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Macroeconomic Thoughts on the Prices and Incomes Accord

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Written By Mr Chris Mouratidis [B.Ec(hons)/B.A.]

‘Those who rule wages rule the country.[1]

 

The “Prices and Incomes Accord” was a macroeconomic policy implemented by the Hawke Government in March 1983, combating the seemingly endemic problem of that era, stagflation; (high unemployment and high inflation.)[2] The policy affected prices, wages, non-wage incomes, taxation and the “social wage.” As a form of ‘incomes policy,’ its initial economic goal was to limit nominal wage increases, in order to achieve a sustained decrease in inflation. In addition, it was hypothesised that through this ‘anti-inflationary’ tool, employment growth would result, leading to the simultaneous decrease in inflation and unemployment, signalling an end to the troubling stagflationary period of the late 1970’s and early 1980’s.[3] The institutional mechanism through which this policy was to operate from involved a form of ‘corporatism,’  which involved the integration of ‘economic production agents,’ (i.e. capital and labour representatives,) within a system of representative and co-operative mutual interaction mediated by a third, external body; the federal government’s “Industrial Relations Commission.”[4] Arguably, one of its main aims was to constrain repetitive macroeconomic cycles of expansions and contractions, that were partly caused by the struggle for a larger piece of the national income share between business and wage earners.[5] Whether any or all of its overall aims were achieved or not, is subject to widespread analysis, criticism and praise. Some macroeconomic theorists would applaud the policy whilst others would undoubtedly denounce it on their own respective grounds. For instance the ‘neo-classical synthesis’ sympathiser, Mr Robert M Solow, surprisingly found merit in anti-inflationary incomes policies similar to the Accord in his 1960’s conference paper about ‘wage/price guideposts.’ In contrast, our ‘monetarist stalwart’ Mr Milton Friedman, argued at the same conference that the policy was useless since it didn’t directly deal with the issue at hand, inflation. Others like ‘Kaleckian-sympathiser,’ Mr  Malcolm Sawyer, would agree with Milton on the basis that the policy doesn’t work, but for entirely different reasons. It is envisaged that through the objections, agreements and qualifications of different macroeconomic theorists, the Prices and Incomes Accord can be dissected in a unique way, allowing us to identify the possible strengths and weaknesses of the policy.

 

            The “Accord” was implemented on the back of wage inflation that varied between 30% in 1974/75, and 18% in 1981/82.[6] For several years, previous governments attempted to solve the stagflation problem through various fiscal and monetary policies, without success. The Accord promised a solution to the problem via two important effects. Firstly, a decrease in nominal wages without the need for contractionary fiscal and monetary policies would increase employment at a given, achieved moderate inflation rate, (without government induced drops in labour demand.) Secondly, (in the short run,) nominal wage cuts would lead to decreases in real unit labour costs, with an increasing proportion of Australia’s GDP heading towards business profits, and away from wages. This would increase business investment, economic growth and ultimately employment.[7] Therefore, wage rises were traded off for economic and employment growth. The Accord was revised on seven occasions between 1983 and 1996, many illustrating Australia’s changing economic issues as well as fundamental changes in the policy’s direction. The aims and objectives of the Accord were to be achieved, via a tripartite arbitration commission. ‘Mark One,’ (March1983-September1985,) established a centralised system of wage fixation, adoption of full cost of living adjustments, productivity based real wage increases, a consultative framework between government and  unions, a ‘no-extra claims’ commitment from unions once an agreement was reached, the establishment of the ‘Prices Surveillance Authority,’ ‘Medicare’ and ‘National Wage Cases;’ (where wage/award payments were adjusted by the Industrial Relations Commission or AIRC, based on the previous two quarterly movements of the CPI.)[8] ‘Mark Two,’ (September1985-November1986,) involved changes on the back of declining terms of trade and a dramatic depreciation in the Australian Dollar. A two percent discount on wage indexes to CPI movements and a decrease in income taxes offset the depreciation.[9] ‘Mark Three,’ (November1986-July1988,) involved a mechanical change called the ‘two-tier wage system.’ This involved the provision for generational wage changes for all workers via national wage cases involving two flat wage increases, with the AIRC determining the two wage ceilings. Generally, the first ceiling adjustment was granted for all workers but the second was granted with the qualification that certain, enterprise prescribed productivity improvement targets were achieved.[10] Hence, the Accord took a decisive move towards the enterprise level illustrated by the ‘restructuring and efficiency principle.’[11] ‘Mark Four and Five,’ (July1988-February1990,)Fe986 and July 1988,), anmd enhancedcrease in skill related career paths, a reduction to the impediments to multi-skilling, crea involved the ‘structural efficiency principle’ that linked wage increases to increases in skill related career paths, reduced impediments to multi-skilling, created and enhanced wage relativities.[12] ‘Mark Six’ (February1990-March1993,) most importantly involved the changes to the Industrial Relations Act. The changes increased the adoption of single enterprise agreements subject to AIRC certification and a ‘public interest’ test, (involving measuring the effects on unemployment and inflation.)[13] It is clear that the Accord was a tool used to adapt to the changing needs of the Australian economy evident by the move from centralised wage bargaining to single enterprise based bargaining in the early nineties.

