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What killed real wage growth?

Summary:
This is the Project Link chart that most startles me: What killed the growth in real wages in the early 1970s? I've been trying to come up with an answer to this question, and I think I have one. I'm not entirely sure that it's the correct answer, but I think it's a plausible conjecture. Of course, an obvious thing for a Canadian economist to do is to check what was going in in the US at the time: Something happened to real wage growth in the US as well an in Canada in the early 1970s. What, though? The first candidate I thought of for a negative shock that hit both the US and Canada at around that time is the oil shock that followed the October 1973 Yom Kippur War. The timing doesn't work though: US real wages peaked in October 1972, and the inflection point in Canadian

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This is the Project Link chart that most startles me:

Canada wages

What killed the growth in real wages in the early 1970s? I've been trying to come up with an answer to this question, and I think I have one. I'm not entirely sure that it's the correct answer, but I think it's a plausible conjecture.

Of course, an obvious thing for a Canadian economist to do is to check what was going in in the US at the time:

Fredgraph us wages

Something happened to real wage growth in the US as well an in Canada in the early 1970s. What, though?

The first candidate I thought of for a negative shock that hit both the US and Canada at around that time is the oil shock that followed the October 1973 Yom Kippur War. The timing doesn't work though: US real wages peaked in October 1972, and the inflection point in Canadian real wages occurred in December 1976.

Canusa wages oct 1973

So the question now becomes 'Was there something that happened in the US a year before the oil shock, and that also happened in Canada three years after the oil shock?'

If your answer was "wage and price controls", then you are many, many months quicker on the uptake than I am. In both the US and Canada, real wage growth ended about one year after the imposition of wage and price controls. The Anti-Inflation Act was passed in December of 1974, and was in force until the period of decontrol started in April of 1978:

Canada wages controls

Most of what we remember of the August 1971 Nixon shock revolves around the abandonment of Bretton Woods and its implications for the international monetary system, but the New Economic Policy also included wage and price controls until April of 1974:

Us wages controls

In both countries, the turning point arrived a year after the imposition of controls. But if wages are adjusted only once a year, and if the controls only applied for wage increases, then this sort of delay would be expected: it would take a year for the controls to be applied across the entire economy.

So the conjecture is that the imposition of wage an price controls put an end to real wage growth. Let's look at a couple of other countries, and we'll start with Australia. Australian wage data going back to the 1960s are hard to come by: the FRED series for hourly wages only goes back to 1976. After a bit of digging, I managed to unearth a series for Australian men's weekly earnings in a 1992 Australian Bureau of Statistics publication. There's no point in trying to splice men's weekly earnings to hourly wages for all workers, so I rescaled them so that the average over 1977-1986 is 100. The two series have similar properties over the years in which they overlap, so I think they basically tell the same story: real wage growth until 1975, a leveling-off (with a certain amount of volatility) between 1975 and 1985, a decline between 1985 and 1996, and finally a recovery in wage growth after 1996:

Australia wages

Australia also had wage and price controls, and the controls-kills-wage-growth conjecture fits this narrative surprisingly well:

Australia wages controls

You can even see a bit of a spike in the brief interval 1981-82 when there were no systemic controls, and a sharp drop during the wage freeze that was imposed between December 1982 and September 1983. Real wage growth resumed after the newly-elected Howard government let the Prices and Incomes Accord lapse in 1996.

Finally, let's look at Germany, a country that didn't impose wage and price controls:

Fredgraph germany

No controls, no structural break in wages.

Weak as this evidence is - we're only looking at four observations from a not-particularly-clean experiment - it offers some support for the hypothesis that the imposition of wage and price controls stops or reverses real wage growth.

At this point, you have to ask yourself "what were they thinking?" From the perspective of 2019, wage and price controls were and are a pointless measure if monetary policy is too loose. But at the time, Milton Friedman's clam that "inflation is always and everywhere a monetary phenomenon" had not yet achieved the consensus it now enjoys. The idea behind 'incomes policies' - the popular euphemism for wage and price controls - was that corporations and unions had become so powerful that they could extract wage and price increases that were in excess of what a competitive market would predict. In the case of wages, the argument was that wages had been increasing faster than what could be justified by increases in worker productivity.

There any number of theoretical problems with using market power to explain inflation, but what did the data say? I'm still researching this episode, but I've yet to find an empirical basis for the conclusion that wages had been increasing faster than what productivity growth would justify. argument. Certainly I  don't see where that claim comes from.

It's perhaps unfair to apply the data we have now to the question, so I decided to look at the data in Historical Statistics of Canada. It's important to remember that in the standard model of the firm, the relevant price for calculating real wages is the output price, not the CPI. This is a point that is still not well-understood, so it's understandable that the analyses of the time used the CPI instead of the output deflator. Understandable, but still wrong.

Canada productivity

When you use output prices to calculate real wages, you get a series that tracks productivity quite closely. If anything, real compensation lagged productivity during 1972-74, the data people would have been looking at at the time. It's true that workers' purchasing power - as measured by the CPI - increased faster than productivity over the years leading up to the Anti-Inflation Act, but that was due to an increase in the labour terms of trade. The prices of the goods and services they were producing were growing faster than the consumer goods they were buying.

Incidentally, real wages - as calculated using the output deflator - also tracked productivity in the US:

Us productivity

The difference there was that US workers were seeing a deteriorating labour terms of trade, so purchasing power lagged productivity.

This is a rough first pass at the question, of course: it uses average productivity instead of marginal productivity. This is fine if you made the standard assumption of Cobb-Douglas technology,  but it may be that a more sophisticated treatment might find something else. The point here is that the data support the vanilla model of competitive labour markets; there's no obvious evidence of workers using their bargaining power to extract increasingly larger rents.

I'm not sure why I haven't come across the link between wage and price controls and a structural break in real wage growth. The only reference I've come across that makes the connection is here, and Google Scholar says it has been only cited once, in a thesis submitted to the Federal University of Rio de Janiero. I suppose the obvious reason is that reducing real wages was a stated goal of wage and price controls - after all, the starting point was a claim that wages were 'too high'. Supporters of controls would greet such a finding with satisfaction. And since the most vocal opponents to controls were monetarists (who, with no small amount of justification, thought controls were as dumb as a sack of hammers) and labour unions (who were, with no small amount of justification, outraged at the adoption of a policy designed to reduce workers' buying power), it was easy for supporters of controls to tell themselves that theirs was a prudent, centrist option.

What I still don't understand is how the effect of controls on real wages could have persisted for so long after they removed. There's some sort of hysteresis story there, and it remains to be told.

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