IMF Working Paper: Loss of bargaining power leads to recession

For decades now, economic orthodoxy has held that government policy that impedes the accumulation and expansion of private capital is bad policy. The International Monetary Fund and the World Bank have promoted and often enforced this orthodoxy.

The two institutions have encouraged countries to weaken laws protecting job security, eliminate or reduce corporate taxes that support social protections like unemployment insurance, and implement austerity measures that make life harder for workers. 

But the financial crisis of 2008 and the instability that ensued, including the recent uprisings in Tunisia and Egypt, are causing some within these two institutions to reconsider their position. It would be naive to think that this moment of new-found uncertainty and reflection represents a change of heart for the ruling classes of the world, but it does show that cracks are starting form in the foundation of economic conventional wisdom.

Last November, the IMF published a working paper by two of its economists entitled Inequality, Leverage, and Crisis that argues that income inequality was at the heart of the Great Recession and that if this inequality is not addressed, it will lead to new recessions and growing instability

The working paper, which reflects the position of its authors and not the IMF, says that in the US wealth has been redistributed upward with the rich getting much richer and the rest of us treading water or falling further behind. “The share of  total income commanded by the top 5 percent of income distribution increased. . . from 22 percent in 1983 to 34 percent in 2007.”

According to the paper, this upward wealth redistribution has been caused by  a decline in workers’ bargaining power over wages, which has led to stagnant wages for some and falling wages for others. The authors cite several reasons why workers’ bargaining power has declined: the increased use of performance-based compensation such as bonuses is the leading cause; the decline of unions is the second.

In the face of stagnant and falling wages, workers over the last 30 years have taken on more debt to maintain their standard of living.  This debt has been bundled and sold as securities to financial institutions, institutional investors, and wealthy individuals. The financial crisis happened when workers’ debt to income ratio became too high,  which made debt-based securities less secure and lowered their value. As the value of these securities continued to decline, it became harder to trade them and markets eventually crashed.

The paper suggests that unless government policy changes to give more bargaining power to workers, they will continue to over rely on debt to finance consumption and the downward spiral that led to the Great Recession will be repeated.

It’s not just policy wonks at the IMF raising alarms about the instability caused by income inequality. Dominique Strauss-Kahn head of the IMF said recently that the world’s economy is built on an unstable foundation. “Global unemployment remains at record highs, with widening income inequality adding to social strains,” Strauss-Khan said.

In January, Strauss-Kahn and Robert Zoellick, World Bank president, met with representatives of the International Trade Union Confederation (ITUC) to discuss how the benefits of economic growth could be distributed more equitably and social protections could be enlarged.

Strauss-Kahn is also working with the International Labor Organization to establish a social protection floor that would provide workers around the world with essential services and income security.

At the same time, the IMF and World Bank have not done much besides talk about possible changes. The World Bank continues to support government austerity measures in spite of high unemployment around the world, opposes government standards that regulate labor, and still opposes taxing corporations to pay for social protection benefits. 

According to Sharan Burrow ITUC general secretary, “the World Bank has caused enormous damage to workers by advising borrowing countries that labour standards should be dispensed with. . . . It is simply irresponsible to promote the idea that companies should not have to pay one cent of tax or social contribution.”

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