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Global trends converging to put more money in workers' pockets

Global trends converging to put more money in workers' pockets
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A key longer-term issue for investors at present is whether the era of globalization is now moving in reverse. By fostering greater access to product markets, labor markets and capital markets, that era has had big ramifications for the pace and distribution of global growth.

By exerting downward pressure on wages, it has equally had big ramifications for inflation, for profits and for equity returns. Less widely appreciated, but perhaps more importantly, globalization has had big ramifications for real inflation-adjusted interest rates.

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This is because there has been a substitution by companies of capital for labor in recent years, and this has lowered the demand for capital and reduced its cost. For all these reasons, the fate of globalization is clearly important.

A key area for investors to keep an eye on for assessing that fate is the labor market. If wages now rise and labor accordingly captures a higher share of the economy’s national income, the current political backlash against globalization may bear fruit.

Returning to those points above, this could yield some noteworthy implications for economies and financial markets as well.

Our recent research at Nomura suggests several reasons for thinking that wages will indeed now rise more forcefully. One of the more straightforward reasons is the degree of slack that exists in labor markets.

Measured with reference to Organization for Economic Cooperation and Development (OECD) estimates of natural levels of unemployment, there are now a large number of developed economies where labor markets are deemed to be tight.

As a result, wage inflation is already picking up in a number of these economies. Our aggregation of the incoming data for the U.S., Europe and Japan, for example, suggest that wage growth is now climbing at its fastest rate for around 10 years.

In the absence of offsetting forces that might slow these economies, this means there are sound reasons for expecting even higher wage inflation (and a higher wage share of GDP) in those economies in the immediate period ahead.

A more important reason, however, for expecting higher wage inflation concerns structural drivers that are rooted in globalization’s reverse. Take, for example, the expansion in the world’s labor supply that has been fueled by the economic development of — and greater access to — major developing economies.

Forecasts from the United Nations suggest the working-age population is likely to decline in most economies in coming years, most notably in China. To the extent that labor-market globalization has been a function of an increase in the supply of cheap rural labor in China, this could have significant implications.

Additional structural reasons for expecting higher wage inflation concern global value chains and offshoring, where the recent rise in protectionism will almost certainly result in reduced trade flows and less efficient supply chains.

The U.S. administration’s disposition toward protectionism will reduce trade openness via the imposition of tariffs, but it could also indirectly sap supply-chain efficiency by encouraging other countries to follow suit.

Could this political backlash against globalization and the fervor for protectionist policies begin to fade as wages rise? That’s possible, but it may take a long time.

Estimates from the World Bank show that some of the biggest winners from globalization were China together with those that lie at the top of the income distribution in rich developed economies.

Those that barely reaped any benefit included very poor regions (e.g. Africa) and the Western lower-middle and working classes. The implications of this are obvious but important. They suggest the political backlash against globalization is unlikely to fade in the period ahead even as wages slowly rise.

They equally suggest that Western antagonism among populist politicians toward China is also unlikely to fade. And they further suggest that antagonism toward the upper elements of the income distribution — the so-called "metropolitan elite" — is unlikely to fade either.

Until such time as those in the lower-middle and working class in Western economies achieve much higher wages, it seems fair to argue that the trend toward protectionist policies could pick up pace.

One might further argue that wage inflation will almost certainly increase in the coming years because politicians and electorates demand that this be so.

What’s the bottom line? Taken together, the current economic and political environment appears increasingly conducive to higher wage inflation and an increase in labor’s share of national income. That will have implications for inflation, for trend profitability, for interest rates and for the broader economic outlook.

If, moreover, negative structural forces rooted in globalization’s reverse are key drivers behind rising wages, we could see a scenario where both equity markets and bond markets underperform. That would be a big surprise for market participants that have been accustomed to negative bond/equity market correlations in recent decades.

Andrew Cates is the head of developed markets economics at Nomura.