Are wages around the world converging?

Crossposted from: the ILO

Unlike several other disciplines, economics is far from being an exact science. It is often hard to find clear answers about basic economic facts and trends.

Take wages, for instance. Half of all employed people rely on wages for a living. These wages tend to reflect the combined efficiency of capital, labour and technology in any given country. So it is important to know whether economies are leading to better wages for the large majority, especially in a highly interconnected global economy.

According to the ILO Global Wage Report 2012/2013, in the last decade, real wages – adjusted to reflect purchasing power – had doubled in Asia, almost tripled in Eastern Europe and Central Asia and increased by 15 per cent in Latin America. That compares with a rise of just five per cent in developed economies. These trends confirmed what we already know about the direction of the current changing regional dynamics, but do they tell us the extent to which wages around the world are converging?

Multiple answers

Answering the question is not straightforward. The prices of goods and services in each country tend to differ as do wages. And comparing them raises a number of difficulties.

Several options are available:

One is to convert nominal wages into a single currency, usually the US dollar, using market exchange rates. This is the least preferable option as exchange rates are subject to many forces other than economic fundamentals. A better option for international comparisons is to work out what it would cost to buy a single basket of goods in each country – the purchasing power parity (PPP).

Comparing countries in this way, results in the following graph, which displays average wages for 2010 in 10 sample countries.

Table 1: Average nominal monthly wages, in PPP international dollars, 2010
Source: ILO Global Wage Database and IMF

Here we can identify three groups of wage levels of around 700, 1500, and 3,000 international dollars respectively, corresponding to three levels of development or economic efficiency.

A disadvantage of this approach is the difficulty of composing one identical basket of goods that serves all countries.

A variation of this method is to compare wages (again using PPP), in a single occupation, for example unskilled work in construction. A broadly similar picture emerges, with wages of construction labourers in emerging countries 3 to 5 times lower than those in advanced countries. There are, however, interesting differences in the findings of the two graphs when comparing the United States with Germany and Turkey with Portugal.

If the trends in real wages mentioned earlier were to be sustained into the future – a questionable assumption – the wages of construction labourers in Asia and in developed economies would equalize by 2038.

Table 2: Average monthly wage of labourers in construction, in PPP international dollars, 2010
Source: ILOSTAT database and IMF (Data for China and Germany are average wages in construction)

Another method is possible, based on the price of a staple food good that is prevalent in each region (rice, pasta, wheat or maize meal), which every household is likely to consume. This overcomes the difficulty of trying to compose one identical basket of goods across several countries.

Table 3 shows the cost of 5 kg of the prevalent staple as a percentage of the average wage. This is the most direct possible formula, as it avoids any exchange rate conversion.

Here the graph shows a different picture: In seven countries, the cost of 5kg of a staple food lies between 0.4 and 0.7 per cent of the average wage. Two countries stand out, Indonesia and South Africa with rather different ratios, suggesting some skewing of the relation between wage levels and average income.

Table 3: Cost of 5 kg of staple food in per cent of monthly average wage
Source: ILO Global Wage database; FAO GIEWS database; Eurostat; US Bureau of Labour Statistics; and South Africa Quarterly Food Monitor

More data needed

There has been much public debate about the role of domestic versus international factors in shaping relative wage levels. Some argue globalization is pressuring wages downward, whilst others argue that domestic institutions retain the upper hand in wage setting.

In order to move closer to a possible answer, we need more frequent international comparisons of wages covering more countries and occupations.

Austerity is no liquidity trap solution

From: Lars Syll

Mainstream neoclassical economists seem to think that there really isn’t any difference between solving a liquidity trap by lowering real wages via inflation or by lowering nominal wages.

 

But that is of course pure nonsense. Lowering real wages via inflation and lowering nominal wages aren’t equivalent measures.

 

As John Maynard Keynes wrote in General Theory (1936):

 

The method of increasing the quantity of money in terms of wage-units by decreasing the wage-unit increases proportionately the burden of debt; whereas the method of producing the same result by increasing the quantity of money whilst leaving the wage-unit unchanged has the opposite effect. Having regard to the excessive burden of many types of debt, it can only be an inexperienced person who would prefer the former … If a sagging rate of interest has to be brought about by a sagging wage-level … there is … a double reason for putting off investment and thus postponing recovery.

 

Or as Irving Fisher – the originator of the debt-deflation theory – wrote in Debt-Deflation Theory of Great Depressions (Econometrica, 1933):

Graphs of the day: the mediterranean current account deficits are gone

The large current account deficits of the southern European countries are gone (graph 1).

