December 17, 2000

Raise your glasses to more inflation and higher wages

Posted in Celtic Tiger ·

This year’s Christmas message is that most of you are being ripped off. Difficult to accept but there you go. Despite the wage increases announced to keep the PPF together, Irish workers are selling themselves far too cheaply when compared to their continental neighbours. In doing so, workers are subsidising owners of capital, particularly foreign owners of capital employed in Ireland.

Despite all the self-congratulatory talk about being the “best this or the fastest that”, Ireland Inc has lost the plot. A lack of direction might explain some of the angst in the country — even among those in decent jobs.

In terms of assessing overall economic policies, it is reasonable to assume that the aim of increased competitiveness is to allow the Irish standard of living to rise to our neighbours’ level. But this has not really started and until it does, industrial relations will remain problematic.

Next year, the fundamental issue of divvying up the economy’s spoils will become more acute and no amount of back slapping can obscure the fact that the social partnership model is very fragile and is likely to become increasingly so.

Let’s get back to basics. If people’s wages do not rise, how are we supposed to get rich? If Irish wages do not rise, and rise substantially, how are we supposed to catch up with the Germans?

It is ludicrous that Ireland’s measured income per head has now surpassed Germany’s (according to the OECD), yet our wages are only half that of the average German worker and still only 70 per cent of the European average.

The anomaly can be explained by profits being too high and wages too low for present levels of productivity (output per head).

Employers are getting a free lunch. And this is not some Marxist treatise, in fact, quite the contrary.

That said, the great Marxists’ logic is as accurate today as it ever has been. Lenin, Mao, Castro, Christ and Engels all supported the idea of rewarding the workers with the fruits of their own labour. This is precisely the same thinking behind stock option schemes operated by the most forward-looking companies these days.

Fusing Marxist views with free-market rhetoric suggests that when labour is scarce and capital is plentiful, labour should be rewarded handsomely. But in Ireland the opposite prevails. Labour is indeed scarce, yet wages remain way below those of our continental neighbours.

In contrast, even though capital is plentiful (measured either by very low rates of interest or burgeoning levels of credit), capital is still rewarded exorbitantly (measured by the fact that Ireland is still one of the most profitable places in the world to do business).

We have got it wrong and, in the absence of an economy-wide stock option plan, free-market economics demands that wages should rise and profits fall. The Japanese economic miracle of the 1950s and 1960s was accompanied by significant wage increases and a long period of 10 per cent plus inflation, ensuring workers got paid for their productivity.

Why has this not happened in Ireland? The main reason is that we have all been conned into the inflation mantra that goes something like this: if wages rise we’ll become uncompetitive which is very bad. So what if we become less competitive? We are too competitive as things are. Within the inflation mantra lies a particularly glaring contradiction.

It appears to be all fine and dandy to have house price inflation of 20 per cent, but wage inflation of 8 per cent is a disaster. A disaster for whom? I would have thought that if free market demand is allowed to drive up the price of houses, then the demand for labour should be allowed to drive up the price of labour?

There is no logical answer for this other than the rather meaningless shibboleth about competitiveness.

Unfortunately, the inflation mantra also leads us into debt. For example, if wages are rising by 5-8 per cent, the only way you’re going to buy a house — with house prices rising by 20 per cent — is to borrow the difference. As a consequence, indebtedness is exploding.

Therefore, the present mantra and policy suits those whose income derives from land, property and capital and penalises those whose only income is wages. In addition, it ensures that a credit bubble builds. Snipping bits from income tax and Vat to keep measured monthly consumer price indexes down is only fiddling around at the margin and actually misses the point.

Ireland’s inflation is not too high; it is too low. Furthermore, the only way to inject fairness into our system is to allow wages to rise steadily over the coming years.

This point was made by the Financial Times this week, which argues that wage increases should rise as unemployment falls and productivity (output per worker) remains high relative to our neighbours.

Basic economics also tells us that over time, as inflation grinds higher, the return on investment (profits) will gradually fall, in turn precipitating a fall in capital investment, leading to a reduction in productivity, resulting in gradually higher rates of unemployment at a higher generalised level of prosperity. This sequence of events is precisely what we all want — a slightly cooler economy, at a higher level of wealth for all.

The irony is that EMU guarantees that such increases in Irish wages will lead to a permanent — not temporary — increase in workers’ wealth because our exchange rate is determined somewhere else. In the past, if inflation rose, the exchange rate would fall and all the gains would be wiped out almost overnight. In EMU this will not be the case and people will be permanently better off.

Instead of proper wage hikes today, Irish workers are being cajoled into borrowing in the anticipation of steady wages tomorrow. This is precisely what happened in the US in the 1920s before the crash. Wages lagged profits and workers satisfied their urge to consume through easy access to credit by “instalment purchases”.

This, as history evidences, is a dangerous route to take. We are taking this road. With such excessive borrowing and buying on tick, Irish workers are simply devouring their own future. At least if you blow wages you have already earned, you’re not up to your eyes in debt come leaner times.

This Christmas we should raise our glasses to inflation and be prepared to think the unthinkable. Higher inflation will not bring us back to the 1970s as many allege. Nothing could be further from the truth. The world has changed and our views should change with it.

Inflation is a healthy sign of economic vibrancy and possibly the one avenue open to us which doesn’t lead up a debtor’s cul-de-sac.