FT Alphaville has published an enlightening article that helps to explain why wages globally have failed to lift amid tight labour markets and low unemployment.
Author Robert Lucas concludes that capital has already won the class war over labour, which means that inflation will necessarily subside once supply shocks unwind. In turn, the world’s central banks are misguided in aggressively hiking interest rates, given the inflation is not demand-driven:
Paul Volcker became an iconic Federal Reserve chair for his aggressive interest rate increases, which in the classical interpretation tamed inflation and led to the Great Moderation…
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Central to this well-known tale is the idea that monetary authorities have kept inflation at bay through a credible pre-commitment that they will anchor the general price level…
But how powerful an influence do the actions of central banks actually have on inflation? A new paper — straight out of the radical confines of the Fed — suggests that the impact of the “Volcker shock” has been vastly overplayed, and that the inflation of the 1970s was solved through de facto class war and the degradation of the union movement rather than monetary policy…
On their understanding, inflation isn’t due to a lack of credible commitment from central banks to control inflation, but a power struggle between capital and labour. The spark for inflation may be hard to locate between commodity shocks and general economic malaise, but its engine is likely to be a battle between capital — who seeks to maintain its share of national income via mark-ups — and labour, who try and do the same through higher wages…
What does this mean for central banks? If sustained inflation derives from class war, then the chances of the current bout becoming entrenched again are extremely low.
The working class as a cohesive social force no longer exists. Businesses can safely protect their margins and the burden of inflation will fall on labour as real wages fall. Sustained price rises will eventually subside as supply shocks from the pandemic and war fade and real spending power is eroded…
Most [central banks] remain obsessed with wages — the Bank of England’s Andrew Bailey has even called for pay restraint…
It may be that what central banks are counting on the most to guide their actions is a class-based theory of inflation, which tells them that ‘capital won and labour ain’t coming back’.
In other words, inflation will subside, not because it’s necessarily transitory, but because workers don’t have the power to make it stick around.
These factors are certainly in play in Australia.
Australia’s real unit labour cost (ULC), which according to the Australian Bureau of Statistics “are an indicator of the average cost of labour per unit of output produced in the economy” and “are a measure of the costs associated with the employment of labour, adjusted for labour productivity”, have collapsed over the past 35 years:
Accordingly, profit’s share of national income has soared to a record high, while wages’ share is tracking near a record low:
Despite Australia’s underutilisation rate tracking at its lowest level in decades at 10%, wage growth remains soft. Historically, a labour underutilisation rate of 10% would be associated with annual wage growth of around 4%, as illustrated in the next chart (latest observation in red):
Jim Stanford from the Centre for Future Work claims the usual forces of ‘supply and demand’ in wage setting outcomes are broken due to “de-unionisation, insecure work, and deregulation of the wage-setting process [which] have shifted the balance of power away from workers”. In addition, “greenfield enterprise agreements, which lock in predetermined pay rates for years”, have embedded inertia in the wage setting process, since changes in supply and demand take years to be reflected in new agreements.
So while Australian wage growth should rise if the labour market remains tight, it will lag well behind historical experience.
Australia also risks losing wage momentum if mass immigration is rebooted, let alone if the economy is pushed into an unnecessary recession by overly tight monetary policy.
Given most of Australia’s inflationary pressures are either imported or weather related, hiking interest rates will do little to resolve them.
Instead, soaring interest rates will merely engineer the biggest proportional rise in mortgage repayments in the nation’s history, adding to household’s cost of living crisis.
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