Cheap labour causes lazy capitalism

The slowdown in labour productivity growth since the early 1970s means that more and more labour input is needed for economic growth. The crux of the problem is that the neoliberal offensive as it took shape in the Netherlands after 1982 has not only led to greater inequality but has also been accompanied by the dismantling of the economic engine of the industrial economy.

Introduction: stagnant productivity growth

Labour market shortages are currently the Netherlands’ most pressing economic problem. Everywhere, in the private sector and in government, people are complaining about work pressures caused by not being able to fill vacancies. And these shortages are not the result of rapid economic growth, as it was slow before the corona years; at most, the recovery from the 2022 corona collapse has made the problems more acute. The problem is that labour productivity growth has virtually stalled, so GDP growth is entirely accounted for by labour input growth. This is also how the problem of labour scarcity is debated in politics: working hours must be extended, part-time work made less attractive, in order to further increase the labour input. This while, especially in an international perspective, the Netherlands already stands out for its strong growth in the labour force.

The question of why we fail to increase labour productivity is asked much less. While productivity growth is precisely the central mission of capitalism (if we may put it that way for a moment): the growth of a society’s ‘productive forces’, enabled by technological development, is seen by economists as diverse as Marx, Schumpeter and Keynes as the historical role played by the capitalist market economy. It is the growth of productivity that, from the Industrial Revolution onwards, has enabled the enormous increase in prosperity that underpins today’s high levels of prosperity. With the current emphasis on increasing labour input, after two hundred years of ‘intensive growth’, characterised by the increase in productivity, we are in a sense returning to the ‘extensive growth’ of pre-1800, which was mainly characterised by the use of more factors of production such as labour, capital and land. The decline in labour productivity growth (and total factor productivity) has been dramatic: in the 1950s and 1960s, it was still growing at 4-5 per cent per year, now it has fallen to 0.2 per cent per year (average 2008-2021).

Paradox 1: Secular stagnation

The usual explanation for the slowdown in productivity growth (and economic growth in general) that occurred in the western world from the 1970s onwards is referred to by terms such as ‘secular stagnation’ and ‘productivity puzzle’. The secular stagnation hypothesis – as articulated, for example, by Gordon – involves the failure of technological development from the 1970s onwards to make the major breakthroughs that led to sweeping changes in consumption and production. ‘Although IR#3 (third industrial revolution, ed.) was revolutionary, its effect was felt in a limited sphere of human activity, in contrast to IR#2 (second industrial revolution, ed.), which changed everything’. Nothing, for example, compares to the impact the car had on the economy, Gordon argues. His answer to the Solow problem ‘you can see the computer everywhere but in the productivity statistics’ is that you don’t see the computer everywhere – for example, not at the hairdresser and the pedicurist.

The literature that primarily articulates the problem as a ‘productivity puzzle’ (in line with Solow) generally does assume that the technological development of the past decades should have had profound effects on the economy, but focuses on the failure of countries’ technological system to fully exploit the potential of the new ICT technology. This leads to analyses of bottlenecks in the adoption of the technologies, due to failing institutions, lack of the right human capital or venture capital, failing government policies, etc. This often leads to policy recommendations to strengthen links between universities/knowledge institutes and companies, make capital available to companies on favourable terms, etc.

The big problem with the latter approach is that the growth slowdown is occurring in all rich countries – in Western Europe, the US and Japan. It is not plausible that all these countries are plagued by failing institutions, although of course there are interesting differences from country to country. The Netherlands is a rather extreme example – as productivity growth has fallen to just 0.2 per cent a year, where it was relatively high before 1973. But this does not square with the fact that in international rankings of the most competitive countries, the Netherlands did and does well to very well until the recent past.

However, the Gordon approach that emphasises more the overall slowing down of technological development also does not mesh well with the development of what economists see as the ultimate source of innovation. The circulation and absolute production of ideas has increased dramatically with the development of the internet and ICT technology in general, the number of knowledge producers in the world has increased enormously (with the rise of China alone), which has greatly increased the accumulation of ideas – the ultimate source of productivity growth. ICT technology, contrary to what Gordon writes about it, did penetrate the capillaries of economy and society. No car is started anymore, no heating turned on, no television channel watched, without the use of ICT.

Paradox 1 is that due to population growth, economic growth, globalisation and digitalisation, the basis for technological development – the accumulation of ideas as analysed, for example, by Kremer – has exploded in recent decades, but this has not produced strong productivity growth in the most developed countries. On the contrary, it shows a strong downward trend.

