Profits And Wages In The Covid Era: Looking Under The Hood

The current pandemic has taught policymakers, regulators, and of course economists, many shades of policymaking. In particular, since the global financial crisis, there have been doubts about economic theories that standard economics textbooks imbibe and the murmurs have only grown louder during the pandemic.

While a comprehensive discussion of the same is beyond the scope of the article, we raise an issue of particular interest: the declining labour share in GDP that was starkly evident during the current fiscal, when companies had cut costs to spur manufacturing gross value added.

This is not a recent trend, though. As per the ILO estimates, labour income share as percentage of GDP declined modestly from 52.2% to 51.4% for the seven years ended 2017. However, for India, there has been a much larger reduction in this period from 56.8% in 2010 to 49.0%. The recent pandemic has led to cuts in wages and an overall increase in unemployment, which can lead to a further reduction in the share of wages in total output.

What’s Happening In India?

As per the Reserve Bank of India survey data on capacity under-utilisation, the Indian economy had been witnessing less than 75% capacity utilisation for quite some time. In the corporate listed space, if we look at the employee expenses and PAT as percentage of net sales as a whole without excluding any sectors, we see that between FY15 and FY20 although employee cost has remained more or less stagnant, the PAT has seen a sharp downward trend. The one reason could be the higher provisioning by the banking sector and telecom sector stress. Thus, if we remove banking, finance, insurance, and telecom from our sample, then the variation in employee expenses and PAT as a percentage of net sales becomes almost similar.

In the first half of the current fiscal, employee expenses have grown by only 3%, while operating profit has grown by 4%, and profit after tax has grown by a whopping 25%.

A closer look at the data shows that from 80 sectors that we analysed, 55 had shown an employee cost contraction in H1FY21 vis-à-vis H1FY20, while 56 have shown PAT degrowth. The companies in the banking, finance and insurance space are showing that PAT has increased quite substantially vis-à-vis employee costs.

Among the sectors that the top 20 companies by net sales in H1FY21 operate in, only IT services reported a rise in employee expenses among those that saw a contraction in PAT. Thus, looking at the data it is evident that there are few sectors that are pushing the overall PAT and their increase is masking a broad-based decline in wages and profits.

The employee expenses of core sectors have not turned negative which is perhaps a good thing. However, overall discretionary sector employee expenses have been hit significantly harder than non-discretionary expenses. The concern is that sectors like education, construction, hotels and restaurants employ a sizeable chuck of the population.

Rethinking Macroeconomics?

Such developments in the manufacturing space have definitive policy implications. On the impact of declining wages, noted Polish economist Michał Kalecki once had said, “during a crisis …reduction of wages causes a reduction of price, but the interval between these events does not permit workers to benefit immediately, while further reductions of wages eliminate altogether the possibility of their being able to do so. As a result, the standard of living of the working class and its share in the social income fall, but at the same time the increased share of the capitalists in the social income flows more into unsold stocks. This in turn further shrinks output and intensifies the crisis.”

Kalecki, who was a strong influence on India’s early Five-Year Plans, had reasoned that even though the price fall might bring about a reduction in the short-term interest rate, which could later encourage investment, this effect may not be of utmost importance and falling prices might rather cause a recession.

Kalecki’s student and collaborator Amit Bhaduri and American economist Stephen Marglin expanded on this “effective demand” idea by counter-posing the under-consumptionist idea that a high real wage is beneficial as it generates high effective demand against the orthodox view that high labour cost discourages production.

How the economy will perform after a change in the distribution of income depends on whether aggregate demand is either wage-led or profit-led in the Bhaduri-Marglin model.

Thus the results from various theoretical models are mixed.

When we juxtapose the listed corporate data with the ILO data, it appears that the formal/informal and listed/unlisted divide is still wide in the country. Any policy that is formulated seeing only the listed corporates’ performance and the formal economy with a relatively cushioned labour force, will have big implications for the future growth of the country.

To summarise, macroeconomics and traditional policymaking has never been at crossroads as before. In principle, we are now in an era of low wage growth. Textbook assumptions from the 1970s about downward wage rigidity are just not valid. This could also mean that the familiar wage and price growth nexus may have broken down and this could explain much of the inefficacy of monetary policy in advanced economies. In the Indian context, we are witnessing similar situations with declining wage growth, lower labour productivity but with higher prices.

Paradoxically, all this leads to a different predicament that mirrors an absence of a working theory of inflation dynamics that was taught in economics textbooks. Monetary policy making is perhaps today based more on conceptual constructs like potential output, output gap, equilibrium real rate and so on. This makes us believe that the role of fiscal policy in the current low interest rate regime may have been less explored. But that debate about the role and coordination of monetary and fiscal policy in the Indian context perhaps for another day!

Soumya Kanti Ghosh is Group Chief Economic Advisor, State Bank of India. Views are personal. The author is thankful to Shambhavi Sharma for research.

The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.