Inflation is skyrocketing. So where’s my pay raise?

When consumer prices began to soar last year, a union representing European Central Bank staff demanded that their wages rise in line with inflation.

This grassroots effort to peg wages to price increases ultimately failed, but it was inflammatory tricks from the supposed guardians of price stability in the eurozone. Indexation, after all, can determine who is protected from inflation and who suffers from it.

From the ECB’s perspective, it is fortunate that the practice of linking wage increases to the rate of inflation is less common today in Europe than it was in the 1970s. Inflation is rising at an annual rate of 7.5% and the bank is desperate to avoid a spiral in which higher consumer prices beget higher wages, further driving up the price of goods and services. Not indexing wages to rising prices makes these dreaded second-round inflationary effects less likely, but the cost is borne by workers whose purchasing power declines.

However, the longer inflation persists, the greater the pressure to incorporate cost-of-living adjustments into wages. Asking people to simply forgo big pay rises, as Bank of England Governor Andrew Bailey did rather callously in February, won’t be enough. Workers also have some influence at the moment: unemployment in the eurozone is at historic lows and trade unions retain a strong voice on this side of the Atlantic. This week, an influential union representing German steelworkers demanded an 8.2% pay rise.

Workers also have reasons to feel aggrieved. Indexation is widely used in the economy to protect the real value of payments. Companies, for example, frequently insist on escalation clauses, allowing them to pass on increases in raw material prices and other costs to customers. Regulated utilities, telecommunications companies and commercial real estate providers are particularly skilled in this area. No wonder corporate earnings continue to take a toll.

Public pensions are also fairly well protected against inflation. Almost all public pensions in the euro zone are fully or partially indexed, as is US Social Security, which rose 5.9% in 2022, the biggest increase in 40 years.

Retirees can still experience a real squeeze on income due to the lag between when prices rise and when benefit payments rise. This is why French President Emmanuel Macron promised pensioners that their pensions would be reindexed from the summer instead of January. By contrast, UK state pensions have risen this month by just 3.1%, the rate of inflation applied last autumn, less than half the current price increase rate. .

Indexation also plays an important role in taxation, normally to prevent workers from being penalized when nominal wages increase. Boris Johnson’s government, however, last year froze indexation of key income tax thresholds until 2026. higher taxation, which will aggravate the cost of living squeeze. The Treasury is on track to raise more than £20 billion ($25 billion) in additional revenue from the freeze, far more than initially expected.

Manipulating indexation is more stealthy than an outright budget cut, and the UK has shown some talent for it. Consider the funding of English universities: institutions are not allowed to raise tuition fees beyond the current cap of £9,250, so in real terms their funding will fall for another two years. Yet students who borrow from the government to pay these fees are expected to be hit with inflation-linked interest charges of up to 12% until an interest rate cap comes into effect next year.

Of course, the UK government is facing a big bill due to the soaring cost of servicing inflation-linked loans. Index-linked interest payments added £35bn to Britain’s debt interest costs in the year to March, around half of the total, the Office for National Statistics revealed this week. European governments face a similar situation.

One area where indexation remains uncommon, however, is that of wages. Economists and employers would say this is for good reason: beyond the risk of a price-wage spiral in the private and public sectors, linking employee earnings to the cost of living can make it more difficult for companies to adapt to economic shocks or to manage a decline in their own productivity and competitiveness. If all income is protected, there is also less societal pressure to eradicate inflation.

According to the ECB, Belgium, Luxembourg, Malta and Cyprus are the only countries in the euro zone to require that the evolution of inflation is automatically reflected in wage setting. These represent only 3% of employees in the private sector in the euro zone. Around one-fifth of public sector wages in the eurozone are also indexed to inflation.

But such arrangements could become more popular as unions push for cost-of-living allowances. Besides the German steelmakers I mentioned, there is evidence that Spain is re-embracing wage indexation, having largely abandoned the practice following the 2009 recession.

As the war in Ukraine and soaring commodity prices continue to undermine economic confidence and growth prospects, job security, rather than anti-inflationary wage hikes, may be the priority. Going forward, however, falling real incomes could trigger a political powder keg.

Rather than calling on workers to turn down pay rises, governments should encourage companies to reinvest their profits in the production of goods, services, raw materials and clean energy, which in the long run will help curb inflation by rebalancing supply and demand. It is also imperative that they help the poorest to resist the pressure of the cost of living, either through direct tax transfers, a cap on household energy bills or by indexing the minimum wage to consumer prices. . At the same time, stronger enforcement of antitrust laws can help correct the imbalance between companies, which have too much pricing power, and workers, who have too little.

Thanks in part to differences in indexation, the burden of inflation will not be evenly distributed. How long until workers find their voice? Central bankers hope not.

Bloomberg

About Alexander Estrada

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