Labour share of income (Part 5: The quandary of labour reform)

Labour share of income (Part 5: The quandary of labour reform)

Phuah Eng Chye (23 June 2018)

Corporations set wages and hence determine the distribution of income. In the early phases of industrialisation, public abhorrence over appalling work and social conditions galvanised governments to introduce labour legislation and institutions (trade unions) to protect ordinary workers. It was argued, at that time, that it was socially incorrect to allow labour to be priced like an ordinary commodity. This implied that the powers of employers should be curbed and wage inequality should be addressed through collective bargaining and minimum wages complemented by social protections and punitive tax rates on high income earners. Hence, though corporations determine wages, government policy can change the terms and price of employment.

In the 1980s, government policies shifted in favour of markets, efficiency, competitiveness, privatisation and globalisation. The loosening of regulations and landscape changes caused wage growth to lag productivity growth and wage differentials between the top and bottom earners to widen. These trends underpinned the structural decline in the labour share of income. In reaction to this, a broad range of policy options have been suggested to strengthen employment, wage growth and the bargaining power of labour.

  • Macroeconomic policies. Broad macroeconomic policies are used to support the achievement of employment and wage objectives. This includes fiscal and infrastructure spending and monetary easing, investment (including tax incentives), sectoral and trade policies to foster job creation or protect jobs.
  • Wage policies. During the industrialization era, wage policies were used to combat poverty and inequality. But the views on minimum wage are ideologically divisive. Advocates argued minimum wage policies could (i) offset weak labour bargaining power by establishing a floor for wages; (2) improve the efficiency of workers through income sufficiency and to induce firms to use labor more efficiently; including investing in technology; (3) as part of compulsory arbitration to prevent or reduce strikes; (4) to build consumer purchasing power to increase output, consumption and employment.[1] Detractors argue firms react to higher minimum wage by reducing working hours and headcount which can have the effect of countering the salary increase. In addition, they also accelerate the replacement of labour, cause marginally-profitable businesses to shut down and increase unemployment. The debate has been difficult to resolve because empirical findings have been mixed. Some studies found “minimum-wage increases tend to raise incomes for people at the bottom of the distribution” with minimal impact on employment.[2] Other studies suggest rises in wage costs will be passed onto consumers and that “the long-run disemployment effect might be bigger than the short-run effect”.[3] The difficulty is in separating the wage effect on employment from the influence of broader trends such as hollowing out, globalisation, technology or a sector fall-out. “All economists seem to agree on is that there is some limit to how high the minimum wage can go without causing serious damage”[4].
  • Work policies. Rather than target wage levels, the alternative is for governments to underwrite employment. Advocates[5] argue job guarantees (JGs) is a cost-effective way[6] to tackle poverty and unemployment and point to their successes in the 1930s. They consider JGs superior to unemployment benefits and basic income as it ensures individuals contribute productively to society and it provides work opportunities to discriminated groups. JGs increases the labour bargaining power, sets a floor on wages and has a macroeconomic stabilization effect by providing jobs during a downturn. It is also envisaged JGs can be used to achieve social goals such as environmental sustainability, public park revitalization, conservation, care-taking, welfare services and community building. Critics see JGs as badly-managed and wasteful forms of government intervention that interferes with market mechanisms and “competes” with businesses for labour and activities. They point to past failures to support their point. Dylan Matthews highlights the critical challenges in designing JG programmes relate to the number of guaranteed jobs that can be created and the permanency of these jobs. “While job guarantee programs envision a broad, inclusive program that can integrate all participants into the broader economy, the result is often a program that serves people who can’t get work anywhere else, and still can’t get work anywhere else after the program is finished.”Another popular suggestion is to ration work by spreading “the bread thin on the butter – to make what work there is still to be done to be as widely shared as possible”.[7] In Europe and in Japan[8], there are policy initiatives to shorten working hours to ensure better health, work-life balance, encourage female and senior citizen participation and to address a declining birth rate. The objections to shortening the workweek are that it will increase costs, reduce productivity or result in substitution of labour.[9] However, there is also a need to consider shorter working hours with the context of part-time and contingent work.
  • Labour bargaining power. The usual recommendations to address labour monopsony is to strengthen trade unions and collective bargaining. However, this advice goes against the structural trend of declining union membership and the changing nature of work. Other measures aimed at improving fairness may be more effective. They include legal reform to promote equal pay, curbing the abuse of non-compete agreements, protecting worker claims to overtime and other benefits and addressing worker rights (e.g. fair scheduling, worker misclassification and pay in non-standard forms of employment and boosting enforcement of labor standards.[10]
  • Anti-trust regulation and enforcement. Industry concentration lessens competitive forces and increases the power of dominant firms. Anti-trust regulation is regarded as crucial to curb the exercise of monopsonic powers. This includes regulation and enforcement against further increases in concentration by blocking mergers, practices that restrict competition, collusion against staff poaching in industry or among franchisors and the use of non-compete clauses. Marshall Steinbaum argues antitrust policy currently places greater emphasis on maximising consumer welfare at the expense of labour bargaining power and should be revised. Hence, courts tend to support “any gains at the expense of workers would be passed to consumers in the form of lower prices, since product markets would be competitive” and “to overlook the use of market power to reduce labour welfare by reducing demand for labor and lowering wages.”
  • Labour market frictions. The co-existence of declining hires-to-vacant jobs (the vacancy yield) and wage stagnation in tight labour market conditions reflects increasing labour market frictions. Nick Bunker suggests “employers seem less willing to raise wages in order to poach other companies’ employees…the structural decline in job-to-job moves is an almost 17-year trend.” In addition, “the difficulty in filling jobs is not simply a cyclical phenomenon but may be caused by a change in the matching efficiency of employers and employees.” Similarly, Ashley Gross, Jon Marcus notes reports which suggest trade jobs, many with above-average wages, in construction, carpentry, electrical, plumbing, sheet-metal work and pipe-fitting are unfilled. This is partly because many “students are being almost universally steered to bachelor’s degrees” rather than to pursue alternative career options in trade jobs. These labour market frictions suggest that the jobs created by infrastructure spending would mainly need to be filled by immigrants. To address these frictions, the usual initiatives are skills retraining, improving job mobility and reducing search costs. Jeffrey Selingo notes skill retraining faces several dilemmas. “Worker retraining is a classic chicken-or-egg dilemma. Employers don’t want to expand or relocate without the availability of an already-skilled workforce.” On the other hand, retrenched workers don’t want to undergo retraining without the assurance of an equivalent or suitable job or if they need to relocate. It is easier to collect benefits, remain jobless or patch together work that doesn’t require learning a new skill or acquiring a college degree. In addition, “entire occupations and industries are expanding and contracting at an alarming pace, and the skills needed to keep up in almost any job are churning at an increasingly faster rate.” Lower-skilled manufacturing jobs (needing only a high-school diploma) was being replaced by higher-skilled jobs requiring higher education. Jeffrey Selingo thinks “federal retraining programs remain rooted in the industrial era in which they were created.” Job training programs also face continuous budget cuts while many studies have found job retraining programs to be ineffective “and it remains unclear to experts whether the programs are even up to the task of preparing workers for the new economy.” There is also a lot of attention on the impact of licensing on job mobility. A study[11] found about 30 percent of American workers and 800 occupations require a license and estimate these requirements resulted in 2.85 million fewer jobs. Corporate benefits for pensions and healthcare can also create a job lock. Other factors considered to impede job mobility include housing affordability and high search costs (the lack of information on jobs, wages, benefits and working conditions). However, there has been little progress on eliminating these barriers. Goldwater proposes “The Right to Earn a Living Act” which imposes the obligation on governments to demonstrate that any regulation “that limits participation in a job or profession must be necessary to address a public health, safety, or welfare concern”.

