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Source link: http://archive.mises.org/7651/credit-expansion-economic-inequality-and-stagnant-wages/

Credit Expansion, Economic Inequality, and Stagnant Wages

January 14, 2008 by

Credit expansion is responsible not only for the boom-bust business cycle, as Mises showed, but also that it is a major source of artificial economic inequality and sharply increases profits relative to wages. These are processes that come to an end and are actually thrown into reverse as soon as credit expansion stops and the recession/depression that is its ultimate consequence begins.

In wasting capital through malinvestment, it undermines the rise in production and accompanying rise in real wages. Despite credit expansion, real wages could still rise through most of American history, because of the substantial economic freedom enjoyed in the United States and did so even in the midst of credit expansion, as in the 1920s.

In the last two episodes of major credit expansion, however, and over the last several decades as a whole, real wages have largely stagnated. This stagnation is the result of massive government intervention into the economic system that undermines capital accumulation and both the demand for labor and the productivity of labor. It is not the result of economic inequality, the profit motive, or any other aspect of the capitalist system. FULL ARTICLE

{ 27 comments }

Grant January 14, 2008 at 8:26 am

In the last two episodes of major credit expansion, however, and over the last several decades as a whole, real wages have largely stagnated.

This is an area where I find myself more in agreement with the GMU camp. Have wages stagnated when benefits (medical insurance, etc) are factored in? How about when accounting for the recent and massive increase in Mexican immigrants?

We’ve had credit expansion for a while. Everyone is used to it. While its certainly not a good thing, I just don’t think its effects are that significant (at least when interest rates are kept relatively sane, and not as low as Greenspan pushed them).

By the way, does anyone know of any (freely accessible) papers published on the Cantillon effect?

fundamentalist January 14, 2008 at 9:03 am

Thanks for another insightful essay from Dr. Reisman! Since learning Austrian econ, I have suspected that credit expansion was a major cause of the rise in inequality, but Dr. Reisman pulls it all together for me.

Grant: “This is an area where I find myself more in agreement with the GMU camp.”

What is the GMU camp?

I have been working on a paper on wages for a while now and looked at the usual suspects for the declien after 1973 as much as possible, but the list is long. As many people are aware, average wages peaked in 1973, declined until about 1990, and have risen since to recover a little more than half the 1973 level. Some people have argued that the 1973 peak is artificial because of Nixon’s wage/price controls which artificially supressed prices and made real wages appear higher than they actually were.

As far as I can tell, the major cause of the decline in wages after ’73 was price inflation, because wages did not keep up with price inflation so real wages fell. In general, all of the explanations commonly used for the fall in wages after ’73 continued to be factors when wages began to rise after ’90, so they seem to have little effect. Immigration, for example, has been higher since the turn around in -90 than before, yet average wages have been rising. On the other hand, the Fed’s success in lowering price inflation occurred relatively close to the the turn around point in wages.

newson January 14, 2008 at 9:21 am

to fundamentalist: george mason university

Inquisitor January 14, 2008 at 9:46 am

GMU Austrians, ultimately, like Boettke and some others. A lot of them are associated with the LVMI as well, however – they just tend to have a more Kirznerian emphasis on things to my knowledge, rather than Rothbardian.

Paul Marks January 14, 2008 at 10:17 am

One does not have to be a slavish follower of Murry Rothbard (actually my own political opinions are closer to those of Frank Meyer – which makes me a Cold War space monster to a lot of people round here) to agree that a credit-money expansion does indeed have very “significant” consequences.

The starting point should be as followers:

Borrowing should be 100% financed by real savings (real savings – not book keeping tricks). If there are efforts to “lower” interest rates by credit-money expansion the economy is going to be messed up by malinvestments.

Who is to say what interest rates are “sane”?

I hold that it should be the market – via what people are prepared to hand over their savings for and what people are prepared to pay to borrow those savings. There is no way that a government (or “private” institution like the Fed) can judge “these interest rates are too high, we should introduce a surge of credit money to lower them”.

