IS MAINSTREAM ECONOMICS REDISCOVERING THE ROLE OF WAGES AND COLLECTIVE BARGAINING IN PREVENTING DEFLATION?
Strange things are happening in the world of international economic institutions and central bankers. Whereas over the past decades the continuous focus of these institutions has been on the weakening of bargaining power of trade unions, there appears to be some kind of “change of mind” with one institution after the other as they start pointing to too low wage outcomes.
IMF calling for a ‘fourth arrow’ in Abenomics
The most recent example came from the IMF last week, when commenting on the wage offers employers are making during the annual spring negotiating round in Japan. According to the IMF, these wage offers are weak and far below the level needed to drive inflation to 2%. IMF representatives went as far to say that a ‘fourth arrow’ needs to be loaded to achieve this target. Besides the usual three arrows of Abenomics (expansive monetary policy, flexible fiscal policy and reform policy), wage dynamics need to go up. Or, as the IMF board of directors stated in their latest review of the Japanese economy: “Authorities are encouraged to improve the monetary policy transmission and to strengthen momentum for wage increases in the tripartite dialogue”.
In doing so, the IMF took the cue from Japanese policy makers themselves. Two years ago at the Jackson Hole conference, the governor of the Japanese Central Bank, Haruhiko Kuroda, already testified to the vicious interaction between falling prices and falling wages that had installed itself since the early nineties. Hit by an initial negative demand shock (the bursting of the asset price bubble), business turned to a strategy of squeezing wages by, among other things, refusing to participate any longer in coordinated wage bargaining rounds , instead resorting to company based wage bargaining where employers are able to extract substantially more concessions from workers. Whereas this type of bargaining certainly boosted profit margins (but not business investments!), it also pushed Japan into a situation, where falling wages and falling prices have been chasing each other over the past decade and a half.
In the same speech, Kuroda also made a point that is crucial for the discussion in the Euro Area (see below): Strengthening wage formation institutions are crucial in raising inflation expectations. If economic actors realise that trade unions are able to raise nominal wages by at least 2 or 3% a year, then they will reconsider their expectations about inflation. And, as we know from the monetarist counterrevolution, if inflation expectations change, so will inflation itself as every actor will start basing its pricing decisions on these higher inflation expectations.
This point was further developed in an article, where one of the co-authors is no one less than the IMF’s ex-chief economist Olivier Blanchard. The authors of the article are actually calling upon the government of Japan to, ‘force the issue’ and to ‘jump-start’ a wage-price spiral by requiring an annual wage indexation of at least 3% in a coordinated, tripartite collective bargaining round and to delay the promised cuts in corporate taxes until companies raise wages across Japan.
Unease at the Bank of England
Shifting from Japan to the UK, Andrew Haldane, chief economist of the Bank of England, in a speech given to the TUC in November 2015 observed that the Bank has systematically overestimated the path of wages when deciding on monetary policy over the recent years.
Wages in the UK have lagged behind productivity for several years and the labour share of income has been falling. The problem Haldane alludes to is that the Bank of England is counting on a clear acceleration of wage growth when making its current economic forecasts. The assumption used in the Bank’s forecasts is that wages in coming years would actually grow faster than productivity so as to enable the labour share of income to catch up with the losses it suffered over the recent past. If that were not to happen and income growth did not experience any lift-off, the Bank’s chief economist warns of a substantial undershooting of the price stability target over the next two years.
A novelty: Is the ECB becoming concerned about low wage dynamics?
Even at the ECB, where some of the staunchest opponents of robust collective bargaining institutions can be found, the mind-set seems to be changing somewhat, although this change of mind is only half-hearted. Take the speech Draghi made, which was reported in the Financial Times on 1 February, where he confirms that the danger of ‘second-round’ effects was indeed occurring. We quote:
“While the most recent wave of disinflation is mainly due to the renewed sharp fall in oil prices, weaker than anticipated growth in wages together with declining inflation expectations call for careful analysis of the channels by which surprises to realised inflation may influence future price and wage setting in our economy”.