* This is not mainly caused by increases in productivity and a surge in exports. Average productivity in Spain is increasing but that’s caused by the decline of construction, which has lower productivity than the average of the rest of the economy. Wages in Greece have declined with about 20% vis-a-vis competitors – but as Greece first has to establish an export industries this has not yet led to any kind of clear competitive advantage. Greek exports of goods and services (including tourism) actually declined, in 2012-IV!

* It is, mainly, caused by the Great southern European Depression. High interest rates, dramatic declines of domestic demand and unprecedented unemployment as well as some decline of oil prices caused imports to decline.On a more detailed level the real changes are mainly in the goods- and income accounts, not in the services accounts.

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New Eurostat data (trade, house prices,unemployment, CtC): we need ‘investments, investments, investments’.

Update: here a little bit about ‘Cyprus waste industries’ (see Ad d.)

New data from Eurostat: (a) current accounts, (b) house prices, (c) broad U-6 unemployment and (d) also some real stuff: packaging waste treatment

Ad a: the most interesting cherry: the current account deficit of Spain, 2012, fourth quarter, improved from -8,6 tot plus 4,4 billion (Euro). That’s a definitive: ‘wow‘. It’s is of course no sign of increasing competitiveness, as estadistica españa tells us that, in February, “Todos los sectores industriales registran tasa anuales negativas en febrero“- it’s a sign of an extremely deep economic crisis. For the same reason the current accounts of Greece, Italy and Portugal showed large improvements too. Looking at the last half-year of 2012 all of these current accounts even showed surpluses.

The Reinhart and Rogoff defense of their work is riddled with mistakes, too

Economists are proud of their advanced mathematical and quantitative methods. The already classic Herndon, Ash and Pollin paper  however pointed out mayor flaws and mistakes in basic arithmetic in the influential work of Reinhart and Rogoff on the relation between debt and growth. Mistakes with ’non-trivial’ implications for their conclusions and present economic policy. Reinhart and Rogoff responded to this – but to an extent this response only made matters worse, see also this Krugman blogpost. As is also pointed out in a new response by Ash (which we can publish here courtesy of the German Handelsblatt), who shows that the Reinhart and Rogoff defense (see below) crucially misquotes and misrepresents their own work.

I appreciate Reinhart and Rogoff’s frankness in acknowledging the errors in their paper.

I disagree with their assertion that our results are not dramatically different from theirs. Where Reinhart and Rogoff report average GDP growth of -0.1 percent above the 90 percent public debt/GDP ratio, we find average GDP growth of 2.2 percent. This is an enormous difference.

We also refute the RR evidence for an “historical boundary” around public debt/GDP of 90 percent, above which growth is substantively and non-linearly reduced. There is no indication of an important threshold in the data and this was an important part of the argument.

Their weighting to calculate mean growth is nonstandard; for example, it gives a single year of data for New Zealand as much weight as 19 years of data for the UK or 19 years of data for Greece. We discuss the considerations around weighting in our paper, and the Reinhart and Rogoff response does not address that the 1951 GDP growth for New Zealand accounts for a substantial share of their result.

Meanwhile, in Austeristia – unemployment is increasing everywhere

1. JEROEN DIJSSELBLOEM, OLLI REHN, JÖRG ASMUSSEN, KLAUS REGLING and WERNER HOYER have published an ‘Austeristic manifesto’ in the New York Times

2. It’s kind of bizarre: unprecedented unemployment is necessary, according to them.

“The current crisis has exposed both fiscal and macroeconomic imbalances caused by a lack of reforms in several euro zone countries as well as structural problems in the institutional set-up of Europe’s economic and monetary union. But in the eye of the storm, we strengthened the foundations of our currency and improved the sustainability of our economies. Not everything is in its right place yet, and the necessary adjustment is bringing serious social challenges, notably in the form of unacceptably high unemployment. These challenges have to be addressed with determination”

3. But it’s extremely flawed, too. The Netherlands, home country of mr. Dijsselbloem, have an extremely competitive export sector which, even at the moment, is doing very well. Not “quite well”, but very well. During the last two years, wages increases were among the lowest of the entire European Union. The Netherlands are supposed to be among the best of the best, when it comes to economic resilience. The current account has a 9% of GDP surplus, pensions funds have an amount of funds which is about twice the size of GDP – exactly what we want Spain and comparable countries to have.

4. But the economy is crumbling in the Netherlands, at least to an extent because of the bust of the house price boom and the commercial real estate building boom. Today, new data on unemployment were published. Even the most negative expectations were surpassed, with a wide margin. Despite low wage increases. Despite an export sector which is doing well. By the way – retail sales went down (volume) with about 7%, in February. Demand matters.

