Noah Smith — Lower Wages Can Be A Good Thing

Menzie Chinn points out that recovery in manufacturing and exports has been stronger than recovery as a whole. As an explanation, he cites America's falling unit labor costs. Unit labor cost is just the amount of wages you need to pay workers to produce one unit of output. Because America's unit labor costs are falling, it is becoming more economical for businesses to produce more tradable goods here, and so they are doing so.

This is a useful reminder of a economic principle often overlooked by progressives: There is sometimes a tradeoff between wages and employment levels (which is another way of saying that labor supply curves slope up and labor demand curves slope down). If economic "frictions" or the actions of policymakers hold wages up when economic forces are trying to push wages down, unemployment will often result. 

Read it at Noahpinion

Lower Wages Can Be A Good Thing
by Noah Smith

My comment there:

Noah, the issue is distribution. There is a difference between growth and prosperity. Growth is an absolute but prosperity is relative to distribution. Increasing inequality is an indication of decreasing prosperity, even though growth is increasing. The gains from increased productivity are not being distributed but rather are concentrating at the top.

The challenge of macro applied as a policy instrument is achieving national growth together with national prosperity. The US gets a failing grade.

What is happening in the global economy as a closed system is that imbalances are correcting. One of the imbalances is compensation (wage, protections, and benefits) per unit of labor. The cost of a unit of labor in the undeveloped world is stagnant, in the emerging world rising, and in the developed world falling. The natural direction you mention is the Great Leveling.

There is so great a gap in compensation level and such a pool of labor coming on line in the global economy now that labor is becoming increasingly more fungible —and yet to come on line for years to come, that the leveling will become severe in the developed world as the wealth and income gap grow, and the class structure become more apparent with more and more people at or near the bottom. This  is already apparent.

The persistent trade gap is an indication of this, as the developed world gorges on cheap imports and hemorrhages jobs, destroying the bargaining power of labor, wiping out entire industries, and enriching a few.

This is resulting in social unrest that will persist and likely increase unless some smoothing is devised to ease the process.

Of course, this is only one of the problems that globalization is bringing, and the road ahead promises to be exceedingly rocky if the world stays on the present course. I don't think that this is acceptable socially, therefore neither is it politically viable.

If that is the case, protectionism and capital controls are in the cards if other means are not put in place to ease the pain. Redefining the natural rate of unemployment to 6-8%  which seem to be the way that Bernanke is thinking, for the US is not going to cut it. There is already a social and political backlash in the works globally. And for the first time in quite a while, the debate in the US is turning away from a preoccupation with social issues and into class warfare based on economic realities.

Moreover, without addressing falling effective demand due to stagnant real wages and without addressing the cost of idle resources and a persistent output gap, the US cannot perform up to potential. The solution is fiscal policy that addresses both distribution issues and also the Great Leveling. Otherwise, the US will slip into a have and have-not country with the have's selling to the ROW instead of US workers purchasing the goods they themselves provide.