Dealing with “sticky wages” – an evolving system?

One of Keynes’ famous axioms is that of “sticky wages”: Nominal wages are supposedly inflexible downwards. Particularly during economic contractions, supposedly nominal wages fail to adjust downward. This results in a labor market which does not “clear”. Hazlitt, Mises and Rothbard have argued that in free market scenarios there is little historical evidence for such a problem.

Yet while that may well be true, judging from their actions one could postulate that many 20th century governments believed otherwise. Specifically, governments have employed a series of measures resulting in the inflation of the currency unit in which wage rates are fixed. In some cases the inflationary impulses came from general expansion of credit; in others, from currency devaluations. Either way, the result was an effective lowering of real wage rates – at least temporarily. One could certainly debate to what extent this effect is or was a primary motivation behind the common inflationary policies of the past 100 years. At a minimum however, this effect could hardly have been seen as a downside.

But workers and unions caught on quickly. Increasingly unions came to expect automatic adjustments of wage rates based on published statistics on inflation. In countries with severe inflation (such as Brazil) wage indexing became the norm.

A new approach was needed.

That new approach was a subtler one: manipulation of the consumer price indexes used to calculate inflation. Put crudely, the logic is as follows: Today’s television or car is “5% better” than last year’s, so if it costs only 3% more, then the “net inflation” is actually -2%. Never mind that the last year’s models are in all probability no longer available. Even supposing that it were possible to calculate some type of neutral “utility value” (an idea which is difficult to defend without applying some sort of normative standard), essentially this amounts to an amount to “value” todays good according to yesterday’s standards. By that measure even those homeless but with cell phone service would have to be accounted amongst the superwealthy of the year 1970.

In the case of the United States, this was evenly done somewhat openly. In 1981 the CPI calculation standards were changed to account for these “improvements”. Many other countries have learned similar tricks.

If the statistics assembled by John Williams of are correct, this trick has allowed the United States government to conceal a dramatic decline in real wage levels – a fall of over 70% in 40 years. The dramatic increase in female participation in the work buffered the effect of this net wage cut somewhat, but obviously hardly completely.

Certainly no sticky wage problem there.

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