January 19, 2023 |
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CIO Macro and Market Observations from Multi-Asset Solutions
February 15, 2023 | 4 Minute Read
Maria Vassalou, PhD
Co-Chief Investment Officer, Multi-Asset Solutions
Maria Vassalou, PhD
Amy Yifan Zhou, PhD
Multi-Asset Solutions
Amy Yifan Zhou, PhD
The relative importance of labor versus capital is greatly influenced by an economy’s secular forces. In the United States, we expect that the Federal Reserve’s focus on bringing down wages along with corporations’ bearish business outlook will continue to weaken wage growth and reduce labor compensation’s contribution to Gross Domestic Product (GDP). Such developments are likely to dampen consumption and hurt growth in the near term. But the redistribution of growth from labor to capital should incentivize firms to boost capital investments, a likely positive factor for risk asset performance over the medium-to-long term.
Labor vs Capital as Drivers of Growth
The share of labor compensation in US national income has been declining for decades. And as the world wrestles with demographic shifts and a period of de-globalization, the relative importance of labor versus capital is also fluctuating—continuing a trend that has persisted for some time. In the late 20th century and early 2000s, globalization and offshoring of supply chains contributed to the re-distribution of US GDP from labor toward capital, which encouraged further capital investments and boosted economic growth. In recent years, however, such developments have been partially reversed as de-globalization is gradually replacing globalization, populist initiatives are gaining more traction, and countries are increasingly turning inward for sourcing factors of production, including labor supplies. Currently, the US labor share has risen from the low of 62.6% registered after the 2008 Global Financial Crisis to about 65%, a level comparable to that which prevailed in the 1990s.
Exhibit 1: US Labor Share Has Risen to Mid-1990s Level
Source: Conference Board, Goldman Sachs Asset Management. As of January 20, 2023.
This issue of labor compensation is particularly important today, as wage developments are among the key determinants for the forward path of inflation, making them a key focus for the Fed. As Fed Chair Jerome Powell pointed out, “wages make up the largest cost in delivering services other than housing, and the labor market holds the key to understand inflation in this category.” By some measures, the US job market is still relatively tight with stronger-than-expected growth in non-farm payrolls and initial jobless claims comparable to pre-pandemic levels. Currently, the 12-month moving average of median wage growth in the US is about 6.3%, with Leisure and Hospitality registering growth above 7%. However, inflation has eroded the earning power of workers, and real wages have in fact been contracting since 2021.
In the upcoming quarters, a combination of macro policy-tightening and company-level cost-cutting are expected to weaken wage growth further. Given concerns of a slowing economy, companies are increasingly focused on reining in expenses, implying potentially weaker demand of labor ahead. To anchor inflation expectations, the Fed is determined to cool aggregate demand and push down wages. So far, the increase in the US labor share has come at the expense of the capital share, which also reduces the incentive for investments and negatively affects future growth. Therefore, by depressing the share of labor, the Fed is also implicitly providing an incentive for capital to invest more. Historically, the decline in labor share has coincided with the de-coupling between wages and productivity, as firms prioritized capital investments over labor compensation. Since the 2010s, the so-called “compensation-productivity gap” has largely diminished with the rise in labor share. Going forward, a more investment-friendly policy environment should continue to stimulate capital spending over labor compensation. The likely result: wage growth for workers may lag productivity again, and a higher capital share at the expense of labor.
Exhibit 2: Going Forward, We Will Likely See a Return of the Productivity-Compensation Gap, and Higher Capital Share at the Expense of Labor
Source: Bloomberg, Goldman Sachs Asset Management. As of February 10, 2023.
Investment Implications
What does it all mean? We believe the economic and market impact from the labor-capital redistribution should be viewed in phases. In the short-term, lower real wages are likely to pose continued challenges to consumption, which has already grown at a below-forecast pace in 2022 Q4. The Fed is expected to continue with the tightening process, given the lack of disinflation in Core Services. As a result, we will likely see loosening of the labor market and the prospects of corporate profitability may look dimmer in the meantime. Nonetheless, greater capital spending and lower labor costs are ultimately in line with brighter prospects for corporate profitability and should benefit risk assets again in the medium-to-long term. The transition may be painful, but we believe the rewards are in sight.
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January 5, 2023 | Macro Insights2023 Outlook: Not out of the Woods
January 5, 2023 The world we live in is becoming more complex. It is undergoing what we believe to be a historic transition that is likely to alter economic alliances, change how monetary policy is conducted and, in the long run, potentially alter the economic structure of many countries. We believe market participants will have to start allocating capital based on what the world may look like tomorrow, not what it was in the past. But as investors who lived through 2022 will appreciate, the journey is unlikely to be smooth or straightforward. In 2023, we believe underlying economic and market conditions may get more challenging before they ease. Read More
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