DNWR and the Euro area’s experiment of internal wage devaluations

From:

Ronald Janssen

Paul Krugman picks up on the Eurostat statistics on wages and wage developments in the private sector across Europe. He concludes that the experiment of an ‘internal wage devaluation’ which the Euro Area in particular is trying to practise is very hard to achieve since downwards nominal wage rigidities (DNWR) are preventing nominal wages from falling. The figures from Eurostat indeed show that Greece is the only financially distressed Euro Area country where nominal wages have fallen between 2008 and 2012 (even by 11%). In contrast, nominal wages in Ireland and Portugal have firmly remained at their 2008 levels whereas nominal wages even increased by 8,9% in Spain (and Italy). Even if this, with ongoing inflation, represents a cut in real wages, it does not really reflect the internal wage devaluation Spanish and European policy makers are aiming for. However, two additional remarks need to be made.

If the Irish labor force had not declined so much, Irish unemployment might have been 20%

Ireland and Greece are experiencing somewhat comparable crises. Though the crises have somewhat different roots, both are characterized by a continuing decline of the number of jobs (by now -15% in Ireland, -22% in Greece), a kind of bank run on the country resulting in a massive decline of the amount of (M-3) money and rapidly increasing government debt. Still, unemployment in Ireland is ‘only’ 14 % and more or less stable, while unemployment in Greece is 27,2 % (January) and still rapidly increasing, a difference which can not be explained by the differences in job losses. Is there another reason? Yes.

The labor force in Greece is at the moment about as large as in 2008 (source: Eurostat), while the Irish labor foce declined considerably. Tinkering a bit with the data shows that about 50% of this decline must have been caused by emigration of the best and the brightest to countries with an own currency and about 50% because people dropped out of the labor force. If all these people had stayed in the labor force, like in Greece, unemployment in Ireland would have been about 20%. The true face of the Eurocrisis. Another aspect of this crisis which is increasingly fragmenting Europe and destroying nations: the number of jobs in Greece keeps getting down (source: Elstat).

How Much Unemployment Was Caused by Reinhart and Rogoff’s Arithmetic Mistake?

From: Dean Baker

That’s the question millions will be asking when they see the new paper by my friends at the University of Massachusetts, Thomas Herndon, Michael Ash, and Robert Pollin. Herndon, Ash, and Pollin (HAP) corrected the spreadsheets of Carmen Reinhart and Ken Rogoff. They show the correct numbers tell a very different story about the relationship between debt and GDP growth than the one that Reinhart and Rogoff have been hawking.

Economics textbooks – decades of scientific fraud and incoherence

From: Lars Syll

As is well-known, Keynes used to criticize the more traditional economics for making the fallacy of composition, which basically consists of the false belief that the whole is nothing but the sum of its parts. Keynes argued that in the society and in the economy this was not the case, and that a fortiori an adequate analysis of society and economy couldn’t proceed by just adding up the acts and decisions of individuals. The whole is more than a sum of parts. This fact shows up already when orthodox – neoclassical – economics tries to argue for the existence of The Law of Demand – when the price of a commodity falls, the demand for it will increase – on the aggregate. Although it may be said that one succeeds in establishing The Law for single individuals it soon turned out – in the Sonnenschein-Mantel-Debreu theorem firmly established already in 1976 – that it wasn’t possible to extend The Law of Demand to apply on the market level

The incentives for black and white entrepreneurs in South-Africa

According to Hobsbawn,

“It is often assumed that an economy of private enterprise has an automatic bias towards innovation, but this is not so. It has a bias only towards profit.’

Johan Fourié writes quite simple about private entrepreneurship, rents, profits, the state and innovation in a South African post-apartheid black and white context (should he also add a female ‘Coco Chanel’ twist?):

Vast volumes have been written on the importance of entrepreneurship in building prosperity. Entrepreneurs innovate, identify new markets, implement new systems and process, connect labour, capital and technology in novel ways; in short, entrepreneurs make stuff more efficient than before. But measuring the contribution of ‘entrepreneursip’ to growth has been difficult, given the unquantifiable nature of entrepreneurial traits: motivation, creativity, risk-taking, to name a few. In a recent working paper, Sascha Becker and Hans Hvide claim to have found an answer to the question: Do Entrepreneurs Matter?

Post-war unemployment and the failure of neo-classical social engineering in the Eurozone. 4 graphs.

