US wages and Europe's austerity: the perfect storm

What if Europe and the US converged on a set of economic policies that brought out the worst in both – European fiscal austerity combined with a declining share of total income going to workers? Given political realities on both sides of the Atlantic, it is entirely possible.

So far, the US has avoided the kind of budget cuts that have pushed much of Europe into recession. Growth on this side of the pond is expected to be around 2.4 per cent this year. And jobs are recovering, albeit painfully slowly.

But a tough bout of fiscal austerity could be coming in six months. The non-partisan Congressional Budget Office warned last week that if the Bush tax cuts expire on schedule at the start of 2013, just as $100bn of budget cuts automatically take effect under the deal to raise the debt ceiling that Democrats and Republicans agreed to last August, the US will fall into recession in the first half of next year.

Even if these measures were to reduce the cumulative public debt, a recession would increase the debt as a proportion of gross domestic product – making a bad situation worse. That is the austerity trap much of Europe now finds itself in.

Meanwhile, real wages in the US continue to fall. A new “World Outlook” released by the International Monetary Fund last Friday showed that in the three years since the depths of the downturn in 2009, total national income has rebounded in most of Europe and in the US. But the share of national income going to workers has fallen sharply in the US, while rising in Europe as a whole.

The trend is even more striking measured from the start of the recession. It used to be that when a downturn began, profits fell faster than workers’ income because companies were reluctant to lay off employees and couldn’t easily cut wages given union contracts or the threat of unionization.

That is still the case in Europe, courtesy of stronger unions and labor-market regulations. But it is no longer the rule in the US. Since the start of the recession, the share of total US national income going to profits has risen even as the share going to the workforce has plunged. Profits in the US corporate sector are now at a 45-year high.

American workers have been willing to settle for lower wages in order to retain their old jobs or secure new ones. At the same time, US companies, intent on increasing profits, have more aggressively outsourced abroad, substituted contract workers and temps for full-time employees and replaced workers with computers and software.

The workforce’s share of total income includes the salaries of managers and professionals as well as the non-salary income of high-flying chief executives and financiers who receive capital gains, interest and stock compensation.

The widening gulf between the stratospheric compensation packages of the latter and most other Americans suggests why the median wage is dropping, adjusted for inflation, notwithstanding a growing economy and a jobs recovery.

The trend is all the more remarkable considering that the share of national income going to workers used to be substantially higher in the US than in Europe because Americans have to buy what most Europeans receive free – including university education and healthcare.

A dozen years ago, 64 per cent of US national income went to the labor force, according to the IMF, compared with 56 per cent in Europe. Today, however, the shares going to workers are converging – 58 per cent of national income goes to the workforce in the US and 57 per cent in Europe.

Political realities in Europe may be pushing policy makers in the same direction. Germany’s Chancellor Angela Merkel has finally started talking about spurring growth. Under increasing political pressure at home, she seems to have accepted the need to add measures promoting growth to the EU’s treaty on fiscal discipline.

But Ms Merkel and her conservative allies haven’t given up on austerity economics. She is still opposed to fostering growth through more spending, insisting that would only worsen Europe’s debt problems. Instead, she wants to spur growth with “structural reforms” – by which she presumably means giving companies more freedom to hire and fire, outsource jobs to contract workers and, in general, be less constrained by regulation.

That is of course the American model – which has been fueling corporate profits at the same time as it depresses wages.

If Europe were to move towards structural reforms that create a labor market similar to America’s while pursuing fiscal austerity, while America embraces fiscal austerity as US corporations continue to shrink payrolls, we are likely to experience the same results on both sides of the Atlantic. Real wages will decline, we will have less economic security and our public services will be diminished. That is not sustainable, economically or politically.

[I wrote this for the Financial Times]