Friday, August 01, 2008

What wage-price spiral? 18 comments

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Inflation is in the air, and Singapore has not been spared. Indeed, as one of the most open economies in the world, we are seen as particularly vulnerable, even a precursor to what the rest of the world will experience several months later due to our lack of subsidies for many common products that typically shield consumers of other countries from immediate price impact.

Given the price pressure faced by people in their daily necessities as a result of imported inflation, it has become necessary to communicate the linkages between wages and prices. No less than two full ministers have come forward to explain the intricacies of inflation and why a wage-price spiral must not be allowed to develop --- which means wages must be controlled.

I sympathise with them because it must be politically difficult to explain to people that their income cannot rise in-step with their expenditure. Before we go further, let's briefly look at what wage-price spiral means. Essentially, it is a classical inflation phenomenon where wages are allowed to chase prices upwards. Prices, in turn, will be positively influenced by rising affordability (rising wages) and hence its upward momentum is not checked, leading to a positive reinforcement cycle. In a sense, inflation begets further inflationary expectations.

But let's look at it more closely. I am in no position to discuss it quantitatively, but let's reason things out qualitatively. Two key points on why I doubt a wage-price spiral will occur even if wages are allowed to rise: firstly, this is widely seen as a cost-push inflation; and secondly, Singapore's inflation is largely imported. A cost-push inflation is caused by drops in aggregate supply due to increased prices of inputs. For example, the 1970s inflation is widely seen as due to a sudden decrease in the global supply of oil due to the formation of OPEC which started to exert control over supply, which in turn increased oil prices. Currently, we are seeing prices of agricultural products, metals and energy commodities rising due to increasing tightening of supply and this is in turn feeding into rising prices of goods/needs that they're used to manufacture/fulfil. Meanwhile, Singapore's consumption expenditure is largely on imported goods because our manufactured goods are largely exported while we produce minimal agricultural goods. Piece the two together and it suggests that inflation is a function of largely external factors where prices are fed from interactions of world demand/supply dynamics directly into the country.

The classical reason on why a wage-price spiral must not be allowed to develop is that the demand-curbing effect of higher prices, which automatically checks and stabilises price inflation, is lost when wages rise in the same proportion to the effect that rise in expenditure is balanced by rise in income. But what if prices is independent of wages, as described above? A part of the argument for not raising wages for fear of a spiral will be lost. Indeed, life can get difficult if prices which are uncontrollable (domestically) rise faster than wages which are negotiable.

In such a scenario, provided that many other countries start to negotiate higher wages for their workers to cope with rising inflation, a country that has a stringent wage inflation policy will gain in competitiveness and become more attractive as an FDI (foreign direct investment) destination. That might also be another reason for not letting wages rise in proportion with inflation. Ultimately it might be a win-win situation too. However, this rationale has not really been presented strongly so far. Anyway, to preserve competitiveness through lower relative pricing does not seem a viable long-term strategy for a developed nation; creating higher value-add should be the way to go. Perhaps we are not ready for it yet?

Of course, wage pressures in certain industries should be checked lest they affect end-product prices, particularly when they are key to the development needs of the country. For example, in the construction industry which is crucial to the remaking of Singapore and where construction material cost pressures are already rampant, it may be important to control wage pressure such that the end-product (the building) does not become so expensive to build that it drives away developers and potential buyers, upsetting the long-term plans of the country. But surely, the control measures should be specific rather than broad-based (and anyway, there're ways of controlling wages --- by lowering regulations for foreign supply, for example)

Caveat: as a non-economist, all my rationalising above might be faulty. Any indignant economists seeing the fault, please kindly point me out in the right direction.




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6/16/2011 10:16 PM  

Their will be no wage price sprial.

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