Stephen Koukoulas was expressing a fallacious view shared by the vast majority of economists when he wrote that
if wage levels remains too low for too long. It holds back or even oppresses growth in consumer spending. The household sector needs steady real income growth if it is to maintain a solid growth rate in consumption spending. While borrowing and a run-down in savings can temporarily underpin higher spending, more fundamentally sound and sustainable increases in spending rely heavily on household income growth.
This is the sort of plausible nonsense that leaves one in despair as to whether sound economics will ever gain ground in Australia, or anywhere else for that matter.
Koukoulas is obviously blind to the fact that his so-called economic opinion is first cousin to the purchasing power of wages fallacy that caused so much misery in the past.
It appears obvious to the man in the street that wages drive the economy because it is wages that purchase the products of labour. Therefore any reduction in wages must depress economic activity. Stephen Koukoulas would endorse this view, as would nearly all economic commentators, with the observation that as consumption is about 70 per cent of GDP it is self-evident that consumption is the principle driving force behind the economy.
But GDP is a net value-added concept and as such does not measure gross economic activity. Alert to this serious flaw America’s Bureau of Economic Analysis is now producing an additional measure of economic activity called gross output*. This new measure includes the extraction of raw materials right through their transformation into intermediate goods and then to the final point of sale. What this means for the orthodox view is striking. Let us take an economy whose GDP is 100 and aggregate consumption is 70 per cent. Now if the BEA approach assessed the economy’s gross output at 300 then consumption as a percentage of measured economic activity would drop to 23.3 per cent, thus undermining the received wisdom.
The Austrian school of economics spent decades warning that the GDP concept was dangerously deceptive because it misled policy makers and their economic advisors into designing policies that promoted consumption. It never occurred to these highly qualified economists that only in an extremely backward economy — one in which the mass of people were destitute — would consumer spending dwarf business spending.
As the BEA’s new measure clearly shows, it is gross business spending that needs promoting and not consumption. (Roosevelt’s disastrous economic policies demonstrated what happens when consumption is heavily promoted at the expense of business spending). The gross output approach reveals an important fact that all policy makers and the vast majority of economists overlook but the Austrians stress: production takes place in stages and it is in these stages that all intermediate production must take place. If spending falls here relative to consumption then wages must also eventually fall if unemployment is to be avoided. It can never be over-stressed that the largest
number of payments is not from consumers to producers, but is made between producers and producers, and tends to cancel out in any computation of net income of net product value. “In fact, income produced or net product is roughly only about one-third of gross income.” [Emphasis added]. What is cost for one producer is in part income for some other producer, but part of that income the latter has to pay out in costs to other producers in another stage of the productive process (for intermediate products, raw materials, supplies, etc.), and so on. All that is necessary in order that equilibrium be maintained is that consumers’ incomes equal the cost of producing consumers’ goods; the total of producers’ payments necessarily exceeds that of consumers’ incomes. (C. A. Phillips, T. F. McManus and R. W. Nelson, Banking and the Business Cycle, Macmillan and Company 1937, p. 71).
This brings us to Stephen Koukoulas’s opinion that a general fall in real wages is “a sign of slack in the labour market”. By this, of course, he means that the real demand for labour is sagging. This is just another way of saying that business is offering less in exchange for labour services. As a classical economist might say: The intensity of demand for labour is falling.
If a long term fall in real wages did set in then this would indicate that business spending (actually gross investment) relative to consumption is dropping which also means that per capita consumption is also falling. This happens in two ways: either the labour force is expanding faster than business investment or aggregate business spending is shrinking. As the Austrian school would put it, the capital structure is shortening.
Those with some knowledge of capital theory can easily see how the BEA’s gross spending approach reveals the truth of John Stuart Mill’s greatly misunderstood fourth proposition (inspired by John Rae’s work) that the “demand for commodities is not the demand for labour”, meaning that increasing consumption at the expense of investment must lower real wage rates. But this also means that raising government spending relative to business spending would have the effect of shifting resources away from gross investment to greater consumption at the expense future living standards. As Mill explained:
The circulating medium existing in a country at a given time, is partly employed in purchases for productive, and partly for unproductive consumption. According as a larger proportion of it is employed in the one way or in the other, the real capital of the country is greater or less. (Principles of Political Economy, Vol. II, p. 528, University of Toronto Press 1965).
The classical school was clearly aware that once government spending exceeded a certain point it would have a detriment effect on investment and hence real wages. I understand how all of this might seem rather strange but economic history confirms it. Before the emergence of industrialisation the ratio of gross business spending to total consumption had to be extremely low because society’s capital structure was very short, which means there was little in the way of intermediate business spending. Now a lengthy capital structure is impossible without the existence of fixed durable capital. This is a fact to which Simon Kuznets paid particular attention, stating that
one may ask whether there was any fixed, durable capital formation, . . . in pre-modern times, whether there was any signi?cant accumulation of capital goods with a long physical life that did not require current maintenance (or replacement) amounting to a high proportion of the original full value. If most equipment lasted no more than five or six years, if most land improvements had to be maintained by continuous rebuilding amounting to something like a fifth of the total value per years, and if most buildings were destroyed at a rate cumulating to fairly complete destruction over a period from 25 to 50 years, then there was little that could be classified as durable capital. . . . The whole concept of fixed capital may be a unique product of the modern economic epoch and of modern technology. (Cited in Fernand Braudel’s The Wheels of Commerce: Civilisation and Capitalism 15th-18th Century, Vol. 2, Phoenix Press, 2002, p. 247).
The question of government spending and growth is a vital one and it’s one to which gross output could make a significant contribution. But the concept also plays a significant role in Austrian trade cycle theory. Unfortunately, the likelihood that this will being debated is about zero for the same reason there is no debate on Australia in the Great Depression or the classical economists and the trade cycle. Australia’s right has made it very clear that once they decide an economic issue has been settled no further questioning is considered legitimate.
*I doubt very much if the BEA realises that their gross output concept undermines Keynesianism and the fallacious Keynesian approach to derived demand.