Prices and wages

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By MICHAEL ROBERTS*

The real purpose of interest rate hikes is not to break any price and wage spiral, but to increase unemployment.

Do “excessive” wage increases lead to rising inflation and thus send economies into a price and wage spiral? In 1865, at the International Workers' Association, Karl Marx debated this topic with that Association's board member, Thomas Weston. Weston, a leader of the carpenters' union, argued that asking for a raise in wages was pointless because all that would happen is that employers would raise their prices to maintain their profits, and therefore inflation would rapidly eat away at high purchasing power; real wages would stagnate and workers would go back to square one because of a price-wage spiral.

Karl Marx responded to Thomas Weston's argument with firmness. His response, which ended up being published in a pamphlet, Value, price and profit, was basically as follows. First, “wage increases usually follow on from previous price increases” – the demand for higher wages is a recovery attempt; it is therefore not due to 'excessive' and unrealistic demands for higher wages on the part of workers.

Second, it is not wage increases that cause inflation to rise. Many other things affect price changes – argued Marx: namely: “the quantity of output (growth rates), the productive forces of labor (productivity growth), the value of money (money supply growth), fluctuations in the market prices (price setting) and different phases of the industrial cycle” (boom or recession).

Furthermore, "a general increase in the rate of wages will result in a fall in the general rate of profit, but will not affect the prices of commodities." In other words, wage increases are much more likely to reduce the share of income that goes to profits and so eventually decrease the profitability of capital. And that is why the capitalists, through the voice of their “Economist” advocates, are so obstinately opposed to wage increases. The claim that there is a price and wage spiral and that wage increases cause price increases is an ideological smokescreen to protect profitability.

Marx was right... or not? Well, modern mainstream economics continues to claim that “excessive” wage increases will cause inflation to rise and create a “wage-price spiral”. Consider the following opinions that were released at the current time when inflation is rising. First, there is the recent statement by Andrew Bailey, Governor of the Bank of England. “I'm not saying anyone should get a pay raise, don't get me wrong. But what I am saying is that we need to have moderation in the salary negotiation, otherwise it gets out of hand”.

Jason Furman, former economic adviser to US President Barack Obama, released the following in the press, explicitly repeating no more than Thomas Weston's argument made over 150 years ago: “When wages go up, prices go up. If airline fuel or food ingredients go up in price, airlines or restaurants will raise their prices. Likewise, if salaries for flight attendants or servants go up, so do prices. This stems from basic micro and common sense”.

Well, this reasoning may result from “basic microeconomics” which does not go beyond “common sense”; it is always repeated by conventional economics. However, he is simply wrong. This week, the IMF presented a comprehensive data analysis of the movement in wage and price increases, which refutes both Bailey and Furman. This supranational body “addresses these issues by first creating an empirical definition of a price-wage spiral and then applying it to a historical database of advanced economies since the 1960s”. So what happened in many countries for sixty years was analyzed econometrically.

In that study, the IMF found the following: “Price and wage spirals, at least defined as a sustained acceleration of prices and wages, are hard to find in recent historical records. Of the 79 episodes identified with accelerating prices and wages since the 1960s, only a minority of them experienced greater acceleration after eight quarters. Furthermore, sustained acceleration in wage prices is even more difficult to find when analyzing episodes similar to those of today, where real wages have fallen significantly. In these cases, nominal wages tended to catch up with inflation to partially recover real wage losses, and growth rates tended to stabilize at a higher level than before the initial acceleration. Wage growth rates turned out to be consistent with observed inflation and labor market rigidities. This mechanism does not seem to lead to persistent acceleration dynamics that can be characterized as a spiral of prices and wages”.

But the IMF went on to say more: "We define a price-wage spiral as an episode in which at least three out of four consecutive quarters saw consumer prices accelerating and nominal wages rising." He then concluded: “Perhaps – and this may seem surprising – only a small minority of these episodes were followed by a sustained acceleration in wages and prices. Instead, inflation and nominal wage growth tended to stabilize, leaving real wage growth largely unchanged. A decomposition of wage dynamics using a Phillips curve of wages suggests that nominal wage growth typically stabilizes at levels consistent with observed inflation and labor market rigidities. By focusing on episodes that mimic the recent pattern of falling real wages and tightening labor markets, the trend was for inflation to fall and nominal wage growth to rise – thus allowing real wages to recover.”

After that, the IMF concluded, still surprisingly: "We conclude that an acceleration of nominal wages should not necessarily be seen as a sign that a spiral of prices and wages is consolidating".

In short – I conclude Michal Roberts: in inflationary episodes, wages just try to keep up with prices. But even in doing so, wage increases do not cause wage price spirals. Now, thus, the thesis of Karl Marx was confirmed.

And if you want immediate proof of this, look at this week's wage deal between German industrial employers and the IG Metall union, Germany's largest. Workers will receive wage increases well below Germany's inflation rate, currently at 11,6%, the highest in 70 years, receiving 5,2% next year and 3,3% in 2024, as well as two flat payments of €1.500.

Jörg Krämer, chief economist at Commerzbank, said unions and employers "have found a compromise on how to deal with income losses caused by the sharp increase in energy import costs". He added: "I still wouldn't call it a price-wage spiral." Not really, as even Germany's best-organized workers will have to accept reductions in their purchasing power over the next two years.

The IMF analysis only confirms many other empirical works done previously. Indeed, wages as a share of GDP in all major economies have been falling since the 1980s. Instead, profit sharing has been rising. And in the period up to 2019, inflation rates did not exceed 2-3% per annum.

Furthermore, there appears to be no inverse correlation between changes in wages, prices and unemployment – ​​the classic Keynesian Phillips curve that asserted this relationship has turned out to be false. In fact, this was observed in the 1970s, when unemployment and prices rose together. And the latest empirical estimates show that the Phillips curve is nearly flat – in other words, there is no correlation between wages, prices and unemployment. There is no spiral of prices and wages.

Despite this evidence refuting the wage-price spiral theory, economics mainstream and official authorities continue to claim that this is the main risk to sustained inflation. The reason for making these kinds of claims is not really because economists, fighters who portray themselves as unrepentant defenders of capitalism, believe that wage increases cause inflation. It's because they want to put a “wage restraint” in the face of spiraling inflation in order to protect and sustain profits. To that end, they support central bank interest rate hikes that will push economies into a recession – which is expected to occur next year.

As Jay Powell, head of the US Federal Reserve, surreptitiously put it: “in principle… by moderating demand, we could… reduce wages and then reduce inflation; thus, there would not be a slowdown of the economy, a recession, a rise in unemployment. So there is a way…”. More bluntly, the Keynesian guru and columnist Financial Times, Martin, demanded: “What [central bankers] need to do is prevent a spiral in prices and wages, which would destabilize inflation expectations. Monetary policy must be tight enough to achieve this. That is, it should create/preserve some slack in the labor market.

Therefore, the real purpose of interest rate increases is not to stop any price and wage spiral, but to increase unemployment and thus weaken workers' bargaining power.

I am reminded of the comment of Alan Budd, then chief economic adviser to British Prime Minister Margaret Thatcher, back in the 1980s: “There were people who made the political decisions [of this kind] (...) and who never believed for a moment that this was the right way to bring down inflation. They saw, however, that [monetarism] would be a very, very good way to increase unemployment; for increasing unemployment was an extremely desirable way of reducing the strength of the working classes”.

*michael roberts is an economist. Author, among other books, of The Great Recession: A Marxist View.

Translation: Eleutério FS Prado.

Originally posted on the blog The next recession blog .

 

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