
Issue No 79		24 November 2000

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Economics

Rethinking Incomes Policy

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While many have thrown incomes policy out with the Acoord bathwater, Graham White argues it still has a role to play.

Though the experience of incomes policy in Australia during the 1980's may give many cause to doubt its usefulness, it is worthwhile, in present circumstances, reconsidering the usefulness of incomes policy, particularly in light of the lessons we can draw from the 1980's.

In my view, incomes policy provides an alternative means of dealing with inflation (assuming for the moment that this is a worthwhile exercise); alternative, that is, to the strategy of slowing down the economy.

Though this may well have been the view of the Prices and Incomes Accord of the Hawke-Keating era either in its initial stages or in its planning, I suspect the there are just as many if not more who see the chief benefit of the 1980's Accord lying in its moderation of real wages as a means of assisting employment growth.

I should state up-front that I clearly reject the latter view. Specifically, I reject first, any notion that employment and real wages are systematically related, and second, that the purpose of incomes policy is a reduction of real wages as a means to lower unemployment.

This does not mean that incomes policy is irrelevant to the task of reducing unemployment. On the contrary, properly run, it allows governments to tackle inflation and unemployment simultaneously - controlling inflation without resorting to deflationary or restrictive macroeconomic policies, and their accompanying tendency to slow economic and employment growth and hence to hinder the path to lower unemployment rates.

Incomes policy provides this possibility because it goes to the underlying process which drives inflation - the incompatibility of claims on the economy's income by employers on the one hand and wage-earners on the other. There may be many things which trigger price rises - but what transforms these into an ongoing inflationary process is the fact that the profit levels desired by employers and the real wage levels desired by wage-earners are together inconsistent with a constant price level. Indeed, continuously rising price levels are a manifestation of the inconsistency of claims by employers and wage-earners.

Lessons of the Eighties

Of course the hard part is the precise detail of a workable and sustainable incomes policy. And it is here that the lessons of Australia's experience in the 1980's become critical. The key lesson is how to build in to the policy what we might call the "shock absorbers" which allow the incomes policy to meet its objectives in the face of the type of shocks which would seriously test the policy. Effectively, this means maintaining in the face of such shocks the incentive for the relevant parties (unions, employer groups) to stick with the policy.

As we saw in the mid 1980's among the most important shocks are those arising from the external sector, in particular exchange rate pressures. A fall in the value of the Australian dollar (which could arise from factors quite unrelated to the incomes policy) would put some upward pressure on domestic price levels, necessitating a rise in nominal wages to maintain real wage levels.

The difficulty presented by such a case is that prices of imports with a fixed foreign currency price (though this is not the only case) will rise and this will feed into the CPI directly and indirectly by affecting the price of some inputs used in producing consumer goods. The point is that these price rises need not entail any increase in profit margins. As a consequence the pressure is placed either on business to wear a fall in profit margins in order to allow wages to rise to compensate wage-earners for higher prices; or for wage-earners to take a cut in real wages in order for business to maintain profit margins.

This was precisely the difficulty and first major challenge to the Accord in the mid-1980's; whether to discount wage rises for the effect of the large depreciation in the Australian dollar on prices. Clearly, any incomes policy intended to be a permanent feature of the economic landscape must provide a circuit breaker or shock absorber to situations such as these, since such a situation would have the potential for either party - wage-earners, employers - to consider the worthiness of opting out of the agreement underpinning the working of the policy. Indeed, not being able to deal with such shocks as a significant depreciation, without significant cost to the position of either party, would simply be a reflection of an incomes policy failure.

Circuit breaker

The use of real wage reductions as a circuit-breaker (and one which will always suggest itself to at least some policy makers) when faced with competing but incompatible claims by wage-earners and employers, is a viable strategy only in so far as the government can be relied on to maintain after-tax real income. There is of course much in the history of our major political parties in government to justify a large dollop of scepticism in relation to any such reliance, particularly as it concerns lower income groups. Put more generally, the strategy in question involves making real income of the working population conditional on the fiscal policy perogatives of the day. Of course, there is nothing unusual in the latter - it's just that this is more worrying in the context of a workable incomes policy which seeks the support of organised labour.