In other words, Draghi is referring to the same mechanism, we described above, which is that inflation expectations matter quite a lot. If the collapse in oil prices brings headline inflation down to close to zero and if expectations about future inflation follow this downward trend, then low inflation is no longer a temporary but a permanent phenomenon as it becomes entrenched in actual price and wage setting behaviour. This is indeed what is currently happening in the euro area and explains Draghi’s concerns. Longer term euro area inflation expectations (as expressed in 10 year swaps) are, at around 1.2%, way below the ECB’s price stability of ‘below but close to 2%’. At the same time, recent euro area nominal wage growth has declined further and is now limited to just 1%, with nominal unit wage costs even diving below 1%. Everything is of course connected since, on the one hand, such weak wage cost developments feed into corporate decisions not to (or hardly to) increase prices, which then cements extremely low inflation expectations even further.
The ECB clearly has a downwards wage-price spiral on its hands, a spiral which puts at risk the euro area’s price stability target and entrenches the situation of close to zero inflation.
And what about the OECD?
In a recent interview, William White, chair of the OECD’s Economic and Development Review Committee, explicitly called for more attention to wage growth. Even if the chair of the Economic Review Committee was speaking in his personal capacity, such statement is remarkable, especially since one may have the impression that the policy recommendations to individual members coming from this OECD committee are likely to be biased against higher wage growth.
Moreover, the OECD already took a careful step in the right direction in September 2014, when presenting the Employment Outlook by stating that the experiment of internal wage devaluation in the euro area periphery had gone too far and needed to stop, exactly because of the risk of triggering deflationary developments.
Coordinated collective bargaining as a tool to fight price instability
Although policy makers in central banks and international economic institutions seem to be increasingly aware of the problem of weak wage dynamics entrenching very low inflation and inflation expectations, they keep struggling with what to do about it.
Mario Draghi’s strategy, for example, is to try pushing up inflation expectations by printing and injecting even more money than before into the economy. In the textbook of monetary economics, putting the money printing press into higher gear is sufficient. The hope is that economic agents will perceive this as credible and will start incorporating higher inflation expectations in their wage and price setting. Trade unions, expecting a recovery in inflation to, let’s say, 2% would then immediately scale up nominal wage demands. Business management on their end will not fight ‘tooth and nail’ against such demands as they will be expecting all prices, including the prices of products from their competitors, to go up by 2%. In other words, it’s the miracle of self-fulfilling expectations to be triggered by the money printing machine.
However, in today’s economy of high debt, rising inequalities and banking systems plagued by non-performing loans, it is extremely unlikely that just by printing more money, it will be sufficient to get the economy going again and, hence, to raise inflation expectations.
It is for example striking that recently, in November 2015 and January 2016, euro area inflation expectations have actually been falling at the very moment the ECB was announcing its intention for further monetary policy easing (see here).
In other words, to put a halt to the downwards slide into deflation and to get the economy back to price stability, more needs to be done.
To start with, central bankers and economic institutions need to stop their continuing crusade in favour of ultra-flexible wages by decentralising bargaining to a strict company-by-company basis. Such atomised bargaining is very difficult to coordinate. In fact, it is almost impossible to expect company level bargainers (both management as well worker representatives) to depart from the individual company level point of view and to regard low inflation as a serious problem and not as an opportunity for the individual company to become more competitive, while leaving the responsibility for the stabilisation of the wider economy to others. With bargaining restricted to company level agreements, there is a failure of coordination.
More broadly, general and indiscriminate calls to accelerate structural reforms, in particular, when these concern deregulation of collective bargaining institutions, are highly counterproductive.
How to expect robust wage deals if, at the same time, the balance of power continues to be shifted by these reforms from labour to capital?
Hence, policy recommendations arguing in favour of an immediate 5% cut to unit wage costs in Spain and Italy, as this one (https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1512.pdf?aec3d2d92f826381cb0443f53c155b83), are simply perverse. If such advice was to be pursued, it would intensify the process of disinflation and entrench deflation even further.
What needs to be done instead is to mobilise collective bargaining and wage formation institutions as an instrument to keep nominal wage dynamics up, even in the face of low and falling inflation. Coordination of collective bargaining, combined with institutions and measures that support the bargaining power of trade unions (ranging from minimum wages over legal extension of bargaining to promoting trade union density) make it possible to align wage bargaining rounds with the macro needs of the economy, in particular, the need to prevent low inflation or deflation from becoming entrenched.
If this may sound utopic, one should reflect that austerity and internal wage devaluation have brought us to a situation where the action proposed above is probably the only effective way out. Let’s hope policy makers will soon come to realise this.