Sunday, April 4, 2010

Wage Indexation

Twentyfive years ago Ezio Tarantelli – a professor of Labour Economics in the University of Rome La Sapienza – was assassinated by the Red Brigades shortly after giving a lecture. A distinguished economist, he was a follower of Franco Modigliani with whom he had studied and taught at MIT, and an economic advisor to CISL (the Italian Confederation of Trade Unions). He was a strong supporter of an incomes policy negotiated within a Social Pact, not just for Italy but throughout Europe as a pre-condition of the single currency, which he also strongly supported long before it materialised. But his main interest was the advocacy of curtailing Italian wage indexation (the scala mobile) which he regarded as responsible for perpetuating and accelerating the wage-price spiral that follows any inflationary shock. He successfully advocated the adoption of a pre-determined inflation target, to be agreed among social partners and the government, in place of actual recorded inflation.

Ezio Tarantelli’s proposal for cooling inflation by indexing wages to a negotiated target instead of actual inflation faced two difficulties:

First, the alternative is never whether a given nominal wage level should or should not be indexed. For a given relative negotiating strength of Trades Unions and Employers' Unions, if wages are indexed there is less need to take into account subsequent expected inflation in wage-fixing. Indeed if indexation is full (i.e. of 100% of the nominal wage with unit elasticity of the wage with respect to prices and with a short enough lag) there is no need and no case for taking into account subsequent expected inflation at all. In times of rapid inflation, especially of accelerating inflation, wage indexation defuses inflationary expectations and allows the negotiation of a lower nominal wage than would have to be fixed if there was no protection from future inflation. This is precisely why, when wage indexation was first introduced in Italy in 1947, the President of Confindustria (the Confederation of Italian Industrialists) shipowner Angelo Costa actually greeted it as a major anti-inflationary measure. Wage indexation thus has an ambivalent impact: it prolongs an inflationary process but starting from a lower wage and price level than is achievable without indexation.

Second, nominal wages are not fixed forever but are normally re-negotiated periodically. Inflation-proofing through indexation, if triggered by a shock after negotiation, will exhaust its effects completely at the next wage settlement. The new nominal wage will be determined by the relative negotiating strength of employees and employers and other fundamentals prevailing at that later time, regardless of how much the nominal wage might have risen in the intervening period thanks to wage indexation. On average, with rounds of nominal wage negotiations taking place, say, at two-year intervals, the impact of wage indexation will last for only one year, for the new nominal wage will be fixed starting from scratch, from a tabula rasa. To be more precise, it will last for one year (half the period between negotiations) minus the lag between price and wage rises (say at least three months), since the last indexed wage rise during that year will coincide with and will be taken into account at the next round of wage re-negotiation.

In conclusion, wage indexation is neither a shield against inflation nor an inflation engine, it has a positive and a negative impact on inflation, respectively defusing inflationary expectations and prolonging the impact of a shock; but both effects - partially reduced though not eliminated by Tarantelli's proposal - are operational only for a very, very short time. In all, we are talking at best of nine months partial wage protection, though on balance the impact of wage indexation on inflation may actually be beneficial. (A paper of mine in Italian developing these points, Indicizzazione e scala mobile (1994), is available on my website).

12 comments:

Klusplatz said...

With all due respect, it is absolutely impossible--mathematically impossible--for wages to affect the rate of inflation. Inflation is only a monetary phenomenon. If unions push wages up too high, there can not be higher prices economy-wide, only higher wages for the people that are not laid off. And for some people to have higher wages, others must be let go (or the government must subsidize the companies for their losses). The more wages are pushed artificially high, the more people will be laid off. This is one of the main functions of the central bank--to pump money in and raise nominal wages so that unions think they're getting ahead when they're not (but while other wage earners fall behind in real terms).

If you want absolute proof of this assertion, let me know and I will email you an audio lecture explaining this in detail.

Kel Kelly

D. Mario Nuti said...

If you were right the case I am making in this post - that wage indexation does not necessarily prolongue inflation - would be infinitely stronger. Within your framework inflation has nothing to do whatever with wage rises and therefore wage indexation cannot have any harmful impact on inflation. I would feel vindicated by your comment.

