Profits, Not Wages, Rising in This Recovery
Business + Economy

Profits, Not Wages, Rising in This Recovery


Does it feel like a long time since you’ve gotten a raise? A new study released Friday suggests the average American worker is going backwards.

The report also hints at why that might be the case. By looking at the share of new national income going to workers instead of business profits, the latest International Monetary Fund World Economic Outlook found Americans are lagging far behind their counterparts in Europe. Only workers in two advanced economies on the continent have fared worse during the recent recovery: Spain and Greece.  

“The recent recovery in the United States appears unusual from a historical perspective . . . with a much stronger rebound in profits relative to labor income,” wrote IMF economist Florence Jaumotte. “One explanation is that workers’ fear of long-term unemployment has led to more subdued wages relative to labor productivity growth during the recent recovery.”

In the three years since the depths of the downturn in 2009, total national income has rebounded smartly in the U.S. as it has in most of Europe. But national income has two components: wages, salaries and non-salary income (interest, capital gains and stock compensation); and profits to business.

While profits are up everywhere, total labor compensation has increased in every leading economy except four: the United States, Greece, Ireland and Spain, the IMF outlook showed. If one looks at the change in relative share of total income going to labor, it has fallen sharply in the U.S. since the trough of the downturn, while rising slightly in Europe as a whole. Nine of 15 countries in the Eurozone showed a rise in labor’s share of total income.

The trend is even starker if one looks at labor’s share of income since the recession hit. Profits usually decline sharply and faster than wages at the beginning of a downturn. But that didn’t happen in the U.S. this time. The share of national income going to corporate profits stayed more or less the same while profits in Europe plunged.

“Profits recovered their pre-recession peak very quickly,” said Josh Bivens, research director for the Economic Policy Institute, which closely follows worker income trends in the U.S. “Unit profits in the corporate sector are now at a 45-year high.”

As a result, the share of total national income going to labor has fallen three percentage points to 58 percent in the U.S. since the start of the recession and continues to fall, at least through the latest data, which was the third quarter of 2011. Meanwhile, European compensation is just 1.5 percentage points below its peak of 58.5 percent and is rising again.

The trend now threatens to overturn some long-standing elements of the American social compact. Workers’ share of national income historically has been much higher in the U.S. because of its lower tax rates and fewer public services. What you don’t get from the government you buy for yourself.

But now the relative share of income going to labor is approaching parity with Europe. Yet American workers still don’t have many government-provided benefits. Most Europeans have a much more generous benefits package from the government, including in many countries, national health care.

Many left-of-center economists argue the declining share of income going to workers in the U.S. is restraining consumer demand and prolonging the economic downturn. A similar shift isn’t underway in Europe – yet. “In advanced Europe, the behavior of the labor share during the most recent recovery seems broadly similar to what took place during other recoveries between 1980 and 2006,” Jaumotte noted.

Of course, all of that could change if the turn to austerity continues on the continent and the Eurozone breaks up. While austerity is politically under assault after the recent elections in Greece and France, the likelihood of tax increases and benefit cuts in periphery countries like Greece over the next few years could push down the share of European income going to workers and restore its historically lower levels compared to the U.S.

However, another chart in the IMF report shows that the narrowing labor income share gap between Europe and the U.S. is a long-term trend that was only exacerbated during the Great Recession. In 2000, 64 percent of national income went to American workers compared to 56 percent in Europe. Today, that’s 58 and 57 percent, respectively.

Politics on both sides of the Atlantic will play a major role in determining the future direction of income distribution. If Europe turns left, as the recent elections suggest, and the November election in the U.S. results in a Republican takeover and the imposition of austerity, one likely outcome is that the pattern that existed throughout the last decade will continue. If it does, the two lines will cross in the next few years.

Politics may not be the driver of workers’ declining share of national income, of course. Some labor economists point to the stagnation in college graduation rates here, which is leading fewer Americans receiving the “college premium” compared to their European counterparts. Others point to the “hollowing out” of the middle class through technological change and outsourcing of medium-skilled jobs. And as Jaumotte speculated, it’s likely the decline of workers’ bargaining power and their fear of asking for raises is playing a role.

Whatever the explanation, current trends in distribution of income between wages and profits suggest the day is not far off when the U.S. economy will still be the largest in the world and even have the highest per capita GDP, but the average American worker’s income will have fallen behind their counterparts in many other countries.