Such a God like point of view is not available to us mere human beings.

Credit-money expansion is market rigging – it really is as simple as that.

“But incomes can go up over time even when there is credit money expansion”.

Yes – but this, in the long term, is IN SPITE OF THE BOOMS AND BUSTS THAT THE CREDIT MONEY EXPANSION CAUSES – NOT BECAUSE OF THEM.

If there was no credit money expansion greater prosperity would be achieved over time.

Also remember the danger of government reaction to credit-money created busts.

The bust of 1921 did not lead to a big government reaction and, sure enough, the economy began to recovery within about six months. But the bust of 1929 was reacted to by government (contrary to the history textbooks) – there was a massive reaction of governmemt efforts to keep up wage rates and rig the market in other ways.

What is more likely in the comming bust (and sooner or later it will happen) – the non reaction (other than cutting government spending) of 1921, or the wild statism of Herbert Hoover (yes he was a wild statist) and F.D.R.?

I know what my prediction would be.

That is credit money booms and busts lead to – not just the terrible distress of the bust, but the danger of government reaction to “help people”.

fundamentalist January 14, 2008 at 10:46 am

Newson, Thanks! What is the GMU position on the issue?

Grant: “Have wages stagnated when benefits (medical insurance, etc) are factored in?”

The data on benefits hasn’t been kept for very long, so it’s hard to tell, but extrapolating backwards from today’s level, benefits don’t seem to have varied that much. They seem to follow the trend in wages, tool.

Grant: “How about when accounting for the recent and massive increase in Mexican immigrants?”

Average wages have risen constantly since the early ’90′s in spite of increased immigration.

Jake January 14, 2008 at 12:13 pm

Fantastic article!!! Thank You !!!

It just makes it so much easier to share with friends and other people in order to spread the message.

Grant January 14, 2008 at 5:57 pm

fundamentalist, the GMU guys are typically a lot less pessimistic, about wages and other things.

The data on benefits hasn’t been kept for very long, so it’s hard to tell, but extrapolating backwards from today’s level, benefits don’t seem to have varied that much. They seem to follow the trend in wages, too.

I’ve always read that benefits have increased significantly, especially in health care. But I don’t know if thats the truth, a damned lie, or a statistic.

I think its pretty obvious that, regardless of what statistics say, the standard of living has increased significantly since 1973. The poor have cell phones, cars with airbags, cable TV and an internet connection.

Average wages have risen constantly since the early ’90′s in spite of increased immigration.

My point is that (all else being equal) the introduction of poor, less-skilled workers pushes down mean and median wages while not actually effecting the well-being of those who were in the sample group before those new workers arrived. It seems to me any statistics should correct for immigration. If China were to suddenly become part of the USA and our statistics, we couldn’t suddenly say the USA got poorer.

Som January 15, 2008 at 2:37 am

What’s this? Yet another social ill that socialists and Keynesians claim to be the consequences of the “anarchy of production” that is actually the result of the government’s legal tender laws and mass counterfeiting? Once again Dr Reisman writes a great article!

I always suspected it since learning from the Mises institute, but now Dr Reisman now confirms a major aspect of it, that most of the social “inequalities” under the truly free market are merely the result of each individuals diverse preferences rather than a stratified hierarchy, like one person having blue socks and another having red socks, instead of one person having blue socks while another has no socks.

This is a great article for the pro-welfare state left to read.

Finally, I think Eugen Bohm Bawerk (forgive my errors in spelling) said that labor cannot increase its share at the expense of capital, but is credit expansion generally a (failed) attempt to increase the share of capital at the expense of labor??

Gabriel January 15, 2008 at 9:07 am

All data is from the BLS, and adjusted (using CPI) into 2007 dollars.

There have been periods of wages + benefits stagnation, there have been periods of wages + benefits falling, and there have been periods of wages + benefits rising in the past few decades.

  • In 1991 (the earliest year I could find both wage and benefits data for), workers received $24.91 per hour ($17.89 in wages and $7.04 in benefits).

