Slovenia's labor market is known for an extensive regulation and barriers that hinder productivity growth. According to the latest Index of Economic Freedom, Slovenia's labor market is known as the most regulated and inflexible in the European region. High labor cost, regulated working schedule, and extensive taxation are hampering the capacity of productivity performance.
Recently, trade unions in numerous fields demanded a collective wage increase that would, in their opinion, boost the growth of welfare. If those demands are not fulfilled by the government in the process of collective bargaining, trade unions promised to launch demonstrations on the streets of Ljubljana. Not surprisingly, the majority of demands come from the public sector.
Inflation is currently above the EU average and is also the No.1 political issue in the public debate.
The question is whether suggested wage increases would really boost the growth of purchasing power or broader negative consequences are inevitable, following wage increases.
Collective bargaining is a zero-sum game
In the long run, wage rate is moving together with the productivity growth. Wage increases are justified only if the value of marginal product of labor is above the actual wage rate. The value of marginal product of labor is, of course, determined by the market value of labor unit. A sudden shock such as an inconsistent wage-increasing claim would leave disastrous consequence to the output activity. If wage claims are above the productivity growth rate, then a private sector would face a significant loss and cost pressures that would be further transformed in higher prices and a decreasing probability of creating jobs in the future. In the absence of perfect competition, price increases would go above the marginal cost. Such a complex situation, does not yield an optimal outcome as firms in imperfect competition create a deadweight loss. Given the conditions of global economy such as an increasing demand for commodities in China and India, the pressure on prices would inevitably be intensified. Consequently, mark-ups on current prices would eliminate the positive effect of wage increases on the purchasing power considerably.
Sudden wage increases tend to make the price elasticity of demand more inelastic. Usually, the elasticity coefficient is between 0 and 1. For example, if price elasticity coefficient is 0,31, it means that given a 1 percent increase in the price of product A, the demand for product A decreases by 0,31 percent. In this, the company has an incentive to raise the price of A, given the gain of price increase. If wage increases and productivity evidence are mismatched, the effect of wage growth on purchasing power is a zero outcome, whereas higher price level reduces (!) the overall capacity of purchasing power and therefore consumer choice and welfare.
Game theory and collective asymmetry
Distinguished economists such as John Nash successfully attempted to derive an equilibrium in non-cooperative games. In the so-called Nash Equilibrium, changing strategy is the best response in non-cooperative games with n-players. Nash equilibrium also became universally applied in national labor relations. The question is what are likely to be the preferences and strategic behavior of trade unions in the collective game. Trade unions can choose the negotiating strategy that aims to stimulate job growth. In this case, wage rate temporarily falls below the equilibrium floor, but only in the short run. Also, union's prime joker can be the maximization of wage fund for all employees. In this case, wage increase is much more sensitive to the level of productivity than in the previous case. The third option is the worst one. Under its circumstances, trade unions can move up the curve of marginal revenue, reducing labor supply and increasing labor demand. This step is called rent-seeking as union's negotiating strategy attempts to bargain the maximization of an economic rent for union members. Aftermath, the analysis of labor market shows that the overall level of welfare has not been increased after union's claims were realized. The wage rate of labor supply in non-unionized sector, is below the equilibrium line while unionized sector's claims reduce the level of employment and the pace of job creation.
How wages affect output and inflation?
In Slovenia, a sizeable proportion of the labor force is employed in the public sector. If trade unions in the public sector claim unjustified and illogical wage increases, the latter could seriously boost inflation pressures. In the negotiating circle, trade unions obviously neglect the principle of budget constraint. In Slovenia, robust economic growth originially based on diseconomies of scale, produced a positive output gap where aggregate demand raised the level of prices. By the fundamental laws of macroeconomics, the difference between potential and real GDP converged into an additional source of inflation. Employment in the public administration is funded through annual budget. Additional wage increases, of course, would have to be conducted by an increasing public spending or by an undisciplined fiscal stimulus that would infuse wage fund. In turn, an increase in aggregate demand would further raise the price level and, again, the effect of wage increases on purchasing power would disappear as the inflation rate would rise.
Proposed wage increases as a threat to macroeconomic stability
The empirial investigation has shown that an additional collective wage increase by 1 percent, would accelerate the inflation rate by 0,6-0,7 percent. Inevitably, higher inflation rate would cause an immense damage to long-term sustainable growth performance and overall macroeconomic stability.
Wednesday, January 16, 2008
Slovenia: Trade Unions, Wages and Inflation
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5 comments:
Dear Rok,
Inflation is always a monetary phenomenon, which means insofar monetary categories remain unaltered, we have no inflation, for whatsoever. Inflation namely means a general level of price increase in a certain period of our interest; usually measured on y-t-y basis. What happens if prizes of certain goods or services go up for whatsoever reasons, ceteris paribus? The general structure of demand would change, leaving general level of prizes unaltered. And wage is another word for prize for offering service called labor, which makes it no different from other goods and services: higher prizes lead to lower demand and vice versa. Economists like to speak of short run schocks as regards inflation, but this is a tautology, adding nothing to explain the inflation; only measures prize changes and telling nothing about causes. Econometrics, on which the analyses you quote rely, has certain serious drawbacks; its inability to capture structural effects; its strong dependence on data (lack of sufficient time series). As a such it is thus extremely biased and unreliable.
Best regards and thumbs up for your enthusiasm!
