Is the world economy heading into a wage-price spiral?

THE IS RICH the world is used to wages and prices growing slowly. In the decade following the global financial crisis, inflation rarely exceeded central bank targets, and wages did not appear to be able to grow much faster. Expenditure on average hourly wages in Britain, Italy and Japan was about the same in the beginning of the pandemic as it had been in the mid-2000s. The fact that US wage growth averaged 2.9% from 2015 to 2019, while average inflation remained below 2%, seemed to be a rare triumph.

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The recovery from the pandemic has brought about a surprising change: prices and wages are both rising. US hourly wages rose by 4.6% in the year to September, while consumer price inflation of 5.4% is more than wiping out these gains. In Germany, inflation has reached 4.1%, and the main public union is asking for a wage increase of 5%. Wages and prices have even risen modestly in Japan.

The reasons for higher prices are clear: the fierce demand for goods has met with bottlenecks in supply chains, and energy prices have risen sharply. Wage growth is more mysterious. In most places, employment is lower than it was before the pandemic. Yet workers seem reluctant or unable to take the plentiful jobs offered. The shortage of labor may reflect how difficult it is to move between industries and places when economies undergo an unusual adjustment. Fear of the virus and the long-term effects of state aid on household income can keep workers inactive. The pandemic may even have caused some people to put family and leisure over their careers.

A vague understanding of what drives wages up makes life harder for central banks. Most have argued that high inflation is temporary. However, excessive wage increases can be the next factor in raising prices, especially if workers demand higher wages in anticipation of future increases in the cost of living – an insurance policy that exacerbates exactly what it seeks to offset.

To avoid keeping inflation, a combination of three things must happen. Companies could absorb higher wages in their margins rather than raise prices. Productivity growth can make higher wage increases sustainable. Or unemployed workers could return to the workforce and curb wage increases.

In the popular imagination, the share of workers in the economic pie has room to grow at the expense of profits. But recent research suggests that the share of labor in the value companies create has actually been fairly stable in most rich countries in recent decades. We estimate that it has already risen by an average of one percentage point in large rich countries during the pandemic. There may not be much room for further increases.

Higher productivity growth is a reasonable hope. Output pr. Workers have risen in America since the start of the pandemic. The digitalisation caused by the pandemic should increase the standard of living, especially if it reduces the need to live close to expensive cities to get good jobs. The problem is that time delays make it difficult to base policies on productivity trends. They are difficult to measure in real time, and it takes about 18 months for central bank decisions to fully enter the economy.

This means that decision makers should focus on the labor supply. Its recovery so far has been disappointing. There is surprisingly little evidence that the termination of emergency programs, such as America’s extended unemployment insurance and the UK’s deadline scheme, has increased the number of people looking for work. But perhaps, as bank accounts dry up and the pandemic subsides, some laxity will reappear in 2022, causing wage growth to slow. Even more than usual, monetary politicians should keep an eye on jobs.

This article appeared in the “Managers” section of the print edition under the heading “Control and Imbalance”

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