  • By 1999, workers received $25.13 per hour ($18.23 in wages and $6.91 in benefits).

That’s an increase of just 22 cents in eight years. I call that stagnation. In contrast, however:

  • In 2000, workers made $25.35 per hour ($18.40 in wages and $6.95 in benefits)

  • In 2007, workers made $28.03 per hour ($19.56 in wages and $8.47 in benefits)

That’s an increase of $2.68 in seven years or about 1.5% per year. It’s not fabulous, but its not stagnation either.

A few months ago, I managed to find the data all the way back to the 60s (and including the famous 1973 year). It turned out that after adding both wages AND benefits and adjusting for inflation, in 1973 worker compensation was less than it was today. In other words, the decline in wages was more than offset by a rise in benefits. Is anyone is interested, I can dig up the numbers again.

fundamentalist January 15, 2008 at 10:34 am

Grant: “the introduction of poor, less-skilled workers pushes down mean and median wages while not actually effecting the well-being of those who were in the sample group before those new workers arrived.”

That’s a very good point. Aggregate numbers hide a lot of interesting things.

Gabriel found something different in the BLS data than I did, and I would be interested in seeing his data. He says that average wages aren’t lower today than ’73, while the data I had seen showed a decline from ’73 until about ’90 then a strong rise but not matching ’73. But my didn’t didn’t include benefits, I believe, and his does. Nevertheless, I have often wondered how middle class standards of living could increase so much since ’73 while average wages haven’t. Benefits could be some of the explanation, but your thoughts on the influence on the mean of immigration may be the rest of the answer.

fundamentalist January 15, 2008 at 10:38 am

Gabriel, Did you find data on benefits back to 1960? I could find it only back to about ’91.

When I was doing my research, I was mainly concerned with demonstrating the effect of productivity on wages. The data shows a strong correlation between average wages and productivity and explains a large part of the downward trend from ’73 and the upward trend since ’90. Since productivity is determined primarily through capital investment, most of the popular proposals to boost wages would actually hurt wages by reducing capital investment.

fundamentalist January 15, 2008 at 10:47 am

Along the line of Dr. Reisman’s point about monetary inflation causing inequality, you should check out the trends of wages by industry on the BLS web site. I don’t remember all of them, but I clearly remember that wages in financial services have outpaced every other industry. I wonder why that could be? Could they be receiving the new money first? On the other hand, consumer services, such as hotels, have the lowest wages. Of course, education plays a role, but financial services doesn’t require any more education than many other industries with lower wages.

Inquisitor January 15, 2008 at 11:45 am

I’d also be interested in those figures – perhaps a link even.

Jonathan January 15, 2008 at 1:47 pm

It is an oversimplification to say that real wages have been falling because of govt policy. I enjoy GR pieces but one must not oversimpolify points as it provides easy refutation for ‘liberals’.
It has been said that the fall of communism saw the global effective labour force double…combine this with mobile capital, exploding communications technology and rapidly increasing standards of education in the developing world it would be startling if real wages in the west were not severely capped.

Gabriel January 16, 2008 at 7:32 am

Jonathan, I’m not aware of any correlation between growth in the rest of the world and lower wages in the West. There isn’t necessarily any connection. For example, since 2000, communications technology has been better than at any previous time, more people in the third world have been better educated, and I’ll bet capital is more mobile than ever. According to you, that’s a recipe for low wages here, but (see the data I posted above), since 2000, wages/benefits have grown.

I’m still trying to find where I saw the data going back to the ’70s. This pdf takes it back to 1986 (see page 12). But I know I saw going back further than that. The problem is, from 1986 and onward, the BLS called this measure “Employer Costs for Employee Compensation,” but before 1986, they called it something else. I don’t remember what. But I will keep looking. Also, as I write, parts of the BLS website are not functioning (they say they they’re updating their database). That may be why I can’t find it.

fundamentalism, you’re right about real wages per hour being less today than in 1973. But the difference was more than made up by the increase in benefits. I hope I can find that data!

fundamentalist January 16, 2008 at 8:26 am

Jonathan,
The problem with the “fall of communism” theory is that wages in the US rebounded in about ’90, right after the fall, and have been climbing ever since. A lot of things affect wages in the short run, but in the long run it’s all about productivity. Capital investment determines productivity levels and anything that lowers capital investment lowers wages. Just about everything the Federal Reserve and the federal government do hurts capital investment.

