Myth of income-led growth

National income is the value-added sum of all output from the country’s people and its enterprises. As capital and labor is essential to produce something, national income breaks down into labor and capital shares. The labor share is the part of the national income devoted to wages.

According to the LG Economic Research Institute, Korea’s labor income distribution rate stood at 70.9 percent as of 2014, having fallen steadily from over 80 percent before the Asian financial crisis in 1997.

The middle or lower income bracket lives off labor wages. The decline in wage’s share of the national income suggests that capital contributes more to the economic output and growth than labor. Capital income mostly goes to the upper-income bracket.

The lower-income class gets by on monthly wage earning. Because income has been reduced, so has spending. That is why domestic demand has been stubbornly subdued.

The new government wants to increase income as a breakthrough in the bottleneck of growth. It argues that when income increases, so would spending.

Higher demand would stoke industrial activity, and companies would increase investment and hiring so as to increase income.

President Moon Jae-in and his liberal team have passed their 100th day in office. Moon’s government proposes to increase fiscal spending to back a double-digit hike in minimum wages, bigger public insurance coverage and monthly cash allowances to low-income senior citizens.

His policies all support wage-based growth. The public-finance spending is designed to prime the pump and give traction to the slow-moving economy.

However, mainstream economists see income as the fruit of economic growth. They believe income will grow as the result of increased output. Moon’s government proposes the opposite. It points to the fact that inequalities have deepened despite prosperity.

If the wealth gap widens, the economy will stop growing and society’s foundations could be wrecked. The Moon administration believes that through its interventionist distribution, income could increase and set the economy on a new growth path.

In fact, mature economies all suffer similar challenges. Simple labor jobs have become increasingly redundant and are replaced by machines. Earnings for low-income class have been shriveling. Different income classes are clashing across the world.

Yet advanced states are skeptical of income-led growth. The theory received impetus after a report by the International Labor Organization in 2012, which was based on the wage-led growth concept as an equitable strategy for economic recovery from post-Keynesian economists March Lavoi and Engelbert Stockhammer.

The concept has been championed by the ILO, which is not represented by UN member states, but by representatives of governments, employers and workers. It has 183 member countries. The tripartite body acts to mediate and support improvement in labor conditions through international alliance.

If one certain country raises labor cost, its overall production cost goes up. The finished good value also goes up, hurting its competitiveness in the global market. Imports will also dominate the consumer market. Manufactures will reduce hiring or go elsewhere in the search of cheaper labor. The policy could end up slashing jobs instead of increasing them. If wages do not go up elsewhere, the theory won’t work.

Such an international alliance is impossible. The wage-led growth concept was tweaked to income-led growth under Moon, given the high share of self-employed businesses in Korea. But the downside is evident, as seen by a lack of policy means.

The income-growth paradigm is too weak to revitalize Korea Inc. It could act as traction, but not as the key engine for growth.

Moon’s government wants to break out of the old-fashioned growth mold and create a new growth momentum.

A non-mainstream economic theory can become mainstream one day. To make the experiment work, innovations are essential. At the end of the day, growth is driven by new innovations and structural reforms.

It also must be followed by labor reform and deregulation efforts. What the government needs to build on is a strategy to stimulate innovation growth. Otherwise, pouring tax money into the economy could end up going into what it essentially a bottomless pit.

JoongAng Ilbo, Aug. 28, Page 32

*The author is the business news editor of the JoongAng Ilbo.

Kim Jong-yoon