 

            Former AIRC chairman and Accord sympathiser, Mr Keith Hancock, would argue strongly in favour of the policy based on its goals and effects on wages, prices and employment. He would firstly indicate that prices such as the price of labour, is subject to direct influence from agents with market power, and incomes policy is designed to influence such agent behaviour.[14] Additionally, the Accord was designed not to be a substitute for demand management policies, but rather to compliment them.[15] Therefore, the Accord could be implemented to restrain wage-price spirals whilst the government expanded demand simultaneously to achieve a higher level of employment. Hancock would argue that the goals of such incomes policies are to curb inflation, positively influencing prices and employment. Many proponents would point to the now controversial Phillips Curve, which represents a relationship between percentage growth in wages, (or prices,) and unemployment. According to the late La Trobe University Professor, Donald H Whitehead; incomes policies cause labour supply prices to increase at a slower rate because of the slower money wage growth and simultaneous productivity increases, pushing the Phillips Curve to the left.[16] Therefore, a lower inflation rate is expected to be achieved with a lower unemployment rate. Hancock could expand upon the above arguments by applying Corden’s View. Corden’s View assumes that the growth in money demand is not arranged at the going inflation rate and thus a rise in prices and wages causes a contraction in real expenditure and employment.[17] This view uses the expectationist model to illustrate the process of decreasing inflation by accommodating it by a certain level of money demand growth.[18] The process involves expectations being revised by wage earners as they realise that they can’t secure previous growth in money wages, due to the drop in price rises. Eventually previous output and employment is restored, however in the interval, unemployment temporarily increases as the economy deflates. It is in this interval, incomes policy has an additional role to play by speeding up the process of the change in expectations, minimising the adverse interval period effects. It speeds up the process by decreasing wage and price inflation directly without the need for interval decreases in employment and output, through “squeezing inflation expectations out of the system.”[19] Advocates would use this as an additional argument for the Accord’s applicability to restraining inflation, moving the Phillips Curve downwards and left, towards the origin; lowering wage and price inflation as well as unemployment.

 

