Wages and Employment

The idea that wage cuts would be deflationary and employment-reducing is being used in some quarters to argue against public sector wage reductions.  Herbert Grubel has a relevant short paper on the use of the Marxist “under consumptionist” argument to obtain wage increases in the US during the Great Depression.



5 replies on “Wages and Employment”

Supposing there were evidence that public sector workers, either presciently factoring in future wage cuts or else just sharing in the gloomy hangover feeling (while still in secure jobs with wages unchanged), have already cut their expenditure, how does this affect the unions’ argument?

Does it make further cuts in consumption likely? Or would public sector workers already have made their (say) 10% cut in day-to-day consumption, meaning savings – which presumably have gone up in recent months – instead would take the hit?

You also have to take into account the open economy nature of our problems, and the fact that we need but can’t have a nominal devaluation.

I think an even bigger question is whether the Irish economy is going to produce those wage cuts in the private sector in the first place. Yes, there are anecdotes, but that is all, and we don’t know how representative they are. We would be quite unique I think if nominal wages declined sufficiently on their own: see http://papers.ssrn.com/sol3/papers.cfm?abstract_id=225496 for example.

So, I think there is a potentially useful coordinating role for social partnership. I thought that the pretty good-tempered and reasonable exchange between Danny McCoy and David Begg last night was a hopeful sign, in a landscape where we badly need some hope.

The classic Keynesian argument against again wage cuts in a recession is that they lead to transfers from employees to employers. Aggregate demand then falls if the former has a higher marginal propensity to consume than the former.

I have never found this argument particularly compelling. But circumstances surronding current calls for public sector wage cuts are different: these cuts will lead to reduced borrowing and not an immediate transfer of spending power. In normal circumstances one would expect that to be contractionary (unless the cuts have already been discounted as Richard suggests).

The argument that public sector wage cuts will be stimulatory then hinges on factors such as increased confidence (stemming from the perception of less out-of-control public finances) or competitiveness effects (on which Kevin has raised some important questions).

To make the mix even more complicated, there is the negative multiplier on government wage consumption reported in Philip Lane’s conference paper. Although Philip is careful to note that this is an aveage effect over a long time period, and thus not necessarily applicable to the current circumstances, his finding it is enough to make me think that wage cuts are a sensible component of the policy package in the current uncertain environment.

The next question is whether the savings should go to support other spending or be used to reduce the deficit. From the reporting on the conference I have seen, I gather there is a strong consensus that stabilizing the public finances should take priority, with adverse effects on confidence and the dangers of an even more severe forced adjustment down the road weighing heavy on people’s minds.

These are important concerns. But the scenario of collapsing demand interacting with deteriorating balances sheets of both potential borrowers and the banks still makes be balk at the wisdom of contractionary fiscal policy. The relatively large multipliers Philip estimates for government investment and non-wage government consumption suggest the marginal value of certain forms of stimulus could be large. Rather than spending all political capital on cutting spending, an alternative would be to fast-forward the development of a medium-term fiscal framework that, among other things, would make a credible commitment to raise (and stabilize) the tax share of GDP. The hope is that this would support confidence sufficiently to minimize the tragic choice of discretionary fiscal contraction in a recession.

Another valid reason for having some cut in public sector pay and signalling that we are serious about sorting out the public finances concerns the cost of international borrowing. Already Irish debt has a risk premium of approaching 1.5% compared to German debt and the longer we are seen to be doing nothing, the worse this spread is likely to get. Given the projected increase in the National Debt the figures involved could be non-trivial.

Does anyone imagine that leaders of the INTO, ASTI, CPSU, INO or SIPTU can sell pay cuts to their members? Between them they represent around 65% of Public Sector workers.

Practically, a pay freeze is the maximum available.

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