Despite the extensive range of proposals, the realities are starkly different for labour reform. Generally, labour protections continue to be eroded and pro-labour reforms unimplemented. The quandary for labour reform is that government policies have instead generally favoured business needs on the grounds of prioritising job creation. Well-known labour reforms in Netherlands and Germany have prioritised “programs offering positive and negative (supply-side) incentives pushing (more) people into the labor market, for instance by shortening the duration of unemployment benefits, introducing job search obligations or cutting benefit entitlements. Doing so involved the (sometimes drastic) deregulation of labor markets, pension and tax reforms, some tightening of access to social security systems, as well as (on average) real wage growth restraint”[12].

In Netherlands, Servaas Storm noted “Dutch wage moderation created (temporary and part-time) jobs but did so as a result of a secular slowdown of labor productivity growth, not higher economic growth. The Dutch miracle of low unemployment…subsequently inspired the German…Hartz reforms of 2004-06”.

The Hartz reforms aimed to change the German labour market by de-regulating the labour-intensive parts of the economy. It comprised initiatives to make the social insurance systems fiscally sustainable; to get people into new jobs more quickly and to create opportunities for the long-term unemployed; and to increase incentives for the jobless to take up work. The initiatives[13] included creating a subsidised Me Inc. scheme to assist self-employment; expanding the minijobs scheme (subsidised jobs for those wanting to work a few hours a week); making it easier for companies to offer fixed-term contracts and hire subcontracted workers; removing entry barriers to Germany’s Handwerk (skilled crafts and trades); making it easier and cheaper to dismiss workers, especially for small firms with fewer than 10 employees; privatising training and job-seeking institutions; and overhauling some inefficient Arbeitsämter (job centres).

