Chapter 10: The means of income policy

(continuation)

Outline:

01st About the concept of income policy

02nd Wage reduction as a means of employment

03rd Wage expansion as a means of employment

04th The productivity-oriented wage policy

05th Overall economic orientation versus sectoral economic orientation

06th The effects of labour time reductions

07th About the problem of the constancy of the consumption rate

08th Consequences of the cost-theoretical approach

09th Consequences of the quantity-theoretical approach

10th The alliance of the labour

07th About the problem of the constancy of the consumption rate

The assumption of a remaining constant consumption rate must be corrected in connection with investment wage contracts, since these provide that part of the wage increase is mandatorily saved (temporarily).

The starting point is again the demand that the wage increase shall not cause an increase in the price level. According to Keynesian ideas, this is achieved - as shown - precisely when the increase in demand corresponds to the increase in supply. The consumer demand of the employees is defined here as the product of wage rate (l), number of labour hours (A) and consumption rate (c).

The change in demand resulting from changes in both the wage rate and the consumption rate corresponds finally to the sum of wage rate increases and the change in the consumption rate calculated in absolute amounts. Since the consumption rate is decreasing at investment wages (more savings are made), a wage rate increase neutral in monetary value may in this case be higher than the productivity increase rate, without any reason to fear price increases due to wage growth.

This consideration became politically relevant due to investment wage contracts (a part of the wage is mandatorily saved temporarily). The demand equation is valid:

N = l * c * A

Now, demand growth depends on both wage rate changes as well as changes in consumption rates. Here, too, we finally conclude by cancelations that the increase in demand consists of two terms, it corresponds now to the sum of wage rate increase (dl/l) and change of the consumption rate (dc/c).

Furthermore, the supply of goods is determined by the product of labour productivity (X/A) and the number of labour hours (A). Differentiated with respect to labour productivity (X/A), the rate of increase of the supply of goods corresponds just to the rate of increase of the productivity labour. Increases in demand and supply thus correspond precisely when the sum of wage rate increase and savings rate increase equals the increase in productivity.

By adjusting the equation, we finally obtain the assertion that, if monetary stability shall be achieved, the wage rate increase must correspond to the sum of productivity growth plus change in consumption rate. Since the consumption rate is reduced at investment wages, the wage increase in this case may exceed productivity growth:

· X: product quantity

· A: amount of labour in labour hours

· pi: labour productivity

· l: wage rate

· c: consumption rate

08th Consequences of the cost-theoretical approach

Now which consequences apply to the question under which conditions a wage policy is monetary neutral if we assume a cost-theoretical approach along with the neoclassics? The starting point is a microeconomic consideration. The entrepreneurs add a costumary profit markup (g) to unit labour costs (k). Therefore, the formula is valid:

p = k + g * k = k ( 1 + g )

g: costumary profit markup

Here, unit labour costs are calculated as the product of wage rate (l) and labour productivity (A/X):

On a macroeconomic consideration, we replace the unit price (p) by the price level (P), as well as the unit costs of an individual product (k) by the average costs of the domestic product (kges). In this way we obtain the following formula for the entire national economy:

P = k _ges * (1 + g)

Again, we can assume that macroeconomic unit labour costs will remain constant if wage rate increases in all industrial sectors are limited to labour productivity increases. However, macroeconomic unit costs will rise even if the shares of the individual sectors in total production change to such an extent that the sectors with above-average unit costs account for a larger share.

This means that in principle also the neoclassical theory, like the Keynesian theory, concludes that wage increases are monetary neutral as long as they are limited to increases of labour productivity.

Nevertheless, the two theories come to different conclusions as to how investment wages affect the price level of goods. We had seen that, in a Keynesian approach, a reduction of the consumption rate allows wage rate increases to exceed productivity increases by the percentage change in the consumption rate without the consequence of price increases.

In supply orientation, by contrast, unit costs rise when wages rise faster than labour productivity and with them the price level of goods:

09th Consequences of the quantity-theoretical approach

Let us briefly ask what results we achieve if we base our considerations on a quantum theoretical approach. Under these assumptions, we conclude that money alone determines the price level of goods. The equation of exchange applies:

· G: money supply

· U: velocity of circulation

· P: price level of goods

· X: trading volume

In the more recent form, developed primarily by Milton Friedman, the quantity theory considers, however, that with an increase in economic growth an ever larger part of the money supply is kept in cash (luxury money hypothesis) and that therefore a long-term decline in the velocity of circulation must be expected.

If this quantity theory is taken as the basis for our analysis, we must conclude that wage increases alone cannot lead to any immediate inflationary tendencies, and that only an expansionary monetary policy which causes the amount of money in circulation to increase more strongly than the real domestic product - perhaps corrected by the increased need for cash - is responsible for price level increases.