Besides, Dr. Reisman wasn’t writing about lower wages, but inequality caused by the wealthy becoming wealthier at a faster rate than other classes. The cause is simple: if certain people consistently receive new money first, before prices rise, they will benefit financially over those who get the new money last, after prices have risen.

Jonathan January 16, 2008 at 10:06 am

If one increases the ratio of labour to capital, then it is reasonable to expect the subsequent cost of labour to be lower than it would otherwise have been. To look at subsequent wage rates isnt very informative…what we would need, which is unfortunately not possible, is to know what wages would have been without such an increase of labour/capital ratios.
With regards to the other points, I am in agreement. I am being pedantic in that one has to acknowledge there are other, signficiant factors at work here which need to be acknowledged.

fundamentalist January 16, 2008 at 10:21 am

Jonathan: “what we would need, which is unfortunately not possible, is to know what wages would have been without such an increase of labour/capital ratios.”

Wouldn’t that wage be the wage that existed before the fall of communism?

Gabriel January 16, 2008 at 4:17 pm

Jonathan, wages are determined by the productivity of labor. The idea that “mobile capital, exploding communications technology and rapidly increasing standards of education in the developing world” would “severely cap” wages in the west depends on the assumption that those things cause workers in the US to have lower productivity. That assumption can be false because the additional growth in the rest of the world can actually provide the means to increasing capital (and thus productivity) here in the US and therefore more than counteract the downward pressure on wages caused by an increase in the global supply of workers. Although it is of course possible for productivity here to fall at the same time that the rest of the world develops, that does not necessarily have to occur if the market here is relatively free. For more explanation, see Reisman’s Capitalism or Reisman’s “Globalization” article.

I’m getting closer to find the historical employee compensation data. The Federal Reserve’s website has a chart showing real compensation per hour all the way back to 1947. The infamous year 1973 is significantly below today’s mark. The increase in benefits has outstripped the decline in wages by far. I’ll keep looking for more precise data though.

Gabriel January 16, 2008 at 4:25 pm

Incidentally, many fringe benefits became tax-free in the 1970s, so it should be no surprise that people responded by shifting money that would have gone toward increasing actual wages instead toward increasing benefits. It’s the market at work.

Mark Humphrey January 16, 2008 at 8:14 pm

Thanks to Dr. Reisman for another great article!

Gabriel is on target in pointing out that wage rates ultimately reflect changes in productivity, while productivity is primarily boosted by the accuumulation of additional capital. And as Dr. Reisman explains in “Capitalism”, an increase in capital goods happens nearly as soon as new workers are introduced into the division of labor.

There are several interrelated ways in which the addition of more workers to an economy boosts productivity and real wage rates. First, the division of labor is intensified and extended by the additional workforce, which lifts the producitivty of the existing capital stock. For workers temporarily displaced by new labor find work as new employment is created in response to new spending. What is the source of this new spending? Reductions in nominal wage costs, which yield higher business incomes, which are consumed or invested. Either way, the new spending adds to capital spending, most obviously in the form of hiring new workers; but also as spending on producer goods to lift production. So the capital base increases and real wage rates are nudged higher.

On a seperate note, there is a small problem with the idea that rising job benefits have rescued real wage rates from stagnation in the USA since, say, 1990. The steadily increasing dollar costs associated with such benefits are due in part to rising inefficiency in the health care system as the result of increasing regulations of medical provision. To cite one of several possible examples, recall the rising cost of medical malpractice lawsuits, which are certainly a form of legalized extortion from Doctors and hospitals to trial lawyers. Skepticism about the value of the growth in “benefits” is in order.

fundamentalist January 16, 2008 at 8:21 pm

Gabriel: “I’ll keep looking for more precise data though.”

