Wages & Inflation in Developing Economies

Many will recall the "good ole days" of the T&T COLA, the "automatic" cost of living allowance [or adjustment] which ensured that wages and salaries kept pace with inflation. It would seem, in hindsight, that the innovators of this mechanism were convinced that the bulk of inflation in the twin republic was created from within the jurisdiction, and not imported. It is still uncertain to many whether the mechanism utilised a core inflation or headline inflation index.

It has been a traditional view of many a Trade Unionist that the most equitable formula for retaining internal purchasing power parity of workers was to adjust wages by the inflation index. They argued that inflation raises the price of goods and services, making it more challenging for wage-earners to meet their obligations. While many economies have moved away from this wage-inflation correlation, it's still a usable option where other data do not exist, and a feature of many Caribbean economies to rely on the consumer price index to negotiate wage reviews. But the burning question remains "why is inflation a better determinant of wages than other growth indices?"

In an article titled, "The link between wage growth and inflation is weakening—why is this", the World Economic Forum wrote, "The link between wage growth and inflation has weakened in recent years [in Europe] amid low inflation expectations, robust corporate profitability and strong competitive pressures. The price of labour is rising at a robust rate…yet, surprisingly, inflation has barely risen. The link…has weakened considerably in the decade since the global financial crisis."

In the scatter plot below, we reproduce data from outside our region showing the relationship between wage growth and price growth from 1960 to 2015. The period January 1960 to June 2009 shows a clear correlation between the two indices as depicted by the red dots and the upward-sloping trend line. Arguing that inflation favoured wage increases during that period was a sound one. The period leading up to the 2008/2009 global recession definitely favoured that kind of correlation.

The period from July 2009 to September 2015 seem to show two mutually exclusive indices. Movements in wages bore little relationship to inflation. Clearly, something other than price rise was pushing wages up. Similarly, wage growth was not fueling inflation. The two were clearly disjointed. The impact of core inflation on wages was only two-thirds as strong as the period before the bubble.

The competitive nature of enterprise nowadays urges the use of caution in raising prices on account of increases in labour costs. With many suppliers in a market, no one has the freedom to inflate prices at will. Additionally, firms can achieve better economies through better sourcing and logistics, reduction in wastage and duplication, factor efficiency, etc., than price increase only.

Since the last global recession, labour productivity has played a greater role as a determinant of wages than inflation. Countries are increasingly utilising tools to enable supply-side growth decomposition in an effort to understand the structure and challenges in a production function. How much of a country or enterprise's growth should be attributed to labour? What investments are being made in the productivity of this factor? Should we be talking about the Cobb-Douglas production coefficient than just inflation index?

Venezuela is a hemispheric State experiencing hyper-inflation for some time now. Consumer prices rise every day and the currency loses value. Increasing wages to match inflation would be unwise because labour is not producing the inflation.

The future is one where more effort will be required to keep inflation in check and, at the same time, tie wage reviews to productivity. And not just productivity of goods and services but ultimately, as expressed by Dr. Joseph Prokopenko of ILO fame, by what is achieved at the marketplace. Productivity in itself does not generate wealth, markets do.