This article is from the source 'guardian' and was first published or seen on . It last changed over 40 days ago and won't be checked again for changes.
You can find the current article at its original source at http://www.theguardian.com/business/economics-blog/2015/mar/29/why-falling-inflation-is-a-false-pretext-for-keeping-wages-low
The article has changed 3 times. There is an RSS feed of changes available.
| Version 0 | Version 1 |
|---|---|
| Why falling inflation is a false pretext for keeping wages low | Why falling inflation is a false pretext for keeping wages low |
| (about 2 hours later) | |
| Earlier this year Shinzo Abe, Japan’s prime minister, told his country’s business elite that he wanted them to take a brave decision. He wanted them to raise wages. | |
| A month or so later David Cameron followed suit. Addressing the chambers of commerce, the prime minister said it was time for Britain to have a pay rise. Two prime ministers, same message, one subtle difference: in Japan there is evidence that executives took notice of what Abe said, while in the UK we are still waiting for the long-anticipated pick up in pay. | |
| There are virtues to Japan’s corporatist model. When Abe spoke, it mattered. When Cameron spoke, it didn’t. | |
| Let’s be clear. We are talking about different countries here. Britain ditched its corporatist model long ago and replaced it with a flexible labour market. What’s more, deflation has been a feature of the Japanese economy for the past quarter of a century; Britain has yet to experience a single month when annual inflation as measured by the consumer prices index has been falling. | |
| Even so, Japan’s recent experience is relevant. It shows the dangers of allowing deflation to become embedded and that radical measures are eventually required to cure the problem. In the UK, it is assumed that the fall in inflation to zero is a temporary phenomenon. Almost all of the nine members of the Bank of England’s monetary policy committee think that the next move in interest rates will be up. | Even so, Japan’s recent experience is relevant. It shows the dangers of allowing deflation to become embedded and that radical measures are eventually required to cure the problem. In the UK, it is assumed that the fall in inflation to zero is a temporary phenomenon. Almost all of the nine members of the Bank of England’s monetary policy committee think that the next move in interest rates will be up. |
| But the warning signs are there. One straw in the wind is what is happening to prices in the shops. Retail sales were strong in February, up 5.7% on the same month in 2013. But shops and stores had to slash prices in order to persuade consumers to part with their money. Prices were 3.6% lower than a year earlier, the biggest year on year decline since modern records began in 1997. | But the warning signs are there. One straw in the wind is what is happening to prices in the shops. Retail sales were strong in February, up 5.7% on the same month in 2013. But shops and stores had to slash prices in order to persuade consumers to part with their money. Prices were 3.6% lower than a year earlier, the biggest year on year decline since modern records began in 1997. |
| Of even more significance is what has been happening to wages. Here, the “deflation-is-not-a-threat” school argue that falling unemployment will translate into higher pay settlements. Confronted with official data that shows this is simply not happening, the response (as it has been for the past two years) is: give it time. | Of even more significance is what has been happening to wages. Here, the “deflation-is-not-a-threat” school argue that falling unemployment will translate into higher pay settlements. Confronted with official data that shows this is simply not happening, the response (as it has been for the past two years) is: give it time. |
| Andy Haldane, the Bank of England’s chief economist, noted in a recent speech that since 2011, unemployment had consistently undershot the Bank’s forecasts. Threadneedle Street has also got it spectacularly wrong with regard to wages. Given the shorter dole queues, the Bank expected wage settlements to become more generous. According to the Bank’s models, earnings should be rising by more than 4% a year by now. In reality, they are struggling to get above 2%. That is not simply because productivity is weak, although that is part of the story. | Andy Haldane, the Bank of England’s chief economist, noted in a recent speech that since 2011, unemployment had consistently undershot the Bank’s forecasts. Threadneedle Street has also got it spectacularly wrong with regard to wages. Given the shorter dole queues, the Bank expected wage settlements to become more generous. According to the Bank’s models, earnings should be rising by more than 4% a year by now. In reality, they are struggling to get above 2%. That is not simply because productivity is weak, although that is part of the story. |
| So what’s the explanation? It could be that the lags between falling unemployment and rising wages are longer than they were in the past. But there might be more to it than that. The relationship between unemployment and wage pressures appears to have changed, so that a much bigger drop in joblessness is needed to provide upward pressure on earnings. Haldane says this might arise because the pool of workers willing to work at existing wage rates has increased, for example because of older workers taking up jobs or workers moving to the UK from overseas. | So what’s the explanation? It could be that the lags between falling unemployment and rising wages are longer than they were in the past. But there might be more to it than that. The relationship between unemployment and wage pressures appears to have changed, so that a much bigger drop in joblessness is needed to provide upward pressure on earnings. Haldane says this might arise because the pool of workers willing to work at existing wage rates has increased, for example because of older workers taking up jobs or workers moving to the UK from overseas. |