Christian Odendahl notes “some of these reforms have worked as intended” as it lowered the cost of firing workers, increased the number of subcontracted workers from 300,000 in 2003 to one million in 2016 and raised the number of workers in ‘minijobs’ from 4.1 million in 2002 to 5.1 million in 2005. But the effects were not noticeable elsewhere. For example, “the number of skilled craft and trade businesses increased considerably after the government watered down occupational licensing in 2004. But employment in these companies continued to fall until 2010 and has stagnated since.”

Pushing unemployed workers to take up employment by restricting access to or making benefits less generous for unemployment insurance and social assistance created some frustration and fear among the public. Christian Odendahl notes these changes “moved the system from one that protected living standards indefinitely to temporary protection of living standards followed by much lower income with strict conditions attached.” These reforms “put an end to early retirement” and increased the employment rate of older workers and “put pressure on benefit recipients to find work and brought previous social assistance recipients into the labour market”.

Nowhere are the labour policy conflicts better illustrated than at the World Bank. For the past two decades, the World Bank’s high-profile Doing Business rankings, together with the World Economic Forum’s competitiveness rankings, has put pressure on governments to deregulate their economies and labour markets. But it had generally maintained a guarded and balanced posture on labour issues.

However, the World Bank seems recently to have thrown caution to the winds. Its recent report espoused the view that “labor markets trends are becoming more fluid…Social protection systems conceived around long-term employer-employee relationships are increasingly disconnected from these trends.” In this changing landscape, the World Bank suggested worker protection should be achieved through reforming social assistance and insurance while “labor markets can be made more flexible to facilitate work transitions”.

The World Bank suggest “reforms need to address three main limitations of labor regulations. First, they cover few, only formal workers whose labor is observed, regulated and taxed by the state. Yet, more than half of the global labor force is estimated to be informal…Second, labor regulations try to do too much and act as a social protection system, including ensuring a minimum income or substituting for unemployment benefits. Third, in many cases, they impose a high cost on firms and society by excluding many, especially youth. While there are cases when these regulations set necessary rules, they can also be excessive in other cases. Yet, the social cost of protecting jobs is increasing. Rapid changes to the nature of work put a premium on flexibility for firms to adjust their workforce, but also for those workers who benefit from more dynamic labor markets”.

The World Bank report noted “some countries are reforming labor regulations in ways that support firms and workers in adapting to the changing world of work…But many are not. Between 2007 and 2017, 99 countries initiated reforms in labor regulations. Approximately 48 percent of the reforms made labor legislation more flexible, and 52 percent enforced more job protections. Notably, 21 countries made the use of fixed-term contracts more restrictive and 17 made severance pay costlier”.

The World Bank called on policymakers to rethink labour regulations. Its most controversial advice is for countries to relook at “the minimum wage both because it adds to the cost of labor (particularly of low-productivity workers) but also because it is a weak tool for securing minimum living standards now that countries know how to set up social protection mechanisms…Even in correcting imbalances in market power, a legislated minimum wage is blunt. It assumes that the unjust distribution of marginal labor product is the same across sectors and space, is unintentionally distortive, and slow or unresponsive to changes in market power.” It also criticised burdensome regulations and “undue restrictions on hiring and firing, strict contract forms…make it more expensive for firms to rearrange their workforce to accommodate changing technologies”.

The World Bank report attracted a barrage of criticisms including on how the report was being drafted. Peter Bakvis relates that “perhaps to avoid having to expose this disturbing vision of the future of work to an open discussion with workers’ representatives, the WDR 2019 team refused to meet with a 38-strong international delegation of trade union economists and policy officers” and that it ignored its own earlier findings that most estimates of the impacts [of labor regulations] on employment levels tend to be insignificant or modest.

Peter Bakvis also criticised the World Bank report for not examining “options for incentivizing the formalization of work” to deliver benefits such as “legal protection of workers’ rights, including their right to safe workplaces, and access to social security”; for assuming “informality as an inevitable state” and for not examining “how the undermining of labor market institutions through deliberate corporate strategies such as outsourcing and disguised working relations can be countered by providing legal protections for these categories of workers.” He characterised the World Bank’s “2019’s future world of work, where firms have been relieved of the burden of contributing to social security and have the flexibility to pay wages as low as they want and fire at will.”