An alternative strategy in the case of something like a depreciation induced rise in the CPI is to allow a full-compensation of awards in relation to the increase in prices, but to use the tax system as a means of preventing a fall in profit margins. Essentially, the problem is how to compensate business for any reduction in profit margins arising from the compensation of wage-earners in respect of higher prices. In fact this may be done through the tax system in combination with some form of a price surveillance mechanism. Businesses in general could be given a tax credit for the extent of the increase in wage costs induced by depreciation triggered price rises. (once the mechanics involved in GST administration are in place, so would a significant part of the mechanics required to work such a compensation scheme.)

Nor is this strategy inconsistent with an incomes policy which allows for negotiation of wage-claims in excess of cost-of-living on the basis of improved productivity or for example in return for changes to work practices. However, a workable incomes policy which has the continued support of organised labour such negotiated wage rises at the level of individual sectors relate to pay claims over and above those associated with cost of living. The latter wage-adjustments would not be negotiable.

Of course, the alternative strategy alluded to here would make the maintenance of profit margins dependent on government tax policy. One can only hope that governments will be more prepared to honour tax commitments in this regard than they have been in relation to wage-earners.

Such an arrangement itself is not without potential problems. It will be necessary to ensure that Governments cannot deplete expenditures on the social wage in order to fund such compensating tax arrangements. Success on the inflation front at the cost of adequate expenditures on health, education and welfare would be a hollow victory.

Interest Rates

Yet this concern underscores the other essential ingredient of a sustainable incomes policy - consistency in the other arms of economic policy. In this regard, monetary - or interest rate - policy is especially important. One difficulty that arises in relation to incomes policy is that if this means that interest rate policy is freed up for use in macroeconomic demand management policy, this could open up a differential between our interest rates and those of our trading partners (who prefer to use monetary policy to target inflation), with downward pressure on the value of the Australian dollar. This may be less of a worry to the extent that our inflation performance as a result of incomes policy is better than that of our trading partners. However, if interest rates are no longer to be used as an anti-inflationary tool, persistent pressure against the value of our currency could only be avoided by the re-imposition of controls on capital flows into and out of Australia.

In a sense this is also a lesson from the 1980's that incomes policy cannot as it were "go it alone" as a weapon with which to fight inflation. It must have supportive macroeconomic policies, and this means especially interest rate policy. But it also means a supportive external policy; in particular, an external policy which would allow a significant measure of autonomy in our setting of interest rates. Finally, and perhaps the biggest challenge of all suggested here, is that in order for a serious and sustainable incomes policy to work there must be something like a sea change in the thinking of the economics profession about the appropriate ways of reducing unemployment and tacking inflation.

Graham White is a lecturer with Faculty of Economics, University of Sydney

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  Issue 79 contents

Interview: Back on Track
After blowing the whistle on rail privatization, NSW Transport Minister Carl Scully is rebuilding bridges with the trade union movement.

Unions: The Problem with Organising
It may be the new mantra, but Brisbane Institute director Peter Botsman argues that organising may be the wrong to go for a movement attempting to attract a new breed of workers.

International: Burma: Workers Act on ILO Ruling
Energy workers' trade unions across the Asia-Pacific have urged Western oil and gas companies to "cease investment in Burma while the use of forced labour continues".

Economics: Rethinking Incomes Policy
While many have thrown incomes policy out with the Acoord bathwater, Graham White argues it still has a role to play.

History: What Goes Around Comes Around
Labor Council's Mark Lennon argues that while trade unions - and labour history - might be unfashionable, there's life left in both of them.

Education: Peas in a Pod
Both sides of politics must take blame for funding levels in our public schools, argues NSW Teachers Federation president Sue Simpson.

Satire: Hurley Rebukes Actors' Guild: I'm No Actor!
Liz Hurley has responded angrily to claims by actors that she crossed a picket line by filming an Estee Lauder ad.

Review: It's Only a Job
In a stunning new book, author Phil Thornton and photographer Paul Jones have combined to portray working life in all its diversity through the eyes of ordinary people like process worker Sharonak Shannon

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