Haseeb A Drabu: Profiting from wages

BACK TO BASICS

The record rate of economic growth, the exceptionally good industrial growth numbers and the unprecedented corporate results is all very good news. But when one looks at the distributional aspects of this broad-based recovery in terms of factor incomes there is an issue: this is the most profit-biased recovery that the Indian economy has ever experienced.

While corporate profits are soaring, growth in labour compensation has been exceptionally sluggish resulting in a decline in the share of wages in gross domestic product.

If the present trend continues, the economy will soon see a landmark crossover: the share of profits will be higher than the share of wages in GDP.

In the organised sector, the share of wages in GDP for listed companies has dropped from 4.2 per cent in 1996 to 3.2 per cent in 2003 and is likely to be a bit under 3 per cent in 2004. The share of profit on the other hand, has increased from 0.5 per cent in 1990 to 2.9 per cent in 2003. Just about a decade ago, the share of wages at 3 per cent was twice that of share of profits! The switching of shares has been dramatic.

It is true that wage growth responds to overall growth with a long lag, but the situation is one where there is a decline in the share let alone a lagged catching up.

Looking at growth in GDP, what stands out in the current recovery, is that a historically low share of income growth in the corporate sector is accounted for by labour compensation, while a historically high share is accounted for by corporate profits.

Profits have never fared better, nor wage and salary income so poorly for this period of the business cycle earlier. Since the turnaround started, between June and December 2003, corporate profits have expanded by 37.5 per cent. During the same period, private wage and salary income has contracted by 0.8 per cent.

Typically, past experience and cross-country evidence suggest that labour compensation's share of total income growth normally averages 75 per cent in most recoveries.

But in the recovery currently underway, overall labour compensation has accounted for about 40 per cent of total income growth. Conversely, profits' share of total income growth averaged 25 per cent in most recoveries.

But in the most recent recovery, profits look like accounting for 60 per cent of income growth. Faster economic growth must be more evenly distributed before rising GDP numbers translate into rising living standards for the majority of the people.

What makes it worse is that this slow growth in wages is happening after the recession ended and does not include income losses incurred while the economy was contracting. Accounting for the prolonged recession, this will certainly be the lowest wage and salary growth ever.

Perhaps the only redeeming feature is that the current recovery is better than most other previous recoveries in terms of inflation and thereby the real (inflation-adjusted) growth in wages and salary income. This does soften the blow, but the moment inflation is up, as it is threatening to be, it will be a double whammy.

This lopsided trends in profits and wages is potentially bad news for the economy as it is bound to threaten growth. Labour compensation is more likely to be converted to demand for domestic production and fuel a sustained growth spiral. In contrast, when income goes to corporate profits, a larger share has being to pay down debt. In the current phase it is not being used to make fresh investments.

If labour compensation is down, what does it mean for consumption and spending? Why are there no signs of an under-consumption type of a crisis?

The reason for that is that spending by consumers has grown only because of increased household borrowing (particularly cash-out refinancing), improved property income, and lower income taxes.

But a sustained, self-reinforcing growth cycle cannot occur without a recovery in jobs that allows wage and salary income to grow. This recovery will not be on sound footing until a sustained growth in incomes (and jobs) kicks in.

haseebd@business-standard.com