Now we were discussing the immediate influence of an expansive wage policy. Indirectly, of course, we must reckon with the possibility that the central bank will feel obliged to respond to an expansive wage policy, in which wage rate increases exceed the increase in labour productivity, by expanding the money supply in order to prevent a reduction in employment as a result of an expansive wage policy.

From this possibility, however, the quantity theorists do not draw the conclusion that therefore the wage policy of the collective bargaining partners must be influenced, but that it was important to give the central bank the task of ensuring monetary stability and at the same time strengthening the autonomy of the central bank in such a way that the central bank also receives the instruments to achieve this aim.

Now, the failure of the central bank could be explained not only by the fact that the quantity of banknotes issued by the central bank is too high with regard to the aim of monetary stability, but also by the fact that the additional demand for money resulting from an expansive wage policy is satisfied by the creation of bank deposit money. It could also be said that the velocity of money in circulation increases with an expansive wage policy and that in this way the product of money supply plus velocity increases.

Here, too, it is in line with the ideas of quantity theorists that in this case the banking system must be reformed in such a way that the central bank can use its instruments to control the entire money supply (central bank money plus bank deposit money). Again, it would not be up to politicians to prevent inflationary tendencies by intervening in the labour market.

10th The alliance of the labour

The Stabilisation Law passed in 1967 allowed the Federal Minister of Economics to convene a concerted action. Here, the government and the collective bargaining partners should jointly agree on orientation data for the upcoming collective bargaining negotiations. These wage guidelines were not mandatory, though.

Karl Schiller (then Minister of Economics and Finance of the Federal Government) had developed this order concept because he was of the opinion that the aim of monetary stability had the character of a public good and was therefore - according to a theory developed by Mancur Lloyd Olson - demanded insufficiently.

Mancur Lloyd Olson had shown that there was too low a demand for public goods. This was because with public goods, the marginal revenues accruing to the producers from private sector were always lower than the marginal revenues accruing to the economy as a whole, with the consequence that the point of intersection between the demand curve and the supply curve (the private sector equilibrium) was at a lower output quantity than the point of intersection between the macroeconomic marginal revenues and the supply curve (the welfare optimum). The following graphic illustrates these connections:

The red line shows the course of the supply (marginal costs) curve, the light blue curve the macroeconomic curve, and finally the dark blue curve the private sector marginal revenue curve. (xp) marks the private sector equilibrium, (xg) the macroeconomic equilibrium.

Since the point of intersection with the private sector marginal revenue curve is at a lower output than the point of intersection with the macroeconomic curve, it has been proven that demand for public goods is too low. Everyone is interested in the public good 'monetary stability', but nevertheless too little effort is made to preserve it. This conflict is referred to in the literature as the public goods dilemma.

Karl Schiller has now proposed the concerted action to overcome this public goods dilemma. If wage rates are agreed in the individual collective bargaining negotiations, then it must also be feared that wage increases will often be implemented which jeopardise monetary stability.

The individual trade union would be better off if it demanded lower wage increases and monetary stability was maintained at the same time. However, this would require that all trade unions try to enforce wage demands that are neutral in terms of the price level. An individual trade union would therefore only do better with a wage increase that was neutral to the price level if it could firmly expect that the other trade unions would also behave in a manner that is conscious of monetary value.

However, as they cannot expect this to happen, they will implement wage increases that increase the level of prices. If an individual trade union is in conformity with monetary value stability, but the other trade unions do not follow it in this behaviour, then on the one side the realised wage increases in these economic sectors turn out below average, and on the other side the employees in these economic sectors bear the price increases caused by the other trade unions, too. It is therefore not worthwhile for trade unions to conform to monetary value.

This is where the proposal of the concerted action approaches. If all trade unions, together with the government, determine which wage increases are to be classified as monetary value-neutral and can thus be absorbed macroeconomically, then each individual trade union can also expect all other trade unions to comply with the jointly agreed resolutions. But if a union can assume that all other unions will behave in compliance with monetary value, it is also appropriate for them to join this concerted behaviour and behave in compliance with monetary value, too.

In the first years after the introduction of the concerted action on the labour market, certain initial successes were achieved. The wage increases implemented by the trade unions initially remained largely neutral with regard to price levels, i.e. they corresponded to labour productivity growth. This initial success, however, could not be maintained in the longer term.

This historical development (initial successes as well as failures in the long run) can theoretically be explained easily. Interest groups can surely be persuaded for one time to put their individual interests behind the public interest for the sake of the economy as a whole. However, it will not be possible to bring about such responsible behaviour in the long term. The task of interest groups is just to represent their own interests, and no group will be able to be distracted from this aim in the long term.

