Global Agenda: A piece of cake

Labor's share of profits continues to shrink; just don’t expect people to take this passively.

One of the metaphors most frequently used by economists to explain the dismal science to ordinary people is that of the cake. The economy is like a cake and you can divide it up into slices, each of which represents the share of one of the groups or sectors active in the economy.
The beauty of this metaphor is that it is immediately understood by everyone, even – or especially – the proverbial six-year-olds who are used as the benchmark for intellectually challenged adults. Everyone wants a larger slice of the cake, or of the pie, or of whatever is available. But everyone understands that everyone else wants the same, so that there has to be some give and take.
The other great advantage of this metaphor is that it works at the macro level of the whole economy, at the micro level of the firm, and at the household level of the couple or the family. It leads directly to the concept of limited resources and the problems involved in distributing them, fairly or in any other way.
Finally, from the economist’s point of view, it has the added advantage of enabling a smooth transition from what would be called in the literature a static model – this is the cake we have, how are we going to divide it between us? – to a dynamic model: if we could achieve a bigger cake, everyone would be able to have a bigger piece, etc.
Let’s adopt this cake metaphor and, using its appealing characteristics of attractiveness and understandability, apply it to the American economy today. At the macro level, an economy is the same as a large firm in that there are two key groups at work: namely, labor (people who sell their capabilities for monetary compensation) and capital (people who provide money for the use of the firm or economy, with the aim of receiving an income stream). The income generated by the economy or firm is divided between these two groups.
As an aside, we may note that some of the income generated by the economy is taken by the government, either before or after the income is divided between labor and capital, and then used either directly to provide services, or redistributed to others. We will skip this element, on the theoretical grounds that the government does not itself engage in activities that generate income and on the practical grounds that introducing the government makes the whole discussion more complicated without making anything any clearer (a fair reflection of the way governments work).
How is the American cake divided between labor and capital? Well, during the whole period between 1945 and the beginning of this century, there was a clear and fairly consistent pattern. Labor’s share was between 62 percent and 67% of the total income produced by the nonagricultural business sector. In recessions, labor’s relative share increased – this may sound strange, but it reflects the fact that a recession has a much greater negative impact on corporate profits than on labor (via wage cuts and unemployment) – and in expansion, labor’s share shrank.
In fact, the postwar pattern began to change in the economic expansion of the 1990s, when labor’s share dropped out of the old range, to as low as 61%. Then, in the recession of 2000-2001, labor’s share rose – but it peaked at about 65%, well below the level reached in previous recessions. However, this period was one in which the overall cake was still growing nicely, so people didn’t pay much attention to a few crumbs missing.
However, in the decade since 9/11, the bottom has fallen out of labor’s share. Official data, picked up and powerfully displayed by David Rosenberg of the Canadian firm Gluskin, Sheff, show that in the period of economic expansion that ended in 2007, labor’s share fell to 60% – the lowest yet. Worse, in the “Great Recession” of 2007- 09, when this share should have recovered strongly, if historic patterns are anything to go by, the change was negligible. At the peak of the Great Recession, labor’s share of the (now rapidly shrinking) cake was about 61%, lower than it had been in any period of expansion in the 20th century and far below the levels reached in 20th century “normal” recessions.
The recovery of the last two years has seen a further dramatic erosion in labor’s share of the national cake, which now stands at perhaps 57.5%. Put another way, the US economy has recovered to the point that its overall size has regained pre-crash levels. However, this same amount of GDP is now being produced by some 6 million fewer workers; i.e., all the additional income is going to owners of capital and none of it to providers of labor.
There are, of course, reasons and explanations for this unprecedented state of affairs – computerization, globalization (China), etc. But the facts are clear. Rosenberg asks, rhetorically, “Is this sustainable?” Economically, maybe. Socially and politically – no way. The number of Americans receiving food stamps is rising remorselessly and now exceeds 45 million.
That’s the flip side of the shrinkage of labor’s share of the cake. But just don’t expect people to take this passively.
As this column noted in January, the demonstrations in Tunis and Cairo were driven by the same economic dynamic. Maybe there they call it cutting up the pita, but whatever the metaphor, they understand it as well in the Midwest as in the Middle East.
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