Wage growth does not automatically equate to inflationary pressure…

One of my coworkers tossed out this line today: “We can’t just increase the minimum wage, because that would cause inflation”. I said at the time that didn’t have to be the case, and I just thought I’d capture my reasoning in writing.

Inflation occurs because prices go up. Prices go up because:

a) costs have gone up, putting pressure on the profit margin; OR
b) people are willing to spend more.

When prices go up, that tends to feed back into A – so inflation causes a feedback loop on itself. So a sudden injection of money can be inflationary (because people have more money to spend – reason B), especially if the money is in the form of pay increase, as that’s an increase in costs (reason A).

But – having more money doesn’t mean people have to spend more on the same things – e.g. more on food and other essentials. Instead, they could take the extra money and spend it on new things (or, heaven forbid, save it!). Spending on new things is good – it causes economic growth.

Nor does increase wages have to increase costs. For the last few decades, we have seen salary budgets go up faster than inflation. It’s just not even – the top end of the spectrum has grown faster than the bottom end. Businesses are happy to pay above-inflation wages to upper management, while at the same time keeping pressure on the bottom end. Simply by changing this around, we could see the minimum wage earners grow faster than inflation.

All but one of the greatest economic advances in history have all occurred from increasing the effective minimum wage. Serfdom in Europe was abolished as a result of the Black Plague – manpower became too valuable, and the serfs (those who survived, anyway) could demand high enough wages to break out of feudal dependency. In the early 20th century, industrialists like Henry Ford had a vision of consumerism where people were paid enough to afford the items they made. Henry Ford said something like “the secret to success is to make the best product possible, for the lowest price possible, while paying the highest wages possible”.

The current focus on trying to squeeze costs by controlling the minimum wage (without controlling overall payroll costs) will ultimately be self-defeating. It’s an argument that will continually see low-end wages fall, in real terms, establishing and entrenching the working-poor of the 18th and 19th century all over again. We’re already well down on that path – income disparity is huge, and asset-disparity is even worse, and the problem accelerates every year.

Author: Robert Watkins

My name is Robert Watkins. I am a software developer and have been for over 20 years now. I currently work for people, but my opinions here are in no way endorsed by them (which is cool; their opinions aren’t endorsed by me either). My main professional interests are in Java development, using Agile methods, with a historical focus on building web based applications. I’m also a Mac-fan and love my iPhone, which I’m currently learning how to code for. I live and work in Brisbane, Australia, but I grew up in the Northern Territory, and still find Brisbane too cold (after 22 years here). I’m married, with two children and one cat. My politics are socialist in tendency, my religious affiliation is atheist (aka “none of the above”), my attitude is condescending and my moral standing is lying down.

6 thoughts on “Wage growth does not automatically equate to inflationary pressure…”

  1. “One of my coworkers tossed out this line today: ‘We can’t just increase the minimum wage, because that would cause inflation'”

    Wish I was there for that one, maybe I should start spending lunch with you guys again 🙂

    “income disparity is huge, and asset-disparity is even worse”

    How is this a problem when we are all given access to the same resources? Granted there are some disparities from nepotism and inherited wealth, but at the end of the day everybody is given similar opportunities, invalidating any basis for complaint.

    1. It’s a problem because the disparities from nepotism (and other closed-circle relationships, such as “the old boy’s network”) and inherited wealth are huge, and they build up over time. Yes, people can overcome adversity and escape poverty – in that sense, our economic system is a lot fairer than many that have been tried. But it is almost infinitely easier for a child of high-wage earners to get through high school and university than it is for a child born into a low-income family. The income disparity is huge – the top 20% of income earners bring in just under 40% of the total income; the bottom 20% bring in about 5%. The disparity is growing worse – the ABS figures for 2005-2006 show that the bottom 20% saw effective wage growth of 8% between 2003 and 2006 (a whopping AU$24/week!), the top 20% saw effective wage growth of 13% in the same period. Income disparity in turn leads to asset disparity – poorer people are vastly less likely to own their own home, or have savings for retirement. In the 2003-4 figures, the top 20% of income earners owned 59% of all assets – average net worth of $1.4 million – while the bottom 20% owned 1% of all assets – average net worth of $23,000. In 2005-6, it got worse: the bottom 20% had increased to an average net worth of $27,000 (an increase of 17%), but the top end of town had increased to 61% of all assets – an average worth of $1.7 million (an increase of 21%)!

      If the rich had just stayed where they were, and that wealth distributed downwards, it would have sufficed to buy low-cost housing for the entire bottom 20%, getting them out of rent traps – in just a 3 year period.

      Furthermore, every time the issue of minimum wage rises comes up, the business community argue that it will cost jobs. However, salary increases at the top end don’t seem to cost jobs…

      It is certainly true that simply raising the minimum wage, in a knee jerk fashion, will cost jobs and will be inflationary. However, more delicate reforms could be made to address income disparity – not eliminate it, but to make it less obnoxious. Furthermore, doing so will stimulate economic growth in the long run.

      We should also do more for non-minimum wage jobs, especially government funded ones – teachers, nurses, police & emergency services in particular.

  2. Also, higher paid workers are generally happier and more productive.

    Productivity is what counts (output for cost), not just cost.

    1. Yeah – the IT revolution (which drastically improved productivity) was the economic expansion that was not linked to a rise in wages. Hence why we’re entering a recession with real-wages going in at about the point they were when we left the last one (and it’s worse in the States).

  3. Also, it’s worth putting some numbers in the debate. A FTE employee works 40 hours a week, 52 weeks a year, plus 4 weeks leave – 2240 hours. The FairPay commission recently knocked back a 50c/hour ($21/week) increase in the minimum wage. That would have been about $1000/employee.

    Let’s take BHP – 15426 Australian employees. They could fund that rise simply by not giving their last chairman his $18 million termination payment for bad performance. You wouldn’t see a dint in the $13 _billion_ profit (up 28% from 2007).

    What about Telstra? Good old Sol pocketed $27 million for 3 years. Last year, Telstra made $2.5 billion in profit – I think we can peal off $46 million to give a 50c/hour wage increase. (And just think – 10 years ago, that $2.5 billion would have been going into government coffers; last year was the point where the lost income from revenues matched the amount raised in the selloff)

    What about supermarkets? Woolies – 91,000 employees, $1.01 billion in profit. Coles – 160,000 employees, $540 million. Give the checkout chick a pay raise, and they still return $380 million in profit.

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