BUSINESS

This Might Be The Best News Wage Earners Have Had In 45 Years

10/10/2015 11:40 EDT | Updated 10/12/2015 09:59 EDT
Darren Greenwood / Design Pics via Getty Images
Edmonton, Alberta, Canada

You’ve heard the argument before: Inequality is increasing. Wages are stagnant and business profits are booming. People are falling behind, and corporations are winning the day.

In other words, wage earners are screwed.

But a new paper co-written for Morgan Stanley by a professor at the London School of Economics has bad news for corporations and good news for their employees.

Economist Charles Goodhart, a former member of the Bank of England's rate-setting committee, says that — thanks essentially to an aging global population — the tables are about to be turned. For the first time since before 1970, workers are going to gain the advantage over business owners. In the endless struggle between capital and labour, labour is about to start taking a larger share of the pie.

Bet you didn’t expect to hear that in your lifetime, did you?

Here’s How The Theory Works

Wages in developed countries have largely stagnated since 1970, with some countries even seeing declining wages when adjusted for inflation.

Goodhart says that’s because, starting around 1970, the post-war Baby Boomer generation began entering the workforce, and that large cohort made the world’s population of working-age people unusually large. This led to what was essentially an oversupply of labour — too many people chasing after too few jobs.

The problem was compounded by the opening of up of the labour markets of post-communist Eastern Europe and China, starting around 1990. At that time, the developed world’s working-age population was around 685 million. The opening up of China and Eastern Europe added another 820 million people to that labour pool.

"It was the biggest 'positive labour shock' the world has ever seen. It is what led to 25 years of wage stagnation," Goodhart told a recent economic forum, as quoted at the Daily Telegraph.

With so many people available, companies didn’t need to raise wages to find employees. Technological change made businesses more productive, and those businesses didn’t have to share the profits in the form of higher wages. Profit exploded, and wages stagnated — and that, according to this theory, is part of what explains rising wealth inequality within nations in recent decades.

Goodhart’s theory directly challenges the one presented by economist Thomas Piketty in his famous 2013 book, “Capital in the Twenty-First Century.” Piketty argued that, without government intervention, inequality will always rise in capitalist economies because the return on investments is always higher than overall economic growth.

In other words, Piketty said inequality rises because people who depend on economic growth (wage earners) will always grow their wealth more slowly than people who depend on investments (“capital owners” or “rentiers” or just rich people).

But Goodhart's theory implies something entirely different -- that inequality grew in part because businesses gained a demographic advantage over labour.

But now the process is reversing. Thanks in part to China’s one-child rule, the Chinese senior population is growing and the working-age population is about to start shrinking, and rapidly. Wages in China have been rising at a rate of 16 per cent per year, on average, for the past decade. The decline in the working-age population will likely accelerate that.

china working age population

In the west, a similar trend is happening as the Baby Boomers move into retirement. Relative to the entire population, the working-age population is shrinking. That means companies will have a harder time finding workers, and will have to start paying more to find the employees they need. That, in turn, means they will have to accept smaller profit margins.

And there it is — the great reversal of our time, as corporate profits shrink and labour’s share of the income pie grows.

Goodhart also argues that all this has an effect on interest rates as well. The downward pressure on wages in recent decades meant inflation eventually began to slow down, and this made it easier for central banks to lower interest rates. Overall interest rates in the developed world have been on a downward path for some 35 years.

Those low interest rates have caused inflation in asset prices — just think what low interest rates have done for (or to) Canada’s housing market. When asset prices rise, the rich get richer. If a $300,000 house rises 25 per cent, it nets you $75,000. If a $10 million house rises 25 per cent, you make $2.5 million.

So low interest rates also increase inequality. But with wages on the upswing in future years, inflation will rise, and central banks will have to raise interest rates, which will now be on a long-term upswing.

Rising interest rates will put downward pressure on asset prices. One "side effect" of this new era of rising wages could be that the days of double-digit house price growth in Canada and many other developed countries will come to an end.

There are certainly weaknesses in Goodhart's theory. As The Economist points out, Goodhart discounts the possibility that software and robots could flood the labour market in the coming years, which could cancel out the upward pressure on wage growth.

Additionally, the Financial Times points out if India and Africa repeated China's economic miracle, these places could create a new oversupply of labour, driving down wages. And notably for Canada, the rising-wage effect could be lessened in countries that replace their aging population with immigrants.

Businesses and shareholders certainly have something to worry about if Goodhart’s theory proves to be right -- and it's certainly not a mainstream theory at the moment. But those of us who earn a living suddenly have reason to hope that, for the first time since our grandparents ran the show, we could have the upper hand in the workforce.