Mitja Steinbacher
In the process of an empirical and analytical investigation of inflation in the long run, there is only one factor indeed: the growth of money supply determined by the central bank's monetary policy, giving a clear evidence that inflation is a monetary phenomena but the features of inflation in the short run should not be neglected. Two distinguised Norwegian economists (Bjornstad and Kalstad) analyzed the effects of the correlation of union coordination and price mark-ups. They examined the panel data of OECD countries and showed that wage-setting has a significant effect on price mark-ups. In that case, union coordination is an explanatory variable of mark-ups. When unions bargain collective wage increases, they set implicit barriers to new entrants, raising the relative price of the existing labor supply by seeking an anticipated anchor of wage rate increases, thus raising the level of unemployment probability of new entrants in the labor market. Equally important issue is the wage ratio in public and private sector. Again, this is a matter of relative prices and it wouldn't be correct and empirically coherent to define wage growth as a feature of an accelerating inflation in the long run. The question of the relative prices is significantly important in the design of the allocation mechanism. Surely, a sudden wage increase moves up the curve of aggregate demand and consequently the price level as well, but in reality the equilibrium outcome depends on the shift of both curves. Wage increases in the public sector that disregard the market value of the unit of labor lead to a significant disallocation of resources considering the addition of job insurance of public employment as well. On the positive level, it is a correct step to consider the market wage rate in the public sector and the productivity as a key indicator of wage setting but of course, it is a mistake to deny the impact of money supply on inflation in the long run and spill it over to wage-setting since this is the issue of relative prices. Inflation also causes distortions levied on relative prices reducing the scope of optimal allocation of scarce resources. In the long run, inflation rate is determined by the growth of money supply but it has never been empirically evident that the analysis and consideration of short-run effects of inflation is a tautology. It does not change the fact that inflation is a monetary phenomena. It does not deny the impact of money supply on the general level of prices. The essence of short-run explanation is to show that, ceteris paribus, collective commitment to wage increases, impairs the ability of competitive allocation, hampering economic growth and pressing up relative prices. What matters in the short run are policy responses to macroeconomic shocks. In case of an increase in aggregate demand, the shock has to be neutralized by an increase in the rate of interest while productivity shocks ought to be absorbed by accomodative monetary policy as output gap is closing while cost-push shocks deserve exchange rate appreciation and, in that case, non-gradual disinflation inputs are essential to the minimization of output loss in the short run, but in the long run a stable and non-accelerating inflation rate is a key to sustainable economic performance. In conclusion: decentralized wage bargaining increases the elasticity of labor and thus isolates price mark-ups from an anticipated anchor of an increase in the relative level of prices as an insurance against sudden bustles, thus raising entry costs and barriers and leading to rigid decision-making hampered by the weight of relative price changes.
Short run analysis brings nothing new to the fact that only monetary categories push up general level of prices. Moreover, no panel data regression neither any other kind of econometric time series analysis will help in anticipating future effects of wage increases for general levels of prices. Those buffers of historical data only explain past developments of structural relations between categories that are under consideration. Speaking about CAUSES of general levels of price increases - not relative shuffles of certain prices - will always bring you back to the roots: monetary categories relative to real categories; supply relative to demand. The latter means considerably different approach to studying economics from the one your views rely on.
Mitja
The recent study by G. Mankiw and R. Reis has shown how central bank's policy target can affect the real meaning of the phenomena of inflation. Again, it all depends on how you measure the inflation. In a classical textbook, David Romer has shown that in the long run, the only determinant of the change in the general level of prices is the supply of money. In that respect, short run variables of change in the level of prices cannot dampen this particular fact. Even the experience suggests that methodological examination of inflation indeed includes the explanation of short-run and long-run determinants of inflation. Nonetheless, it is essential by the very means of analysis, to distinguish what moves the general level of prices in either direction. A paper published in the Journal of Economic Literature by Gali, Clarida and Gertler (1999) has shown that the real contrast of how monetary policy perceives the inflation is grounded in the reaction to shocks and particular economic fluctuations. If the sudden demand-induced shock is not offset by a neutralization of this shock whether by an increase in the interest rate or by a reduction of government spending, the level of prices may certainly be pushed up, ceteris paribus. If short run effect brought nothing to the explanation of an increase in the level of prices, than it would be absurd to claim that particular shocks affect economic fluctuations. Then, it would be impossible to test whether productivity shocks close the output gap while the empirical analysis has shown that productivity shocks stimulate the growth of potential output. Historical data matter indeed. If these data would not matter at all, then (for instance), it would still be assumed that there is a permanent negatively sloping Phillips curve. While today, it would be hard to find an economist that would claim the old postulate of the Phillips curve to be permanent. Also, inflation is the first-order derivation of the level of prices in time which means that relative changes are what explains the inflation either by (1) an increase in marginal cost or (2) by an increase in mark-up. At the same time, it is empirically inconsistent to put the level of prices as an explanation of inflation which is, in the short run, caused by a change in prices which is a dynamic effect contrary to general level of prices which is a static effect. Shocks explain price changes and don't change the fact about inflation as a monetary phenomena. For example, a sudden shock on demand side, say a fiscal expansion, will induce household demand which will affect the supplier's pricing decision and the more inelastic demand will add a motive to push product prices upwards. Hence, current developments in the world market are showing that higher inflation is certainly not a result of irresponsible monetary policy of central banks in the Western world. True, central banks in emerging markets have set the policy mix of monetary and fiscal expansion which brought the interest rate down and boosted investment demand which, in turn, heated the level of prices. The lesson is simple: if shocks are not neutralized, the level of prices will increase. I would disagree with the statement that shocks are a tautology. For example, even monetary expansion is a shock and if shocks were truly a tautology, than "inflation as a monetary phenomena" would be an illusion.
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