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The Paradox of Inequality and Productivity - A Deep Dive into Secular Stagnation


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In recent years, the term "secular stagnation" has become a buzzword among economists.


At its core, it refers to a prolonged period of slow economic growth, even when interest rates are low. Several factors have been cited for this phenomenon, including demographic changes and the long-term decline in the natural rate of interest. Olivier Blanchard's work on "Fiscal Policy Under Low-Interest Rates" highlights how: there's a growing consensus that the Non-Accelerating Inflation Rate of Unemployment (NAIRU) is falling, suggesting that economies can operate at lower unemployment rates - and growth rates - while benefitting from more favourable debt dynamics.


However, a contentious debate has emerged around the role of inequality in this landscape. Some argue that rising inequality suppresses productivity. I, however, have reservations about this perspective.


My hypothesis is not that inequality inherently spurs individuals to work harder because they want to climb the social ladder. Instead, I hypothesise that rising inequality allows firms to extract greater levels of value from workers, who then are coerced to work harder because of their precarious positions. Data suggests that the majority of inequality arises from between-firm disparities; specifically, low-wage workers tend to cluster in specialised, often lower-paying firms. These workers, often not unionised, face a dual challenge: they must be more competitive in their roles, even as more value is extracted from them by their employers.


Unfortunately, traditional metrics, like GDP data from national accounts, have limitations when assessing labour productivity. As such, while it has been proven that between-firm effects are a big driver of wage inequality, there is so far little empirical proof to suggest that this breeds greater levels of productivity. This is because broad national accounting measures fail to capture the nuances between sectors and firms. For instance, two countries might have similar GDP figures, but one might have a tech-driven economy with high-wage jobs, while the other relies on low-wage manufacturing. Simply put, GDP doesn't tell the whole story.


A more insightful approach would involve constructing a dataset from firm-level balance sheets and accountancy data. Such an approach has previously been used by UCL researchers to prove that secular stagnation is occurring, at least because of declining investment rates. For our purposes, such granular data can shed light on whether the trend of "worker clumping" in specialised firms leads to heightened labour productivity. If employers can indeed extract more value from non-unionised, low-wage workers, then inequality might, paradoxically, be a catalyst for productivity.

Regrettably, such a dataset is yet to be crafted. However, we can work around this by looking at a few post-crisis trends to spot patterns and make inferences which support our thesis. The broader economic landscape offers some support for this theory. The US, despite its pronounced income inequality, consistently outperforms many of its European counterparts in terms of productivity. This disparity became glaringly evident during the Global Financial Crisis (GFC). The US's flexible labour market, devoid of many of the regulations found in Europe, saw a sharp rise in unemployment and inequality. Firms, unencumbered by stringent labour laws, could swiftly lay off workers.


In contrast, European economies, with their rigid labour markets, retained many workers who, arguably, were unproductive. This could explain why the US, despite its soaring inequality, rebounded faster post-GFC. Here, we add another layer to our theory: labour market regulations restrict labour reallocation during times of crisis where firms streamline their operations to become more efficient. A great example of this is when firms reduce their in-house cleaning services, instead opting to outsource this work. When this happens, low-wage janitors leave their previous firm and then clump into these specialised firms which increases inequality (because of increased between-firm effects and low unionisation rates) while raising productivity growth.


Of course, attributing productivity solely to labour market rigidities and inequality is speculative. To draw definitive conclusions, one would need a comprehensive dataset and sophisticated models that account for myriad factors, from government spending to unionisation rates.


Even if my hypothesis holds water, it doesn't imply that we should blindly chase inequality to boost productivity. Firstly, there's likely a tipping point – a Laffer curve effect – where extreme inequality undermines productivity. Studies have shown that surging inequality can precipitate financial crises, jeopardising long-term growth. Secondly, and perhaps more importantly, an obsessive focus on productivity and growth, at the expense of rising inequality, raises profound moral and societal questions. After all, shouldn't the ultimate goal be to enhance living standards and overall well-being? As demographic factors shift us towards an ever-stagnating age, we must prepare for mature discussions about the inequality-productivity trade-off.

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