Neo-Classical sympathiser, Mr Robert M Solow, would agree on the merits of the Accord to a certain extent, as demonstrated in his 1960’s conference presentation to a group of Chicago economists. In that speech, he noted that ‘wage-price guideposts’ (or incomes policies like the Accord,) are the “sort of policy you back into to protect an imperfect economy from the worst consequences of imperfect behaviour.”[20] Hence, Solow’s contention is that an incomes policy like the Accord is perfectly acceptable in its application, given the imperfect nature of the economy. If the Australian economy is ‘imperfect’ in nature, rapid increases in money wages and prices are generated without any excess demand. In such situations, if the economy is allowed to run without wage-price guideposts, high unemployment and un-produced output would result, with a one half point increase in unemployment, leading to one to two percentage decrease in real GDP.[21] Therefore, the problem of cost-push inflation has effects on unemployment, and ultimately a stagnant economy. Therefore, the use of ‘guideposts’ should be used whilst the economy is imperfect, allowing the illustration of how wages and prices would have behaved if they smoothly functioned in a free, competitive economy, not subject to excesses or shortages in demand.[22] Solow continues by illustrating that the imperfect nature of the economy is demonstrated by a significant degree of market concentration where wages and prices are not determined by market forces clearing the market, rather being determined with significant discretion, that contribute to ‘premature inflation;’ (inflation that otherwise would have not occurred so quickly nor in such amplitude if the market was free, and perfect.)[23] Therefore, guideposts have the advantage of stalling off premature inflation by dampening money wage increases, thus stalling price level increases. It would then be reasonable to suggest that if Solow was given the opportunity today, he would probably support the Accord on given certain conditions. However he could also indicate some weaknesses in its application. For instance, Solow makes the point that if money wage rates were to increase as fast as productivity, price levels would be constant, leading to the division of national income between wages and profits remaining unchanged. However, if prices increased despite wages following guideline productivity targets, then a transfer of income from wages to profits would occur[24] He would then look at the continual revisions of the Accord for evidence, and argue that despite wages following some kind of guideline target, the resulting CPI increases show a failure in the Accord as an incomes policy since prices did not remain constant, instead continuing to grow, thus signalling a transfer of income from wages to profits. According to Solow’s argument, the Accord was a policy that didn’t achieve what an incomes policy according to his theory was designed to achieve.

 

Major objections to the Accord would ultimately come from monetarist, Mr Milton Friedman. Friedman would probably argue that the Accord like many other incomes policies, does not deal with the real issues that affect inflation. According to Friedman, inflation is a monetary phenomenon because of an increase in the quantity of money relative to output.[25] Therefore, to stop inflation, one must restrain the rate of growth in the quantity of money relative to output. According to Friedman, prices play an important role in the economy and should not be suppressed through anti-inflationary policies such as the Accord, because suppressed inflation can be more harmful than open inflation. He would criticise the ‘cost-push inflation’ theory as a ‘smokescreen’ for a rapid monetary expansion. For instance, suppose costs of production increase through a rise in labour costs, leading to a rise in product prices. With prices rising, a resulting drastic decline in sales doesn’t occur. This phenomenon reflects the existence of excess demand due to a monetary expansion and an increase in money demand occurring through “mysterious, invisible channels,”[26] (i.e. government manipulation of the quantity of money.) He would also explain that the cost and price increases of this phenomenon are their visible tracks. Friedman illustrates here that a rise in prices is produced by excess demand that originates from a monetary expansion, taking the form of increases in costs that enforces a higher price.[27] Therefore, the Accord misses the point altogether, leading to an inefficient allocation of labour. Rather, the price system is displaced by a substitute system that organises resources and rations output.[28] Friedman would rather suggest abolishing the Accord altogether, and allow wages and prices to fluctuate freely, at a given quantity of money relevant to output that leads to a stable inflation rate. As long as open inflation was stable, the benefits of open inflation and allowing prices and wages to fluctuate freely would more than surpass the outcomes under incomes policies according to Milton because the efficient level of output and prices would be achieved. In addition, Milton would argue against the Phillips curve, cost push theory of inflation that the Accord seems to base itself on. He would do this by referring to inflationary expectations whereby an increase in monetary expansion will lead to an increase in output, employment and aggregate demand. However the price that we pay for postponing the eventual adjustment is people’s future inflationary expectations that will kick in, leading to a drop in consumption and economic activity, and an increase in unemployment.[29] Hence in the long run, there is no stable trade-off between unemployment and inflation, and thus the issue that governments should pre-occupy themselves with is controlling the quantity of money to achieve a stable inflation rate, not the implementation of wage ceilings that cause inefficient resource allocation.