The trouble is that you would be right only in a strictly quantitative approach to money, with fixed coefficients such as the velocity of money, and a Central Bank totally and completely in control of money quantity. But the public can also influence such quantity with its own behaviour. And a strictly quantitative approach to money with fixed parameters is a theoretical relic of antiquarian interest only.

But do post your audio lecture in a comment by all means (it can be done) or give us a link to it, so we can all play.

Klusplatz said...

No, I am right under any condition. The quantity approach to money is the only valid approach to money as regards inflation or deflation (as opposed to falling prices). There is no possible way the public can influence prices. For prices to rise on a sustained basis, there must be more paper bills, or more likely, more (higher) total checking account balances. It's amazing that one could still argue that inflation is not a monetary--and only a monetary--phenomenon. Is the difference between Zimbabwe and the U.S., or even the U.S. and Switzerland, mainly a function of cost-push, demand-pull, "shocks," credit-cards, derivatives and the like? Of course not.

Leave velocity out. Velocity does not have a life of it's own. It fluctuates lightly around any given quantity of money. The quantity of money is the primary factor affecting velocity (and most velocity changes derive from financial market transactions, and price movements of financial markets--as a whole--are solely driven by money and credit).

Klusplatz said...

Forgot to mention the lecture: I don't see how it can be posted. Please let me know and I will. I can't provide a link because it's not available on the internet.

I offer the audio because it's quick and easy (30 min or so). But if you really want at the truth of all of these topics we've discussed, please see George Reisman's Capitalism. Here's a free PDF: http://mises.org/multimedia/pdf/capitalism.pdf
The wage-push discussion is on page 909 of the book (965 in the PDF pages).

That discussion is part of the larger discussion proving that the common arguments stating that forces outside the central bank could affect prices are fallacious. The broader discussion begins on page 895.

If I can somehow insert a picture, I will offer my briefer proof that it is only the quantity of money in an economy that can affect prices (more than slight change in demand for holding money)

Also, here is info for you on booms and busts and credit crises and the real economy:

http://mises.org/daily/3128

D. Mario Nuti said...

You can always send any picture or text to my e-mail address: dmarionuti at gmail.com.

Jacob Richter said...

This is but one of many problems with most forms of capitalism, but what's the alternative to indexation for wages?

If capitalism is so dynamic, innovative, revolutionary, etc. we'd see lots more pro-labour reforms than we have historically.

As I see it, over the long-term there is real productivity growth. This long-term growth necessarily exceeds any long-term increases in the costs of living, otherwise we'd be better off going back to feudalism.

Despite this difference, there are still no guarantees for service workers in addition to more conventional types of workers for costs of living.

Klusplatz said...

Jacob,

To ask this question is to not have any idea of how wages and productivity work in real terms, and especially to have no idea how they work in monetary terms. Before posting comments, and (implicitly) voting for such anti-capitalistic policies, you really should have a basic understanding of how markets work. Similarly, you should learn what Capitalism is and is not.

Read chapter one of this book, and see if you still have the same questions:

I give it to you here in PDF form for free (ignore the error and wait for it to load completely; the front page might not load, but just scroll down anyway).

You can buy the hard copy here: http://mises.org/store/Case-for-Legalizing-Capitalism-P10395.aspx

Klusplatz said...

"As I see it, over the long-term there is real productivity growth. This long-term growth necessarily exceeds any long-term increases in the costs of living"

This is the exact opposite of reality. The cost of living increases faster than does productivity. If it didn't, prices of goods and services (cost of living) would decline in money terms (as they used to in the 1800s), not increase. Prices increase faster than do the production of goods and services because the rate of increase of the money supply is faster than the rate of increase of goods and services (i.e., output). The rate of increase of goods and services is the very manifestation of productivity.

Jacob Richter said...

Before I respond, I should ask where the host blogger has gone. I'd like his insights.

Now, this "anti-capitalist" (much more than that, too) has much more than just a "basic understanding of how markets work" and especially what capitalism is and isn't, thanks.

Capitalism is more than just the consumer goods and services market from recorded history. There are labour markets and capital markets.

We just come from politically different schools of economic thought. You measure productivity more closely with profit. I measure it more closely with surplus labour. Under capitalism we see expanding surplus labour paradoxially combined with falling rates of profit.

As for your money supply remark, the Austrian School is far from advocating the kind of public control over the money supply that's needed with the very same fractional reserve crap that you oppose.