Eurozone unemployment is, with 12%, at a historical maximum. This average masks lower levels in the core while levels in the ‘periphery’ are beyond anything ever experienced in the developed economies, post WW II (see the graphs). This is a concern for the European Central Bank (ECB). This bank has next to its inflation fighting mandate a clear, legal, and binding prosperity mandate. The (neo-classical) idea was that just taking care of low and stable inflation was enough to guarantee low inflation as well as financial stability and a steady increase in prosperity and employment. This idea has after 2008 been compromised to its fundamentalist core. Which means that the bank has to find other ways to stimulate employment as much as possible. The question is: how does a central bank fight hyper-unemployment? Models and cherished convictions don’t help as the southern European levels are ‘out of sample’. The best anecdotical examples are probably Finland (see below) and East-Germany. Finland solved its high 1991 unemployment with, among other actions, a 40% devaluation. Around the same time a de facto policy of internal devaluation was introduced in East Germany – and East-German unemployment is at present still above 10%. It has come down from 20% – but only because the labor force declined with 30%. Which indicates that internal devaluation is just too slow and monetary policy has to be highly aggressive: buying government bonds, buying bad assets from banks, paying down mortgage debts of overly indebted households, “Whatever it takes”.

1. Post WW II, 12% unemployment was the limit, in core developed countries

Sources: CBS, INSEE, BLS, ONS, Statistisches Bundesamt

Why isn’t inflation lower, nowadays (common sense edition)

At this moment, there is quite some talk about the question why (European) inflation isn’t any lower, considering the crisis. Three remarks:

Source: Eurostat. The graph does not show the HICP consumption price indicator but the superior national accounts consumption price indicator (which is slightly less volatile than the HICP indicator).

(A) GDP inflation (which does not only show the development of consumer prices but also those of investment prices, government expenditure etcetera) after 2008 was about 1% a year lower than before 2008 which makes for a cumulative difference of about 4%, by now. This surely is not yet deflation – but it is a sizeable difference, which is also larger than the difference between consumer price inflation before and after 2008.

(B) Unemployment in the entire Eurozone shows a relentless increase and has crossed the ‘hyper-unemployment’ threshold (more on this tomorrow). Unemployment in the largest economy of the Eurozone, Germany, has however actually gone down while unemployment in its second most important economy, France, has been fairly steady and is only quite recently showing signs of alarming increases. If these two economies act as a kind of price leaders, little decline of inflation was to be expected.

(C). But as the ‘core’ economies too are, by now, increasingly hit by austerity, a further decline in ‘domestic’ inflation, i.e. excluding imported products, is to be expected.

Democracy versus capitalism: take two

From: Peter Radford

My post last week has elicited a number of lengthy and interesting responses. Rather than answer one at a time I thought I would clarify and extend on my original thoughts.

This comment, by Ken Zimmerman, is my starting point:

Per the latest edition of Samuelson’s “Economics” the 2007-2009 financial crisis was bad, but it followed a half-century of spectacular increases in the living standards of most of the world, particularly those living in the affluent countries of North America, Western Europe, and East Asia. The book asks will these successes be repeated in the 21st Century, will the affluence spread to the poor countries? Or will the four horsemen of the economic apocalypse — famine, war, environmental degradation and depression — spread to the North? According to Samuelson and Nordhaus these are the questions this newest version of the number one selling Introduction to Economics textbook seeks to answer. You’ll notice little is said here about democracy. But elsewhere in the text Samuelson and Nordhaus talk of democracy and a market economy as the twin goals sought in Eastern Europe, China, and the former Soviet Union. What the protestors in these places protested against was socialism and what they protested for was “the hope that they many enjoy the freedom and economic prosperity of democratic market economics.” So Peter as far as the top Economics textbook is concerned you are dead wrong. And believe me this textbook reaches a lot more students and people in general than blog posts anywhere on any blog. That being the case, how would you suggest Samuelson and Nordhaus change their textbook, or in the alternative how would you change your position so that market economics and democracy work together? Samuelson and Nordhaus are smart guys. I would not want to dismiss what they say without a full hearing.

Here in a nutshell is the problem: economics writers, in their zeal to proselytize free markets, ignore that society has learned, the hard way, that those very free markets need to be severely hemmed in.

The big picture. Economic history links-of-the-day

The reconstruction of (macro-)economics is on its way. And we seem to be in the ‘big stories’ phase. On this blog, Peter Radford had a ‘it’s political economy after all’ story: ‘Austerity: democracy versus capitalism’ while David Ruccio wrote about his surprise that ‘History and capitalism‘ suddenly had become a fad. But they were not the only ones to take a broad view – quite some big boys weighed in, too: (I) Brad deLong, (II) Tyler Cowen, (III) George Soros and (IV) William Janeway. Below some extensive quotes and a few remarks

Ad I. Brad de Long is the economic historian and tells the story of the unprecedented increase in prosperity during the last 250 years.

