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May 15, 2005

Comments

Very lucid, hilzoy. I'd heard about bend points before and had a vague idea of what was going on, but it's all so much clearer now.

Just one question. Presumably, that $20,000/year cut-off is going to be adjusted as the years go by. Will it be indexed to prices or to wages? My guess is prices - it'll just grow with inflation.

Hilzoy,

Thank you for the post. Why is it that prices rise more slowly than wages?

Why is it that prices rise more slowly than wages?

Good question, because they haven't lately.

The old answer was, I think, "wages track productivity growth; prices track wage growth."

Excellent post, hilzoy. I love the smell of education in the morning!

Blar; it will be indexed to wages. Think of it as the point at which wage indexing is replaced by price indexing. Ogo: I dunno.

I want to preface everything I say here with the caveat that I don't know spit about economics.

Notyou: If the issue is just how they track, that sounds like a feature of a time of a lag, not a persistent differential that compounds over time, as Hilzoy's post asserted (I believe).

Hilzoy: As I recall, the classical idea was that this sort of thing should be incoherent. Prices can't rise any more quickly or slowly than wages because prices are wages. Or, at least, prices are wages plus profits. You can have a profit squeeze over the short- or medium-run, but it's hard to imagine how this could be a permanent feature of economic life. How could that share grow indefinitely as a proportion of the whole? Wage growth is, of course, a big cause of inflation, so if to imagine, as a historical fact, that prices grew more slowly than wages, I think you'd have to imagine a persistent inflationary pressure with a deflationary market outcome.

I really hope that this is the case, because it would be a great argument for capitalism. If wages rise more quickly than prices, then wage-earners have larger command of the overall stock of goods. The converse prediction, by the way, is exactly why Marxists economics turns out wrong. Marx and Ricardo both predicted that wages would be a lesser and lesser share of national income, leading to increased relative impoverishment, hoarding, insufficient consumption, and market contraction.

Let me just add that there must be something I'm missing, because too many people who know far more about this than I do keep stating it as if it were a law of nature that prices rise more slowly than wages.

But I don't know what it is, and if anyone knows, I'd very much appreciate it if they told me. Be blunt. Be unceremonious. I need to have a confrontation with the truth here.

Ogosdinos,

Wages are thought to rise more quickly than prices because real wages depend on productivity. As individual productivity increases, so should wages.

Think about a completely self-sufficient family. They grow their own food, build their own house, etc. If they become more productive - improve their agricultural methods perhaps, or learn how to make better tools, their "wages" rise. They have more goods to show for the same amount of work.

...following Bernard Yomtov's comment, prices rise as increasing wages chase the (more or less) same number of products (i.e. inflation). Prices can't rise faster* than wages, because it's rising wages that push prices up.

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*Unless they do, as has been happening recently, because of slack in the labor market and/or price spikes in key commodities.

Actually, rising wages do not cause inflation. This used to be thought to be the case, as people spoke of "wage-push" inflation, but I don't think this is a widely held view at this time. Note that in my example, while there is a rise in wages, it is exactly matched by a rise in output. The ratio of income to production has not changed. There is just more of both.

It is also possible for wages to rise while declining as a share of income. Remember that production increases increase income. How that increase is divided is a separate matter.

This used to be thought to be the case, as people spoke of "wage-push" inflation, but I don't think this is a widely held view at this time.

It appears I'll need to update my limited economics background.

It is also possible for wages to rise while declining as a share of income. Remember that production increases increase income. How that increase is divided is a separate matter.

One would assume the recent productivity gains have been captured by capital, given recent weak wage growth. This may counter Ogosdinos' theory that capitalism offers workers an ever increasing share of the goods over time. Instead, workers can get more of goods when they can enforce a claim on a greater share. Right now they can't.

Yomtov: If wages increase [say because of tough union action], businesses may or may not, depending on elasticities, be able to pass that off to consumers. If they succeed, profits aren't squeezed, but the increased buying power of wage-earners vanishes. What's the difference between demand-pull and wage-push inflation? Are you saying that nobody believes in demand-pull inflation either? If I'm understanding this right, they're two sides of the same coin and the difference rides only on which market mechanism dominates. Do businesses increase prices because they are incurring higher labor costs or do they increase prices because they suddenly find an increased demand? But whichever it is, it seems to have no bearing on the issue of how wages and prices track one another.

But if nobody believes in wage-push inflation, this is great news for liberals. It means that there is no serious ideological opposition to unionization any more. And so much for all the incomes and price policies of the 70s.

Yomtov, I'd be grateful if you explained why it might be that no one believes in wage-push inflation any more.

I'm beginning to see your point about wages. If the wage rate = price level * the productivity of labor, and the productivity of labor is ever increasing, the wage rate has to grow faster than the price level.

Ogosdinos,

I'm no macroeconomics whiz, so I can't answer your good questions too precisely. Suffice it to say, for now, that inflation has to do with the money supply relative to production, the degree to which people want to hold money (as opposed to longer term investments), and interest rates and so on.

It's important to note that a price increase in one sector of the economy does not necessarily imply inflation. Prices elsewhere may drop. Relative prices - the price of one good in terms of another: how many apples an orange costs - change constantly.

Suppose the UAW extracts major wage increases from the car companies. What happens? The price of cars may rise, but then fewer will be sold. Demand for steel and rubber may drop. Some workers, and car salesmen, may be laid off, reducing demand elsewhere in the economy. Some people who were thinking of buying a new car will change their mind and keep the old one. Used car prices rise, etc. The effects are manifold, but the point is that this by itself does not increase inflation.

I'm going to try to give you a better answer, but it will take a while.

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