The controversy swirling around the World Bank report reflects labour reform is a thorny issue. While its view on accommodating flexible labour practices has merit, the World Bank barely acknowledges the adverse effects of its proposals on labour. The World Bank view is also at odds with the international calls for multilateral coordination to avoid beggar-thy-neighbour competition. In this regard, the ILO has “called for global-level policy coordination to avoid either the simultaneous pursuit by too many countries of wage moderation policies, or competitive wage cuts with a view to increasing exports, either of which could lead to a fall in regional or global aggregate demand or deflation…In 2016 the G20 called for the implementation of macroeconomic policies to achieve substantial wage and productivity growth, and for sustainable wage policy principles in which strengthened labour market institutions and policies – such as minimum wages and collective bargaining – could help wage increases to better reflect improvements in productivity growth.”[14]

Overall, government policy on labour reform is beset by confusion. Labour protection needs are usually overshadowed by the accommodation of business needs for flexible work arrangements. Flexible work arrangements effectively translate into wage cuts. This seriously contradicts efforts by governments to increase wages via fiscal and monetary policy stimulus and through raising minimum wages. The labour reform quandary also highlights the need for a holistic perspective within the context of addressing the declining labour share of income.


Ashley Gross, Jon Marcus (25 April 2018) “High-paying trade jobs sit empty, while high school grads line up for university”. National Public Radio.

Christian Odendahl (10 July 2017) “The Hartz myth: a closer look at Germany’s labour market reforms”. Center for European Research.

Council for the Realization of Work Style Reform (28 March 2017) “The action plan for the realization of work style reform”. Provisional Report. Japan.

Council of Economic Advisers (October 2016) “Labor market monopsony: Trends, consequences, and policy responses”. Council of Economic Advisers Issue Brief.

Dan Kopf (17 August 2017) “Economists still can’t decide whether the minimum wage is a good thing”. Quartz.

Daniel Aaronson, Eric French, Isaac Sorkin (19 March 2016) “The long-run employment effects of the minimum wage: A putty-clay perspective”.

Dylan Matthews (6 September 2017) “What America would look like if it guaranteed everyone a job”.

Goldwater (14 March 2018) “Restoring the right to earn a living: a common-sense solution to occupational licensing job barriers”. Goldwater Institute.

International Labour Organization (2016) “Global wage report 2016/17: Wage inequality in the workplace”.—dgreports/—dcomm/—publ/documents/publication/wcms_537846.pdf

Jeffrey Selingo (8 January 2018) “The false promises of worker retraining.”

Jeff Spross “You’re hired!”. Spring No.44.

John Maynard Keynes (1930) “Economic possibilities for our grandchildren”. Scanned from Essays in Persuasion, New York: W.W.Norton & Co., 1963, pp. 358-373.

L. Randall Wray, Stephanie A. Kelton, Pavlina R. Tcherneva, Scott Fullwiler, Flavia Dantas (February 2018) “Guaranteed jobs through a public service employment program”. Levy Economics Institute of Bard College. Policy Note.

Marshall Steinbaum (20 September 2017) “Antitrust in the labor market: Protectionist, or pro-competitive?” Promarket Blog.

Nick Bunker (12 April 2018) “Employers may be behind the problems with U.S. hiring”. Issue brief. Washington Center for Equitable Growth.

Noah Smith (5 April 2018) “Econ 101 no longer explains the job market”.

Paul H. Douglas (1938) “The economic theory of wage regulation”.

Peter Bakvis (11 April 2018) “The World Bank’s troubling vision for the future of work”.

Phuah Eng Chye (26 May 2018) “Labour share of income (Part 1: Theories and measurement)”.

Phuah Eng Chye (2 June 2018) “Labour share of income (Part 2: The difficulty of overcoming wage stagnation)”.

Phuah Eng Chye (9 June 2018) “Labour share of income (Part 3: Causes of wage inequality)”.

Phuah Eng Chye (16 June 2018) “Labour share of income (Part 4: Does wage inequality matter)”.

Sandwichman (15 April 2017) “Why you can’t have a shorter workweek”. Originally published at

Servaas Storm (26 Feb 2018) “With official unemployment this low, why are wages rising so slowly?” Institute for New Economic Thinking.

World Bank (20 April 2018) “The changing nature of work”. Working Draft. World Development Report 2019.

[1] Paul H. Douglas.

[2] Based on research by Kevin Rinz and John Voorheis cited by Noah Smith.

[3] Daniel Aaronson, Eric French and Isaac Sorkin.

[4] Dan Kopf.

[5] See L. Randall Wray, Stephanie A. Kelton, Pavlina R. Tcherneva, Scott Fullwiler and Flavia Dantas.

[6] Jeff Spross notes the costs would dramatically shrink over time; citing Argentina’s Jefes program where the two million recipients in 2003 fell by 40 percent by 2006 as unemployment fell from 21 percent to 8 percent. In addition, JGs would reduce the number of recipients of other safety net programs should as Medicaid and housing assistance.

[7] John Maynard Keynes.

[8] Council for the Realization of Work Style Reform.

[9] Sandwichman.

[10] Council of Economic Advisers.

[11] Brooking Institution’s Hamilton Project

[12] Servaas Storm.

[13] Christian Odendahl.

[14] ILO

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