Winning the fight for the climate, one community at a time

We desperately need investments – but not in coal.

From the Greenpeace site

Blogpost by Lauri Myllyvirta

For a long time, efforts to stem the growth of global CO2 emissions and avert the impending climate chaos have been synonymous with complex international negotiations between governments.

The unwillingness of governments to commit to action has given those of us concerned about the future a reason for pessimism. However, a series of new recent victories might give reason to rethink what progress on climate looks like.

Graphs of the day. Hourly labor costs, European Union, change, 2008-2012

From Eurostat:

Graph 1.Relative change in hourly labour costs 2008-2012 for the whole economy

Remarkable: per hour labor costs in Greece relative to direct competitors like Italy and Spain (tourism!) declined with about 20%. Unemployment in Greece is however still increasing. Something comparable holds for Eastern Europe: wages over there are extremely low, compared with the rest of Europe. Still, their economies are not doing too well. We need investments, not wage cuts.

Graph 2. Estimated labour costs for the whole economy in EUR, 2012.

A neo-classical idea brought Margaret Thatcher down

Does neo-classical economics have ‘utility’ after all? Margaret Thatcher passed away – you might have noticed. More interesting is what brought her down as a politician. It is well-known that this was the ‘community charge’, or poll tax, a wiki about this tax here. It is less known that this poll tax – basically a tax based upon the number of adult members of a household without regard to income or wealth – is a genuine neo-classical idea. A very neo-classical textbook (Dutch) states it like this (my imperfect translation, emphasis added):

“Ideal in this regard it the poll tax, known from the UK, or in good Dutch the ‘hoofdgeld’ (head money). It’s … a lump sum per capita without regard to income or consumption, such a tax leaves áll relative prices uninfluenced. The fact that it’s not based upon income is a weak point, as people quite soon regard this as unjust“.

Eijgelshoven, P.J., A. Nentjes, and B.C. van Velthoven (2010), Markten en overheid, 5th edition, p. 276.

Mind the undemocratic thinking, mind the idea that existing prices are supposed to be perfect in the neo-classical sense, mind the implicit assumption that the existing division of income is efficient and just, mind the implicit assumption that the existing division of wealth and property is efficient and just, mind the implicit idea (read the wiki) that ‘land’ is not important.

That’s the kind of thinking that brought Thatcher down.

Indian Drug Ruling Strikes a Blow for Free Enterprise

From: Dean Baker

Last week India’s Supreme Court rejected the Swiss pharmaceutical company Novartis’ patent on the cancer drug Gleevec. While the immediate issue was the ability of Novartis to charge its patent-protected price for the drug in India, the decision will have an enormous impact on the future of public health not only in India, but around the world.

The key issue is whether we will follow a pattern in which patent monopolies are continually lengthened and strengthened. This has been the goal of the U.S. government in trade negotiations led by both Democratic and Republican presidents. The TRIPs provisions of the Uruguay Round of the WTO negotiations were the clearest manifestation of this drive. These provisions, which were added at the request of the U.S. pharmaceutical industry, require countries throughout the world to adopt U.S.-type patent laws. In addition, the United States has sought to further strengthen patent protections in all the bilateral and multilateral trade agreements that it has negotiated over the last two decades.

There is a similar story domestically where the duration of patents was increased from 14 years in the 19th century to 17 years up until 1994. Currently the duration is 20 years from the date of filing. More importantly, the United States has a notoriously lax patent system that makes it possible for drug companies to patent almost anything in order to throw obstacles in the path of would be competitors. In the 1997 there was a famous incident in which an “inventor” was able to obtain a patent on a peanut butter sandwich.

The result of stronger and longer drug patents is incredibly high drug prices. The United States is the only country in the world that effectively gives drug companies a complete monopoly on the production of drugs that are essential for life or health and then lets them charge whatever they want. The result is that we spend almost $300 billion a year for drugs that would likely sell for less than $30 billion in a free market.

Are structural reforms of the (East) German labor market a template for Europe? 3 graphs

About a week ago I promised to write a little more about Cyprus, Dijsselbloem and all that. I first set out to state that the ECB does not only has an inflation mandate: it also has a legal mandate to foster prosperity. And belatedly but nevertheless the ECB has de facto said ‘goodbye’ to its long-standing conviction, inspired by ‘rational expectation economics’, that as long as inflation is low and stable, financial stability is guaranteed.

The ECB however still clings to another fallacy, i.e. the ‘rational expectations economics’ idea that unemployment has to be solved by ‘structural’ measures, i.e. changes in national labor market institutions and in the medium run by definition is caused by labor market rules, just like large slumps are caused by dysfunctional labour markets.