Actually, the introduction of the concerted action did not resolve the public goods dilemma. In fact, the creation of the concerted action also creates false incentives which reward those who do not adhere to the jointly agreed wage guidelines and materially sanction those who conform to them. This is because if an individual trade union implements wage increases that exceed the guideline, it receives an above-average nominal wage increase on the one hand, but the resulting price increases must be borne by all, so that their real incomes decline.

The following dynamics should now result: Initially, almost all trade unions adhere to the jointly agreed wage guidelines; since everyone adheres to them, their expectations are also confirmed. Sooner or later, however, an individual trade union will break out of this concert and enforce higher wage demands, either because there is a particularly high backlog demand in this collective bargaining area or also because enterprises will give in to these demands due to above-average profits.

The success of this individual trade union will cause further trade unions to follow in this incompatible behaviour in the next collective bargaining rounds. Now that several unions are breaking out of the concert, the hereby caused price increases are getting higher and higher and this means that conforming behaviour will be sanctioned more and more materially and that for this very reason there is a danger that more and more individual unions will break out of the concerted action. One day, therefore, the concerted action will necessarily collapse. This prognosis has indeed come true.

Even the internal logic, according to which collective bargaining takes place, speaks against the long-term success of the concerted action. Collective bargaining will be successful in the long term if both tariff partners are ready to compromise and therefore none of the parties loses face in the long term. But in order to be able to make compromises at all, employers will start collective bargaining with wage concessions that are significantly below the wage level they are ready to grant, while the other way round, trade unions will enter into collective bargaining with wage demands that are significantly above the wage level they consider realistic.

If, within the framework of a concerted action, a certain wage increase is decided as acceptable and desirable, it is hardly possible for employers to start collective bargaining with an offer that is significantly below this wage guideline. After all, a higher wage increase has already been accepted officially as desirable. Employers will therefore have to enter the collective bargaining process, whether they like it or not, with a wage approval which largely corresponds to the wage guideline adopted by the concerted action.

Any other conduct would be contradictory and would also jeopardize the success of further rounds of the concerted action, as the employers cannot agree to the decided wage guidelines in the concerted action on the one hand, but would on the other hand contradict these jointly decided guidelines in the subsequent collective bargaining negotiations.

In this case, however, employers lack the leeway for further concessions in the course of collective bargaining; the climate for negotiations is worsening and it is now more difficult to achieve a result. In any case, collective bargaining will generally end with higher wage increases than described as desirable wage increases in the concerted action.

This objection could now be countered by proposing that the concerted action should consider this connection when determining the wage guideline and that wage increases should be determined slightly lower than they are actually desired. If, for example, the expected increase in labour productivity were 3%, then only a 2% wage increase would have to be issued as a wage guideline, so that the actually desired wage increase of 3% would then be achieved during the course of collective bargaining. But precisely in this case the trade unions would certainly not be ready within the scope of the concerted action and would put forward macroeconomic arguments to the effect that the economically desired wage increase would amount just to 3%.

A further argument is added. We can assume de facto that different wage agreements will be arranged in the negotiations of a collective bargaining round since the individual trade unions have different positions of power and since the individual economic increases in labour productivity will be different in the individual sectors of the economy. Such different agreements may even be desirable to a limited extent from an economic point of view, since the shortage ratios of the individual economic sectors change again and again and therefore changes in the wage structure are also getting necessary.

But if a general wage guideline is now established within the framework of the concerted action, then even those trade unions will attempt to enforce this generally accepted wage increase which otherwise would have been satisfied with somewhat below-average wage increases due to the special features in the individual sectors. The pressure of the members on the trade union negotiators increases when general wage guidelines are adopted, no matter how much the government or the scientists point out that a wage guideline only determines the average of wage increases.

If, on the other hand, the wage guidelines adopted in the concerted action are below the level that the trade unions are striving for in this sector, they will find reasons why the wage level in their collective bargaining area should differ upwards. They may announce a need to catch up, because in the past collective bargaining rounds only a below-average wage increase was enforced, or in their own sector above-average profits are achieved, which make it necessary for distribution policy reasons to have a share in this above-average growth.

It must also be considered that in the concerted action it is never possible for all negotiators to be involved, the number of individual collective bargaining negotiations that take place in Germany is too large because of the decentralised structure, only the representatives of the head associations and individual very large trade unions can participate in the meeting of the concerted action.

In this case, however, it is much easier for a negotiator to distance himself from the decisions of the concerted action; they themselves generally did not take part in these decisions at all. This, however, removes one of the essential preconditions for the success of the concerted action. Karl Schiller wanted to overcome the public goods dilemma of monetary value stability just by the fact that the trade unions accept the wage guidelines as their own resolutions in collective bargaining and therefore also adhere to these resolutions.