Paradox 2: the fruits of the neoliberal offensive

The decline in productivity growth is remarkable for other reasons too. The first break in post-war productivity growth, in 1971 or 1973, can be explained by the deterioration in economic conditions. The collapse of the Bretton Woods system, the wage and price spiral, the sharp rise in the burden of taxes and social security contributions, the oil price shock of 1973 (and again in 1979), the high labour income ratio and the low profitability of the corporate sector – it would have been a miracle if economic growth had not declined. But a radical turnaround took place from 1982 onwards: wages were moderated, social transfers and taxes reduced, interest costs also fell over time, and business profitability recovered, starting to rise sharply from the 1990s. After the fall of the Berlin Wall, a new phase of accelerated globalisation began, from which business could benefit greatly. Economic policy began to show increasingly neoliberal traits from Lubbers I onwards, with a dose of neocorporatism in the form of wage restraint agreed with the trade union movement. Labour costs were also kept low by the increase in flexible contracts, the massive entry of women with part-time jobs into the labour market, and eventually the rise of the self-employed. The central aim here was to create employment (Work, work, work!) and reduce the share of labour and government in GDP in favour of business, which was brilliantly succeeded in. And the Dutch ‘job-machine’, once in motion, caused a sharp fall in unemployment.

Wonderful, but this neoliberal offensive (similar to some extent to developments in the Anglo-Saxon world), led to little or no acceleration of economic growth (the trend remained downward), and even less to an increase in productivity growth (which, on the contrary, declined even further). This is the real paradox of the post-1980 period: under the influence of neoliberal thinking, everything was done to make the preconditions for rapid economic development as favourable as possible (while, at the same time, a technological ICT revolution swept through society), but this did not lead to an acceleration in productivity growth. As a result of this interplay of developments, business made consistently high to very high profits, but productivity growth did not increase. On the contrary, it fell to very low figures even by international standards (the already mentioned 0.2% per year between 1998 and 2021). Why did the economic ‘engine’ not revive, as it did in the 1950s and 1960s?

Productivity growth from the Industrial Revolution onwards

To answer that, we need to delve further into economic history. How did ‘modern economic growth’ (as Simon Kuznets called it) come about? The deeper, underlying force, it is agreed, was the accumulation of ideas (promoted by economic and legal institutions), and the technological development made possible as a result. But what mechanism ensured that this knowledge was transformed into productivity growth, the core of ‘modern economic growth’? The economic historian Robert C. Allen – inspired by Hicks – arrives at the following analysis. England had already become a country with relatively high wages in the centuries before 1750, mainly due to the expansion of international trade. At the same time, capital costs (due to favourable institutions) were low and England had a relatively cheap source of energy, coal. The Industrial Revolution consists of a wave of new techniques adapted to these factor prices, which have a strong labour-saving and capital-using character. The steam engine and the numerous techniques derived from it (railways, steamships) are the best examples. In other words, driven by these factor prices – of which expensive labour is the core – new techniques are developed to make and keep industrial production profitable under these factor costs.

This then triggers a movement whose core is the interaction between rising real wages and increasing (labour) productivity. Labour is replaced by capital and cheap energy as rising wage costs incentivise entrepreneurs to develop and adopt new labour-saving techniques. The resulting increase in labour productivity enables wages to be raised further. The emergence of trade unions that manage to force wage increases fits into this picture.

At the heart of the process of modern economic growth is this interplay between real wage increases and growing productivity. The investments needed to increase productivity (initially consisting of the steam engines and factories powered by this source of power) further drive growth. The Golden Years between 1950 and 1973 saw this engine of economic growth in full action; despite attempts to moderate wages, they rose sharply, provoking a wave of mechanisation that further accelerated economic growth. The success of this period can be seen in the strong growth in employment, which created great tightness in the labour market, which via even sharper increases in real wages eventually led to the well-known wage and price spiral of the 1970s. The labour income ratio thereby rose sharply, partly due to the expansion of the welfare state, and business profitability came under strong pressure.

The turnaround of 1980/1982 set in as a necessary correction to what had been skewed in the 1970s. But the result was a radical trend reversal, with real wage growth coming to a near standstill – due to post-1980 widespread unemployment, due to wage moderation. When the economy recovered after 1990, this did not change. A factor here was that the position of trade unions had become much weaker. But at least as important was the increasing flexibilisation of labour, through temporary employment agencies, part-time contracts and eventually the self-employed. Permanent contracts were widely transformed into flexible ones – mostly by outsourcing work. These changes were part of a much broader wave of neoliberal ‘innovations’ aimed at increasing the influence of  market forces. Whereas before 1980 labour-saving technological development had been core to corporate strategy, profit growth was now mainly sought in reducing labour costs through the institutional changes that led to lower costs but did not increase productivity.