 

Another major objection to the Accord would probably come from ‘Kaleckian sympathisers’ like Malcolm Sawyer, but for entirely different reasons to Friedman’s monetarist theoretical opposition. Sawyer like Kalecki, would argue that there is a positive impact of wages on the level of demand and employment, and government authorities are wrong in assuming that lowering the growth of money wages will lead to an increase in employment. They are wrong because a decrease in money wages leads to a decrease in real wages, stimulating employment because real wages are determined in the product market.[30] If given the opportunity, Kalecki would counter arguments in favour of the Accord by stating that money wage decreases (or slower positive growth rates,) do not necessarily mean real wages will follow in the precise fashion because output prices relative to nominal wages are determined by the degree of monopoly, techniques of production, intensity of labour, and the relationship between imported input costs and domestic output costs.[31] Therefore, if factors between prices and money wages don’t change then a fall in money wages leads to a fall in prices leaving real wages unchanged. Hence, the classic argument made by proponents of the Accord, (that nominal wage cuts would lead to increased employment,) is invalidated according to Kaleckian economic thought. An increase in real wages is not the cause of unemployment because the increase may be reflective of a decrease in product prices determined by lack of demand.[32] In response, Kalecki would probably explain the Australia pre-Accord economic phenomenon as indicative of a typical capitalist economy whereby excess capacity and output are expanded at constant unit costs, inflation increasing because of increases in minimum wages. When the full employment level of output is reached, upward pressure on minimum wages begins, increasing unit costs constant to output, whilst the degree of monopoly remains unchanged. As a result, prices increase further in line with cost increases.[33] Prolonged full employment will result in increased union power with further spontaneous tendencies for minimum wages to rise leading to a wage price spiral. Capitalists will desperately try to maintain their degree of monopoly by increasing prices further. The end result; an overheating economy.[34] Kalecki would advocate an alternative solution to this typical problem by controlling prices via direct or indirect subsidies that are applied to the real problem the area, the product market.[35] In addition, he would probably advocate mass public spending on public investments covered by borrowing, involving constant budget deficits and redistribution of income from higher to lower income groups due to their higher marginal propensity to consume, leading to higher consumption and a demand-side economic expansion, diminishing the aggregate degree of monopoly. By lowering real wages to productivity, incomes policies like the Accord attack inflation by switching resources from consumption into exports and investments, switching incomes from workers to capitalists (and the state) via increased profits and increased tax collections. The Accord’s deflationary approach to solving Australia’s stagflationary problems, would “teach workers a lesson”[36] but fail in returning full employment. 

 

Cambridge Post Keynesian sympathiser, Mr John Cornwall, would agree with Solow on the basis that incomes policies are appropriate tools to use for the same reasons, but with differing methods. Cornwall argues that the key to decreasing inflation and unemployment simultaneously is not via temporary stagnationary fiscal and monetary policies that are expected to lead towards increased unemployment rates and lower growth rates in order to achieve lower inflation.[37] Rather, a ‘permanent’ incomes policy should be implemented, where all economic production agents restrain wages and prices to achieve lower levels of unemployment and inflation.[38] This form of co-operative, consensual based mediation seems to have close similarities to the objectives of the Accord. However, Cornwall believes that in order for income policies to be successful, they need to provide financial rewards or penalties relating towards compliance levels to the guidelines set.[39] Therefore, according to Cornwall, incentives should be built into the Accord, to ensure the guidelines are followed in a precise manner. The Accord featured the ‘no-extra claims’ agreement which involved no further over-award payments would be granted after a national wage case. This would be one example of how wages were controlled via Cornwall’s incentive mechanism, in this case via legislative prohibition. Cornwall though, as much as he would positively remark on this legislative limitation, would argue for a “tax based incomes policy” (T.I.P) instead. A “T.I.P” would provide economic incentives via a tax penalty if guidelines were exceeded, (through a tax imposed on the employer and/or employee,) or a tax reward if they were followed, (through a tax break or subsidy.) The rationale behind this policy is that “price inflation” will lower if “wage-inflation” is lowered, similar to the Accord, but different in its method. Under this system no government intervention would be required like an arbitration commission, changes in relative wages would occur allowing the price mechanism to allocate resources, decreasing union wage demands and ultimately full employment would result via a rapid rate of growth in labour productivity and an associated increase in real wages.[40] It is envisaged that the greater a prescribed level of wage rises are exceeded by, the greater the tax incurred on the participants would be. Therefore, by setting the tax rate at an appropriate level, the problem of wage inflation would be eliminated altogether via a taxation penalty/reward mechanism, ensuring the control of price inflation in an economy, and thus opportunities to achieve full employment. Importantly, the discretionary power of oligopolistic/monopolistic employers and union cost-push tendencies would be controlled, illustrating the ‘Cambridge Post Keynesian’ sympathies Cornwall has, as demonstrated by his T.I.P proposal.