D. Mario Nuti said...

The host blogger is back - see today's post http://dmarionuti.blogspot.com/2010/09/global-policy-forum-yaroslavl-8-10.html.

I found all comments by Klusplatz somewhat tedious and doctrinaire, I strongly disagree with them but I respect diversity of opinion and I did not censure them. I thought you could look after yourself, which you did.

I have no quarrel with your Marxian concepts, except that I do not see evidence of a falling profit rate, quite the contrary; I do not regard surplus labour as a more useful concept than profit, and I would look at labour productivity measured in value added and the wage share in it.

In advanced countries the wage share in GDP has fallen by 10 percentage points in twenty years, 1985-2005, from 65 to 55 per cent (IMF data, World Economic Outlook, 2007 I think). Is that not serious enough for your purposes?

Jacob Richter said...

Hi Dr. Nuti,

That's a good question, since I'm an ordinary worker and not an academic. To me, disproportionate immiseration is serious enough to warrant collective political action, but generic political consciousness is still stagnant.

I would say that decline in wage share is normal without generic political action. Only three times in capitalist development have real wages gone up in the developed countries: after the Long Depression but before WWI, the decade after WWI, and the post-WWII boom. In all those cases, however, geopolitical powerplay was involved, and two of those cases were buttressed by colonialism (the stuff of early Kautsky, Hobson, Hilferding, Luxemburg, and later Bukharin and Lenin).

I'm not a big fan of GDP even as a non-"social" measure. It doesn't take into account which labour directly or indirectly sustains the worker's consumption bundle, and which labour doesn't. In short, which labour is productive in goods and service, and which isn't (financial real estate, legal administration, needless government spending because of a privatized military-industrial complex)?

BTW, please forgive us for making off-handed remarks on the money supply.

Klusplatz said...

Regarding the posting by Jacob Richter on Sept. 2nd:

I don’t understand your last sentence. You’re right: we oppose fractional reserves and a government manipulation of the money supply and of the rate of interest. Were there no fractional reserves or increase in money supply, booms, busts, recessions, and financial crises could not exist.

Indeed Capitalism is more than just more than just the consumer goods and services market, but the increase in (physical, not moral, or emotional, spiritual) standards of living are derived solely from the increased production of goods and services. Even Leonid Brezhnev said this.

No, I do not measure productivity with profit. Profit, the compensation to those who loan capital in order to improve lives and earn a rate of return, is what is required in order to achieve productivity.

There is no such thing as “surplus labor.” Wages are not a deduction from profits. Profits are what exist prior to the existence of wages. Wages are a deduction from profits. The more capitalism, the lower are profits (though profits could never fall to zero).

The very fact that you are Marxist tells me you no know nothing about economics besides the b.s. that Marx wrote. Are you aware of the fact that virtually no economist in the world supports Marxism, because Marxism was thoroughly disproven over 130 years ago. The only adherents of Marxism are ignorant history, literature, arts, and classics teachers in academia, except for the naïve leftwing students who think they are cool learning illogical, ignorant, fallacious theories. I can only assume you fall into one of the above categories.

Are you aware that Bohm-Bawerk refuted marks ten ways to Sunday? Are you aware that Marx ended up practically conceding just about all the points Bohm-Bawerk made against the theory in the third version of Das Capital? That’s when Marxism was extinguished as a viable theory. To believe in Marxism is to pretend the up is down and that circles are squares.

Are you also aware that Marxism has never worked in any country? Are you aware that communism has killed well over 100 million people? (No, it’s not the case that it was done incorrectly: it was done the only way it could be done—by oppression and total control, prohibiting freedoms of any kind, otherwise, people would run from the system as fast as they could). Yet capitalism, to the degree it was allowed as eradicated disease and poverty, and improved standards of living. The more capitalistic a society---historically, or across various countries today—the higher standards of living that exist, and the less suffering people endure.

You want to promote death and suffering all because you think—wrongly—that workers are not paid the extra 10% you think they are due, because incomes are unequal (because people and their desire and ability to produce are unequal). Are you serious with this ridiculous thinking? Have you learned nothing from looking at history or the world around you? You just want to stick your head in the sand and pray to false gods?

Educate yourself and think morally and logically.