I’ll take you word for it.

Jonathan January 17, 2008 at 5:03 am

Fundamentalist, the answer to your question is very no. For what reason ought wages to remain unchanged? Prices are never static in a free market.
Mark, you make a good point. But I would conjecture that an almost instantaneous increase in one variable, labour would preceded the resulting capital accumulation. To say that there has been no impact on wages due to ‘fall of communism’ argument and to blame the unimpressive rise of real wages exclusively to government is unnecessarily extreme.

Gabriel January 19, 2008 at 7:48 am

The data is available from the St. Louis Fed. See Nonfarm Business Sector: Real Compensation Per Hour and the actual data.

The base year is 1992 so 1992 = 100. From the BLS website we find out that in 1992, total compensation per hour was $17.27 ($12.33 in wages and $4.94 in benefits of which $1.13 was health insurance). Adjusting for inflation gives the following numbers: $25.52 per hour total compensation, $18.22 per hour in wages, $7.30 in benefits of which $1.67 was health insurance.

With that information, we can calculate the dollar amounts of real per hour compensation in any year from 1947 to today. For example, in 1973 the index is about 85. We set up a mathematic ratio as follows: 25.52 / 100 = x / 85. Solving for x gives $21.69 which is the total compensation per hour in 2007 dollars in 1973.

We can go further and figure out how much of that was in wages and how much was in benefits. Wage data is available from the BLS. Using that information, we find out that in 1973, average hourly earnings were around $9.08 in 1982 dollars. In 2007 dollars that is $19.51. So the wage component of total compensation in 1973 is $19.51 leaving $2.18 in benefits ($21.69 – $19.51).

Compare that to the total compensation numbers for 2007. Workers received $28.03 per hour total which included $19.56 in wages, and $8.47 in benefits of which $2.21 was health insurance.

Alex January 23, 2008 at 5:17 pm

George Reisman needs a course in basic accounting. He says, “But now imagine that the firm spends the same amount of money in buying durable machinery that will be depreciated over a ten-year period. Once again, a seller — this time the seller of the machinery — will immediately have additional sales revenues equal to our firm’s additional expenditure. But in this case, our firm will certainly not have an equally large additional cost of production to report in its next income statement. If its expenditure for the machinery was $1 million, say, then while the seller has $1 million of additional sales revenues in his next annual income statement, our firm will probably have merely $100,000 of additional costs to report in its next annual income statement.”
George: the firm that sells a $1 million piece of machinery will have the costs of producing that machinery as an asset (the machine) on its balance sheet (it would be in an inventory account). When it sells the machine, it’s profits for the machine sale will be recorded in the period of the sale as $1 million less the cost of sales, say $800,000 or $900,000 or whatever it cost it to make the machinery. With accelerated depreciation, it is even possible that the sum of the recorded profits of the buyer and seller with regard to the machine are negative.

George Reisman January 23, 2008 at 8:42 pm

Answer from George Reisman: Alex, it’s true that the seller of the machinery may have $800,000 cost of goods sold and thus that his profit on the sale is only $200,000. But the seller of advertising also has costs, and they will likely be comparable. So either way, we have a $1 million of sales revenue to a supplier and something on the order of $800,000 of costs to the suppliers. The difference is that in the case of the machine purchase, we have only $100,000 of cost to the buyer instead of $1 million of cost to the buyer, which is what we would have had in the advertising case. Thus, in the economic system as a whole, costs are still $900,000 less and profits are $900,000 more.
If you’d like to learn more about the application of accounting to macroeconomics, please see Chapter 16 of my book Capitalism. It’s on line in pdf format at http://www.capitalism.net. One of the things is demonstrates is that aggregate profit and aggregate net investment are very closely related as a matter of definition and often, as in the example I gave, move together dollar for dollar.

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