| “There is evidence of many of these trends intensifying over the past few years”, he said in his speech. “For example, the unemployment rate among 18 to 24-year-olds has fallen by almost 4 percentage points over the past year. The trend in labour force participation has picked up significantly among women and older cohorts over the same period. And net migration to the UK was estimated to be almost 300,000 in the year to September, almost double the level two years earlier.” | “There is evidence of many of these trends intensifying over the past few years”, he said in his speech. “For example, the unemployment rate among 18 to 24-year-olds has fallen by almost 4 percentage points over the past year. The trend in labour force participation has picked up significantly among women and older cohorts over the same period. And net migration to the UK was estimated to be almost 300,000 in the year to September, almost double the level two years earlier.” |
| There was a time, as the LSE economist Alan Manning notes in his contribution to a collection of essays published by the Resolution Foundation when year after year of falling real wages would not have been tolerated. “Forty years ago an improving labour market and prices rising faster than wages would have led trade unions to march into the boardroom demanding higher wages and threatening strike action if those demands were not met. Pretty soon, union leaders would have been invited round to No 10 for beer and sandwiches to be cajoled into wage moderation to prevent and inflationary spiral taking hold. A lot has changed in the past 40 years.” | There was a time, as the LSE economist Alan Manning notes in his contribution to a collection of essays published by the Resolution Foundation when year after year of falling real wages would not have been tolerated. “Forty years ago an improving labour market and prices rising faster than wages would have led trade unions to march into the boardroom demanding higher wages and threatening strike action if those demands were not met. Pretty soon, union leaders would have been invited round to No 10 for beer and sandwiches to be cajoled into wage moderation to prevent and inflationary spiral taking hold. A lot has changed in the past 40 years.” |
| Too right it has. Employers now call the shots not unions. “Once workers would have been looking for the first opportunity to press for higher wages; now employers are looking at pay rises as a last resort,” Manning says. | Too right it has. Employers now call the shots not unions. “Once workers would have been looking for the first opportunity to press for higher wages; now employers are looking at pay rises as a last resort,” Manning says. |
| Falling inflation now provides employers with a pretext for keeping wage settlements low. And if lower wage settlements start to embed the idea that disinflationary pressures are stronger or longer lasting than previously imagined, that’s the start of a deflationary spiral right there. Haldane notes that the evidence from the Bank of England’s agents, who pick up information from businesses across the UK, is that “contacts cite falling inflation expectations as the most important factor currently holding back wage settlements.” | Falling inflation now provides employers with a pretext for keeping wage settlements low. And if lower wage settlements start to embed the idea that disinflationary pressures are stronger or longer lasting than previously imagined, that’s the start of a deflationary spiral right there. Haldane notes that the evidence from the Bank of England’s agents, who pick up information from businesses across the UK, is that “contacts cite falling inflation expectations as the most important factor currently holding back wage settlements.” |
| The weakness of earnings growth is not new. As Manning notes, there has been a ratcheting down of wage growth since the 1980s. The ecology of the labour market has changed; the balance of power between workers and employers has shifted decisively in favour of the latter, and this is reflected in strong profits and weak wage growth. | The weakness of earnings growth is not new. As Manning notes, there has been a ratcheting down of wage growth since the 1980s. The ecology of the labour market has changed; the balance of power between workers and employers has shifted decisively in favour of the latter, and this is reflected in strong profits and weak wage growth. |
| This creates its own problems, because workers struggle to buy the goods and services they are producing. It is for this reason that central banks have run highly stimulative policies for the past six years. If they want to get wages up they may need to continue doing so. | This creates its own problems, because workers struggle to buy the goods and services they are producing. It is for this reason that central banks have run highly stimulative policies for the past six years. If they want to get wages up they may need to continue doing so. |
| Why? Because those who argue that wages will eventually rise if unemployment falls far enough are right. They will, but only if competition for labour among employers is so strong that they have no alternative but to offer more money. That is what happened in the US during the late 1990s, the one period recently when the demand for labour more than compensated for the almost complete absence of collective bargaining. | Why? Because those who argue that wages will eventually rise if unemployment falls far enough are right. They will, but only if competition for labour among employers is so strong that they have no alternative but to offer more money. That is what happened in the US during the late 1990s, the one period recently when the demand for labour more than compensated for the almost complete absence of collective bargaining. |
| But be clear. The amount of stimulus required has increased over time. And there are side-effects of the ultra-low interest rates necessary to boost labour demand: asset-price bubbles and excessive personal debt to name but two. | But be clear. The amount of stimulus required has increased over time. And there are side-effects of the ultra-low interest rates necessary to boost labour demand: asset-price bubbles and excessive personal debt to name but two. |
| There is an alternative. Governments could order bigger increases in minimum wages; they could insist that those companies bidding for state contracts pay a living wage; they could make it easier for trade unions to organise and bargain collectively. Like Abe in Japan, they could tilt the playing field back in favour of labour. |