 


[1] Kreisler, P. & Halevi, J. “Corporatism in Australia.” In: Arestis, P. & Marshall, M. (1995) The Political Economy of Full Employment. Conservatism, Corporatism and Institutional Change. Edward Elgar Publishing Ltd. England. Pg 225.

[2] Willis, R & Wilson,  K. “Introduction.” In: Wilson, K; Bradford, J & Fitzpatrick, M. (December 2000) Australia in Accord: An Evaluation of the Prices and Incomes Accord in the Hawke-Keating Years. South Pacific Publishing. Australia. Pg 1.

[3] Chapman, B. “The Accord as a Macroeconomic Policy Instrument: Influences and Changes.” In: Wilson, K; Bradford, J & Fitzpatrick, M. (December 2000) Australia in Accord: An Evaluation of the Prices and Incomes Accord in the Hawke-Keating Years. South Pacific Publishing. Australia. Pg 231.

[4] Dabscheck, B. “The Accord: Corporatism Visits Australia.” In: Wilson, K; Bradford, J & Fitzpatrick, M. (December 2000) Australia in Accord: An Evaluation of the Prices and Incomes Accord in the Hawke-Keating Years. South Pacific Publishing. Australia. Pg 147.

[5] Willis, R & Wilson,  K. (December 2000) Op Cit. Pg 19.

[6] Chapman, B. (December 2000) Op Cit. Pg 232.

[7] Ibid. Pg 233.

[8] Ibid. Pg 2.

[9] Ibid. Pg 2 &3.

[10] Ibid. Pg 3, 4 & 5.

[11] Ibid. Pg 5.

[12] Ibid. Pg 6.

[13] Ibid. Pg 10.

[14] Hancock, K. (1981) Incomes Policy in Australia. Harcourt Brace Jovanovich Group. Sudney, Australia. Pg 2.

[15] Ibid. Pg 7.

[16] Whitehead, D.H. (1973) Stagflation and Wages Policy in Australia. Longman Australia Pty Ltd. Victoria, Australia. Pg 36.

[17] Hancock, K. (1981) Op Cit. Pg 18.

[18] Ibid.

[19] Ibid.

[20] Solow, R.M. “The Case Against the Case Against the Guideposts.” In: Shultz, G.P. & Aliber, R.Z. (1966) Guidelines, Informal Controls and the Market Place. Policy Choice in a Full Employment Economy. The University of Chicago Press. Chicago, U.S.A. Pg 41.

[21] Ibid. Pg 43.

[22] Ibid. Pg 45.

[23] Ibid. Pg 44.

[24] Ibid. Pg 48.

[25] Friedman, M. “What Price Guideposts?” In: Shultz, G.P. & Aliber, R.Z. (1966) Guidelines, Informal Controls and the Market Place. Policy Choice in a Full Employment Economy. The University of Chicago Press. Chicago, U.S.A. Pg 18.

[26] Ibid. Pg 23.

[27] Ibid.

[28] Ibid. Pg37.

[29] Ibid. Pg 57.

[30] Sawyer, M.C. (1985) The Economics of Michal Kalecki. Macmillan Publishers Ltd. Hampshire, U.K. Pg 111.

[31] Ibid. Pg 109.

[32] Ibid. Pg 112.

[33] Ibid. Pg 119.

[34] Ibid. Pg 121.

[35] Ibid.

[36] Ibid. Pg 142.

[37] Cornwall, J. (1983) The Conditions for Economic Recovery. A Post Keynesian Analysis. Martin Robertson and Company Ltd. Oxford, U.K. Pg 245.

[38] Ibid.

[39] Ibid. Pg 248.

[40] Ibid. Pg 272 & 273.

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  Chris Mouratidis - Promoting Economics.