The Danger of Wage Cuts

The Washington Post perfectly fails to summarize the problem in its headline, "Wage Growth Is Eroding As Firms Rush To Slim Down". Um, actually, most of the examples in the piece show extreme wage cuts, not an erosion of growth. As Hilzoy notes, the bottom 90% of wage earners saw their wages "grow" a mere 10% over the past 30 years, while those in the top 10% grew 232%. Wages are falling now for that same group of workers not at the very top, because the threat of job loss forces them to accept cuts. And the result for the broader economy is tragic.

Suppose that workers at the XYZ Corporation accept a pay cut. That lets XYZ management cut prices, making its products more competitive. Sales rise, and more workers can keep their jobs. So you might think that wage cuts raise employment — which they do at the level of the individual employer.

But if everyone takes a pay cut, nobody gains a competitive advantage. So there’s no benefit to the economy from lower wages. Meanwhile, the fall in wages can worsen the economy’s problems on other fronts.

In particular, falling wages, and hence falling incomes, worsen the problem of excessive debt: your monthly mortgage payments don’t go down with your paycheck. America came into this crisis with household debt as a percentage of income at its highest level since the 1930s. Families are trying to work that debt down by saving more than they have in a decade — but as wages fall, they’re chasing a moving target. And the rising burden of debt will put downward pressure on consumer spending, keeping the economy depressed.

Constant wage deflation led to economic stagnation in Japan in the 1990s. That's what it looks like we're saddled with. There's a difference between saving the economy and leading to a real recovery. Wage cuts lead to the former but not the latter.

You Say That Like It's A Good Thing

Yesterday, the President bragged that highway projects from the Recovery Act were "ahead of schedule and under budget." On the latter, I agree with Krugman:

Ahead of schedule is good. Under budget — well, ordinarily that’s a good thing. But the point of the stimulus is to increase spending! So if we don’t spend as much as expected, that’s less stimulus [...]

Seriously: if the projects really are coming in cheaper than expected, that doesn’t mean we should bank the savings; it means that we need more projects.

As the LA Times story makes pretty clear, the reason the projects are coming in under budget is that contractors are so desperate for work that they're bidding each other down. More than anything, this is the biggest indicator of the true crisis in the economy.

At the same time, several factors have conspired to drive down project costs.

At the top of the list is the searing downturn in residential and commercial real estate construction.

Because the companies that construct highways also tend to build the roads and other infrastructure for housing projects, their business burst along with the housing bubble.

Thousands of workers were jettisoned. Now, state officials say, construction companies are submitting especially aggressive bids in an attempt to win new business.

The massive falloff in construction is also driving down the cost of building materials, while the drop in world oil prices has reduced other costs.

In California, Obama said in his speech, some bids have come in as much as 50% under budget.

Those are fire sale prices. And we're seeing in the concurrent drop in retail sales and prices the risk of a deflationary trap. I certainly hope that the Administration doesn't view this "under budget" stuff as a virtue, but an opportunity to create more infrastructure projects. In addition to using the full appropriation of stimulus money for additional projects, the White House should use the upcoming highway bill to increase spending and create an infrastructure bank to regularize these construction projects.

...Matt Yglesias says that more projects are going to be instituted to ensure that all the money appropriated is spent, and he agrees that the reason everything is coming in under budget is a cause for deep concern.

Global Letdown

Paul Krugman, reporting from Europe, shows his concern with how European leaders are dealing with, or failing to deal with, the global economic crisis.

Europe has fallen short in terms of both fiscal and monetary policy: it’s facing at least as severe a slump as the United States, yet it’s doing far less to combat the downturn.

On the fiscal side, the comparison with the United States is striking. Many economists, myself included, have argued that the Obama administration’s stimulus plan is too small, given the depth of the crisis. But America’s actions dwarf anything the Europeans are doing.

The difference in monetary policy is equally striking. The European Central Bank has been far less proactive than the Federal Reserve; it has been slow to cut interest rates (it actually raised rates last July), and it has shied away from any strong measures to unfreeze credit markets.

The only thing working in Europe’s favor is the very thing for which it takes the most criticism — the size and generosity of its welfare states, which are cushioning the impact of the economic slump.

Actually, the social welfare system may be the reason why the crisis is being faced with such less urgency, because the popular outrage is necessarily more muted than in a country whose social safety net is frayed. On balance, I'd rather have the state protect its citizens from harm, but the policymakers cannot rely on the automatic stabilizers of social democracy to sustain them through a massive crisis.

There's a bigger problem, however; the continent has a loose affiliation without any institutional strength from the structures that the EU has put in place, and the result is chaotic:

Europe’s economic and monetary integration has run too far ahead of its political institutions. The economies of Europe’s many nations are almost as tightly linked as the economies of America’s many states — and most of Europe shares a common currency. But unlike America, Europe doesn’t have the kind of continentwide institutions needed to deal with a continentwide crisis.

This is a major reason for the lack of fiscal action: there’s no government in a position to take responsibility for the European economy as a whole. What Europe has, instead, are national governments, each of which is reluctant to run up large debts to finance a stimulus that will convey many if not most of its benefits to voters in other countries.

You might expect monetary policy to be more forceful. After all, while there isn’t a European government, there is a European Central Bank. But the E.C.B. isn’t like the Fed, which can afford to be adventurous because it’s backed by a unitary national government — a government that has already moved to share the risks of the Fed’s boldness, and will surely cover the Fed’s losses if its efforts to unfreeze financial markets go bad. The E.C.B., which must answer to 16 often-quarreling governments, can’t count on the same level of support.

Hendrik Hertzberg calls this particles of confederation - the limits of a weak federal system and a bias toward, in effect, state's rights. On issues where they have a rough consensus, like re-regulation of the banks, they can move forward; but since no country wants to create the deficits necessary to make up for demand, the urgent short-term crises go unfixed. I am happy that Switzerland and smaller countries are loosening their bank secrecy rules, for example, which will lead to a greater crackdown on offshore tax havens. But that's not going to create any jobs in the short term. So the confederation has to make up for a lack of institutional muscle by relying on international economic diplomacy, which is not advisable. And the crisis deepens.

Someone needs to help do the lift of picking up global demand, and we're running out of countries.