So what was lacking in the years of the ICT revolution was pressure ‘from below’, from rising labour costs, which would have encouraged entrepreneurs to develop and adopt labour-saving technology. In this respect, business was pampered, creating an economy that could be characterised as lazy or complacent. Although the cost of capital, after a dramatic spike in the early 1980s (to break the wage-price spiral), fell equally dramatically to close to zero per cent, this did not lead to a spurt in investment to replace labour with cheap capital. On the contrary, the investment to GDP ratio tended to fall and growth in capital intensity of output structurally flattened, despite large corporate profits. The ECB noticed how limited the impact of low interest rates was on the economy that just could not be stimulated by this instrument. Profits were not invested but used to buy back shares (in the new world dominated by shareholder value).

The Netherlands was extremely successful from this perspective from 1982 onwards: wage costs were kept low by the combination of neoliberalism and neocorporatist wage restraint, and entirely consistent with this, the decline in productivity growth was also more radical here than elsewhere. It ultimately led to a labour market that is extremely tight, whose shortages are seriously delaying the solution of all kinds of societal problems, because professionals simply cannot be found to speed up the transition to sustainability, address bottlenecks in youth care, or rebuild defence. Moreover, the 2022 inflation wave means that even the increase in nominal wages driven by labour shortages will melt away in real terms. The policies to address the labour shortages seem aimed at yet more of the same effort to squeeze more labour out of a stress- and burnout-plagued workforce.

Conclusion

That the policy of wage moderation has had adverse effects on the Netherlands’ innovative strength is not a new insight. Kleinknecht has made this point regularly since his inaugural lecture in 1994, although he managed to convince only a limited part of the economists of this idea.[1] The crux of the problem is that the neoliberal offensive as it took shape in the Netherlands after 1982 has not only led to greater inequality – the most common criticism of this turn of policy – but has also been accompanied by the dismantling of the economic engine of the industrial economy, and as a result has led to a serious slowdown in the growth of output per capita and productivity. Other factors also play a role here: in the ICT era, it is more difficult to measure GDP (many digital services are ‘free’ and are therefore not included in their estimates), self-employed people are also presumably responsible for some of the low growth, and the contraction of the industrial sector has affected the heart of productivity growth. But the crux of the problem remains that the stagnation of wage growth does not and has not put pressure on business to develop and adopt techniques that will enable further productivity growth. Entrepreneurs have in a sense been so pampered – by low labour costs, low capital costs, low taxes and high profitability – that there were no grounds for a search for new labour-saving technology. As a result, we are now in a development path that produces growing inequality but no productivity growth, and we are now almost forced to solve economic problems through the ‘sweat and tears’ of more hours of labour rather than the creativity of new ideas and techniques.

 Jan Luiten van Zanden

Utrecht University

This is a summary of the working paper the author wrote with Arthur van Riel, which presents the scientific justification and the underlying quantitative data; Arthur van Riel and Jan Luiten van Zanden, Complacent Capitalism. Productivity Growth and Secular Slowdown in the Dutch Economy, 1982-2020. Maddison Project Working Paper, WP-17. 2023.https://www.rug.nl/ggdc/historicaldevelopment/maddison/publications/wp17.pdf

Literature

Allen, Robert C. (2009). The British Industrial Revolution in Global Perspective. Cambridge UP, 2009.

Robert J. Gordon, The Rise and Fall of American Growth. Princeton UO, 2016, 578.

Kleinknecht, A. (1994) ‘Does the Netherlands need a Wage Wave? A neo-Schumpeterian Narrative of Corporate Profits, Employment and Exports’ Journal of Political Ekonomics 17: 5-24.

Michael Kremer, Population Growth and Technological Change: One Million B.C. to 1990, The Quarterly Journal of Economics, Volume 108, Issue 3, August 1993, Pages 681-716.

[1] Kleinknecht, A. (1994) ‘Does the Netherlands need a Wage Wave? A neo-Schumpeterian Narrative of Corporate Profits, Employment and Exports’ Journal of Political Ekonomics 17: 5-24. We refer to a more detailed discussion of the debate on this in the extensive working paper we wrote on complacent economics.