There is heated debate surrounding income distribution and the way in which the lives of many can be improved if that distribution were to shift towards those less fortunate. This debate is especially pertinent to South Africa, given our historical context. One aspect of this debate considers the way in which class-based income distribution influences the Macroeconomy, in particular Gross Domestic Product (GDP).

Concerning the functional distribution of income – i.e. how income is split among various power-relations/classes within the economy – Structuralist economics typically defines two major classes: those who make the majority of their income through the ownership and use of productive assets/capital and the profits earned therefrom (i.e. the capitalist class), and those whose majority income is earned through wage-labour (the working class). Both classes’ income, when added up, make up total national income. It is this income that drives economy-wide demand (Taylor, 2009).

Aggregate/Economy-wide demand, as Keynes (1936) points out, is determined by the relationship:

Y=C+I+G+NX

In words, supply for domestic production (Y) is determined by the sum of household consumption expenditure (C), private investment expenditure/gross fixed capital formation (I), government expenditure (G) and net exports (NX).

This demand for goods and services is inherently driven by income distribution; consumption of all goods and services -either domestically produced or imported- is determined by how much money each class within domestic or foreign economies are endowed with. Investment in capital stock (assets which produce other assets) is driven largely by net profit (Ricardo, 1891), and government spending is determined by how much tax revenue each class pays forward to the fiscus (Taylor, 2009).

If profits were to go up, one would expect the capitalist class to be incentivized to invest more in capital goods- enabling the capitalist to produce more, and thus, make a larger profit (Kalecki, 1942). In the short term, this investment might prop up economic growth and employment alike, but over time this may lead to unemployment through various sources. The most obvious of these sources, seminally termed creative destruction (the creation of new jobs based on new technology, along with the destruction of jobs which that technology replaces), sees a mechanizing capitalist move from being labour-intensive to capital-intensive in the event that his profits are able to increase (Schumpeter, 1942). Although the effects of creative destruction are argued to be worse in low-skilled economies like South Africa, this problem is argued to also persist (perhaps, to a lesser degree) in the developed world alike (The World Technology Network, 2015).

Interestingly, this is not to say that the capitalist will always mechanize; whether a capitalist chooses to be more capital- or labour-intensive depends on the cost of the actual resource in question as well as the productivity gains enjoyed from each resource. In the event that the cost of purchasing capital is much higher (and the productivity gains enjoyed, much lower) than employing more workers, a capitalist may look to employ more people, rather than utilize more capital (Taylor, 2009).

Nevertheless, an investment into capital from the South African labour market’s perspective would inevitably push the labourer’s share of national income down (with fewer people employed in the economy as a result of mechanization) and weaken bargaining power (Goodwin, 1967). This decrease in the labourer’s share of national income then decreases consumption (Taylor, 2009), and pushes up the profit-share of national income (if the wage bill is supressed and profits are being extracted, this means that relatively, the capitalist’s share of national income has increased).

This simultaneous investment-increase and consumption-decrease has an ambiguous effect on Keynes’ (1936) level of production within an economy (due to the fact that both consumption and investment relate positively to demand as seen in the above equation). If, for instance, an increase in the profit share (as explained above) increases investment, and this were to have a larger impact on national production than the decrease in consumption based on the decrease in the labourer’s share of national income, output would surely rise- this signifies that a particular economy is “Profit-Led”. If, on the other hand, this increase in investment was smaller than its counterpart consumption decrease, the resultant decrease in national production would define the nation as “Wage-Led” (Bhaduri & Marglin, 1991).

Thus, being Profit-Led implies that production/economic growth positively relates to an increase in profits (an increase in the profiteer’s share of national income), while being Wage-Led implies economic growth positively relating to the betterment of the working class standing (an increase in the labourer’s share of income).

The question then becomes one of context; under which regime (i.e. Profit- or Wage-Led growth) does South Africa fall? Tentatively, as pointed out by Malikane (2017) as well as Onaran & Galanis (2012) (who themselves quote many works), the South African economy is Profit-Led, signalling that increased wages worsen economic growth. Put differently, if economic growth is boosted by capitalist investment, then an increase in wages would decrease the share of national income that capitalists could use to invest- this then decreases economic growth.

To those disappointed by this analysis, it is important to note that research suggests this country-specific-regime can change over time (Goodwin, 1967), with a likely possibility for South Africa to be Wage-Led within the next 10 years.

This change over time is due to the cyclical nature of market economies. In periods of economic prosperity, unemployment rates are low. This improves the bargaining power of workers, due to the decreased size of the reserve army with which they can be cheaply replaced. This improvement in bargaining power allows for workers to ask for higher wages- provided that worker productivity is high, the capitalist will acquiesce. This signals two things simultaneously- 1. That the demand for labour is relatively high (as wages have increased), and 2. That the demand for capital is relatively low (assuming that labour and capital are at least relatively substitutable (Ricardo, 1891). Output, in this instance, is driven by worker consumption and wages.

This larger wage bill cuts into capitalist profits marginally, but this is offset by the productivity gains of employing workers at wages below their marginal product and the gains that the capitalist enjoys from improved worker consumption. When wages increase to a level above worker productivity, this squeezes the profit of capitalists and forces the onset of retrenchment. At this stage, two things happen simultaneously- 1. The demand for labour decreases, decreasing wages, and 2. The demand for capital (now the relatively cheaper source of productivity gains) increases. At this point, profits (due to decreased operational costs and increased productivity) and unemployment tick upwards. Output, in this instance, is now driven by accumulating capital (and ipso-facto, improving profit)

Thus unemployment, over time, constrains how much profit can be made by the capitalist while simultaneously decreasing the bargaining power of workers (and their wage demands). All the while, capital demand increases (increasing the cost of capital) until the productivity gains of employing more capital are lower than the cost of employing that capital. This, once more, starts an increase in hiring at low wages, pushing up the number of people employed in the economy, until worker bargaining power increases once more- and the cycle then perpetuates (Goodwin, 1967).

The policy implications emanating from a determination as to where our economy is on this cycle, as well as the estimated time in which our economy will transition from being Profit- to Wage-Led, will be explored in the next part of the blog.

Bibliography

Bhaduri, A. & Marglin, S., 1991. Profit Squeeze and Keynesian Theory. In: Nicholas Kaldor and Mainstream Economics. London: Palgrave Macmillan, pp. 123-163.

Goodwin, R., 1967. A Growth Cycle. Socialism, Capitalism and Economic Growth, pp. 54-58.

Kalecki, M., 1942. A Theory of Profits. The Economic Journal, 52(206/207), pp. 258-267.

Keynes, J. M., 1936. The General Theory of Money, Interest and Employment. London: Macmillan.

Malikane, C., 2017. The Labour Share and the Dynamics of Output. Applied Econometrics, 49(37), pp. 3741-3750.

Onaran, O. & Galanis, G., 2012. Is Aggregate Demand Wage-Led or Profit-Led?. National and Global Effects: Conditions of Work and Employment Series, Volume 31.

Ricardo, D., 1891. Principles of Political Economy and Taxation. s.l.:G. Bell.

Schumpeter, J., 1942. Creative Destruction. Capitalism, Socialism and Democracy, Volume 825, pp. 82-85.

Taylor, L., 2009. Reconstructing Macroeconomics: Structuralist Proposals and Critiques of the Mainstream. Boston: Harvard University Press.