The Global Economy as a Movie

The plot may seem familiar, as globalization threatens to drive down wages everywhere. But that sad outcome has a happy alternative

By Michael Mandel

Movie directors sometimes shoot two endings to a film, undecided about which to use until the very last minute. Jaws, Invasion of the Body Snatchers, Bride of Frankenstein, Close Encounters of the Third Kind, and the 2004 film The Terminal all had alternative endings. In the Casablanca everyone knows, Ingrid Bergman leaves Humphrey Bogart, but in another ending Bogart got the girl.

In some ways, it feels like we're in the middle of a movie made by some deranged economist, and we don't know yet if we're going to get the happy ending or the sad one. Does the rise of China and India supercharge global growth, or will all the new competition pull down wages in the industrialized world? Is this period going to be titled the The Bright Dawn or The Big Squeeze?

Certainly for workers in the industrialized world, the latest signs are troubling. Profits seem to be outpacing wages just about everywhere. As a result, from Japan to the U.S. to Europe, labor is getting a smaller share of the economic pie. The numbers are pretty straightforward: In Japan, the share of national income going to workers dropped from 53.1% in 2001 to 51.1% in the year ending with the first quarter of 2005.


  In the U.S., the employee share of gross domestic income dropped from 58% to 56.8% over roughly the same stretch. In Western Europe, workers' share of national income dropped from 51.7% in 2001 to 50.5% at the end of 2004, before bouncing up a bit in the latest quarter.

An obvious -- and pessimistic -- explanation for this broad decline is the intensification of global competition, forcing formerly privileged workers in advanced countries to accept a lower standard of living. Harvard economist Richard Freeman has argued that the entry of China, India, and the former Soviet countries into the global economy has effectively doubled the size of the world's workforce. As a result, labor is relatively abundant, capital is relatively scarce, the returns to labor go down, and the returns to capital go up.

"Having twice as many workers and nearly the same amount of capital places great pressure on labor markets throughout the world," writes Freeman. That "shifts the balance of power in markets toward capital, as more workers compete for working with that capital."


 This is the unhappy ending to the global economy story. However, the numbers are also consistent with another, much more upbeat ending. It could be that corporate restructuring efforts in Japan and Europe are finally taking hold, leading to higher profits and faster productivity growth, even as U.S. companies continue their efforts to boost efficiency. And it could be that there's just a lag before the productivity gains get passed on to workers in the form of higher wages.

While this scenario may strain credulity, it's exactly how the 1990s played out in the U.S. From 1995 to 1997, labor's share of the economic pie plummeted in the U.S., eventually falling to a lower level than today's. The reason? An unanticipated surge of productivity growth sent corporate profits soaring, and it took a couple of years for wages to catch up.

It's important to note that at the time, the government's economic data didn't show big productivity gains. Productivity growth in 1996, for example, was originally reported as only a weak 0.8% (the government later revised that number up to a very strong 2.7% gain). In the absence of hard data, in July of the next year, Federal Reserve Chairman Alan Greenspan cited rising corporate profits as a major reason to believe that productivity had accelerated, though many economists were skeptical at the time.


  Some evidence indicates that the same thing is happening in Japan and Europe, which have endured a decade or more of weak productivity gains. Japan's productivity growth is "accelerating smartly," says Jesper Koll, chief Japan economist at Merrill Lynch (MER ), due to "good use of technology and successful deregulation." A recent report from Merrill Lynch notes that "despite wage increases, Japan's unit labor costs continue to fall -- now being supported entirely by the rise in productivity."

And in Europe, an increasing number of companies are showing decent profit gains. Alcatel, the big French maker of telecom equipment, in the first quarter reported that operating profits were up more than 27% over a year earlier. In Germany, ThyssenKrupp, the huge diversified manufacturing giant, reported earnings before interest and depreciation were up 12.8%. And companies that aren't doing so well, such as large German retailer KarstadtQuelle, are restructuring in an attempt to boost profits and productivity, a step that U.S. retailers took years ago.

True, the economic statistics in Europe still don't show productivity accelerating. But as the U.S. example from the 1990s demonstrates, initial estimates of productivity growth can change a lot when the final numbers come in. A slight upward revision in output, a slight downward revision in the number of hours worked, and presto, a small gain in productivity becomes a big one. That could very easily happen in Europe.

So, will we get the happy ending or the sad ending? There's no way of telling yet -- but hey, what fun is a movie with a predictable ending?

With Ian Rowley in Tokyo and Jack Ewing in Frankfurt

Mandel is chief economist for BusinessWeek in New York

Edited by Patricia O'Connell

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