, with unskilled or lowly skilled people in emerging markets.
NARRATOR
But is globalisation as important a factor as some claim it is?
JAMES PLUNKETT
I think people often go straight to globalisation as the kind of key driver of a lot of these trends. I think it can be overstated.
NARRATOR
James Plunkett from the Resolution Foundation.
JAMES PLUNKETT
For example, I'd point to the fact that a lot of the jobs in Britain that we're really worried about in these kind of conversations are in actually non-traded sectors. These are sectors where we're not really talking about competing with China and India. Jobs aren't being outsourced to India.
NARRATOR
You can't get your hair cut in China.
JAMES PLUNKETT
You can't get your hair cut in China. Likewise, hotels, an Indian worker from India cannot change a bed in a hotel room in London. And so these jobs aren't really jobs that are being outsourced to India and China, and yet are huge jobs, are very badly paying jobs. Similarly, social care is a big example. Care for the elderly in Britain is not going to happen from China. And so this is a really big part of the picture, and it's not really just down to globalisation, I think.
NARRATOR
For Stewart Lansley, politics is one missing ingredient.
STEWART LANSLEY
There were a series of acts in the 1980s that weakened the power of unions. And regulations were taken off business, particularly in relation to the labour market, which gave business more power. So effectively, what happened was that balance shifted. Industry had a lot more power.
NARRATOR
Another phrase that keeps cropping up to explain what has happened to wages is the concept of "shareholder value." This idea suggests that in the 1980s, the way corporations were run changed as they became more exposed to pressure from financial markets and concerned by their share price. Stewart Lansley again.
STEWART LANSLEY
In the 1950s and 1960s, we had a very, very different model of capitalism, in which the share price and profits were both key drivers of business activity, but only one of them. So relationships with the staff, relationships with the community, the role they played in society worked hand in hand. But what happened, then, a lot of those extra responsibilities and social responsibilities that companies accepted were all ditched.
End transcript: Audio 1
Audio 1
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According to the interview, what have been the main changes in the wage level in the UK and how wage income is shared among all workers in the economy?

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Discussion

In the lead-up to the 2008 recession wages didn’t grow for the low and middle part of the earnings ladder despite 11% of economic growth. Wages for this group have been stagnating since 2003, but already since the 1980s median wages have been failing to keep up with productivity. In the interview, wages are described as being frozen, that is there has been very little wage growth, even before the recession. In particular, wages have not been keeping up with changes in productivity. The increased productivity enables more output to be produced which generates more income. However, much of the income that this extra output has generated since the 1980s, has not been passed on to labour but instead has been paid to capital. References are made in the interview to wages, particularly at the middle and bottom of the income distribution, stagnating at the expense of increased profits. The interviewed worker explains that his firm is making profits yet he has not seen a wage increase in 4 years.

What are the two main reasons give in the discussion for the fall in the share of wages in total income?

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Discussion

The first reason given in the discussion to explain the fall in the wage share is changing technology. The advancement of technology has resulted in more skilled jobs. At the same time, however, lower skilled jobs have been lost as many of them have been replaced by automation. The same number of employees is therefore chasing fewer lower skilled jobs. This put downward pressure on wages in this sector of the labour market. As there are relatively fewer jobs for the same number of workers it is the employers who saw see a strengthening of their bargaining position, being able to extract more profit.

The second reason given in the discussion is globalisation. While productivity has increased in manufacturing, wages have not increased. The interview describes how the increase in globalisation has meant that there has been an increase in competition for jobs from workers in other countries. In particular, production of the manufacturing sector has in large parts shifted overseas. Many manufacturing processes are outsourced to countries where there are low wages. This again puts downward pressure on wages in the domestic market.

What other reason relating to the relationship between workers and employers are discussed in the interview to explain the fall of the wage share?

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Discussion

As explained in the interview another reason often given by economists for the falling share of wages in total income is the reduction in the power of trade unions. During the 1980s several acts were passed which reduced the power of trade unions. In 2017 approximately 6.2m employees were union members. This is a sharp contrast to the 13m employees who were union members in 1979 (ONS 2018). This again reduces the worker’s bargaining power and so produces a downward pressure on wages.

A final explanation given for the falling wage share in total income discussed in the interview is the change in corporate behaviour, coinciding with the deregulation of financial markets, which has taken place since the 1980s. In the interview it is argued that there has been an increased emphasis on shareholder value, which boosted profits of firm owners. This happened because a larger share of corporate profits was redistributed to shareholders rather than reinvested in workers, which lowered wages relative to profits.

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