Excerpts from an article of CK Liu
Debt Bubbles Caused by Low Wages
The single most damaging outcome of globalized trade and finance in the past three decades had been increasingly low wages compared with asset prices in every economy that participated in cross-border wage arbitrage. The failure of wage income to keep up with rising asset prices, particularly home prices, created a deficiency in consumer purchasing power that left all economies with productive overcapacity. Monetary policymarkers then compensated for this overcapacity with serial monetary easing to provide easy consumer credit and low-interest home mortgages that stagnant wage income could not sustained and had to be refinanced by additional asset value from continually rising home prices. The gap between mortgage payments and wage income was closed by sharp rise in home prices that would in turn allow lenders to release more loan proceeds to borrowers to finance higher payments and everyday consumption.
On the other side, lending institution employed all manners of structured finance to pass the liability in the form of tradable instruments of varying credit ratings with commensurate returns to investor of varying risk appetite in the credit markets to expand the total debt bubble.
This credit crisis has been thoroughly analyzed, its causes identified and listed as among others market deregulation, excessively high leverage, underpricing of risk through structured finance, etc. These causes were real and were all contributing to market failure. But the fundamental cause was the imbalance between wage income and high consumption needed to prevent productive overcapacity in the economy. In a word, the current credit crisis was fundamentally caused by insufficient wage income world wide.
The Low Wage Trap in China
China today is a visible example of economic growth driven by global cross-border wage arbitrage that has kept wages low. In theory, the socialist market economy in China seeks a balanced public/private interphase through market regulation and direct investment participation by government. The policy aim is to fill the investment gap left by the short term preoccupation on the part of private capital to invest only in projects that can produce the required immediate return on capital. Another policy aim is to regulate the market against self-induced failure. A third policy aim is to direct the economy toward national goals of long-term economic development of the nation and all its population. Projects designed for long-term economic growth will not offer short-term profit within the short operational time frame of private investment. Government credit and investment must be made to finance these project of long-term growth and development.
Still, despite appearances of success, the Chinese economy is far from being a trouble free engine for long-term growth and development. The regulatory framework is far from being adequate and the market is far from being efficient. The private/public interphase is still underdeveloped. There appears to be two separate economies in China, one state-owned and the other operated by private enterprises. The two economies work against each together, rather than complimentarily. The state-owned enterprise economy, though much improved is still plagued by residual structural inefficiency and the private enterprise economy is grossly unruly.
What is needed is to continue to improve the efficiency of the state-owned enterprises through better management nd accounting, particularly social and environmental accounting. This cannot be done through privatization. Much improvement will come from strengthening management and planning skills of state-owned enterprises, and not merely forcing management to adopted models of successful private enterprise. Measurement of state-owned enterprises performance should be based on their real contribution to long-term economic growth and development of the national economy and to social welfare and environmental restoration, rather than on short-term profit.
At the same time, private enterprises must be required to be better corporate citizens and be guided by socially responsible business ethics to serve the needs of society and the population, rather than to seek maximization of profit by exploiting legal and regulatory loopholes to engage in counterproductive speculation and to externalize the social costs of its business operations.
But the most critical shortcoming of China’s economic development policy in the past three decades has been its passive acceptance of low wages as a key prerequisite competitive advantage for its export sector in world trade. Chinese policymakers can take lesson from the case of Germany, a successful export economy with high wages. High wages in the export sector is an effective way to make export trade contribute to the domestic economy.
Furthermore, China will not be able to develop its domestic market unless Chinese wages rise to the level at which Chinese workers can afford to buy the products they produce with their own labor.
Export of surplus production after domestic demand has been satisfied is a positive economic strategy, but export of goods because domestic workers cannot afford to buy them with their wages is a dysfunctional strategy. The problem is made worse if export is denominated in dollars, a foreign fiat currency that the export economy cannot spend at home without automatically generating inflation.