Wage indexation: Social benefits and private incentives

The question addressed in this paper is: Do social benefits from wage indexation coincide with private incentives to incorporate COLA clauses in union contracts? In general, market forces provide an “approximately correct” solution so that legislative remedies are not required. Based on the work of Gray and Fischer, full indexation is beneficial when the economy is subjected to stochastic nominal shocks, but only partial indexation is optimal when real disturbances dominate. If unions and management of firms are risk-averse they both have an incentive to adopt full indexation when monetary uncertainty exists. On the other hand, when the economy faces real shocks, union negotiators oppose indexation if the demand for labor is elastic, but insist on full indexation if demand is inelastic. Managers of firms prefer nominal wage contracts in either case. This suggests that both parties will agree to omit COLA clauses in the first case, but are likely to compromise with partial indexation in the second case. A role for government intervention is indicated only to the extent that bargaining strength may dictate a degree of indexation that deviates from the social optimum. The analysis is extended briefly to other assumptions about the utility function of the two parties at the bargaining table.     

GENERAL WAGE ESCALATOR CLAUSES AND THE INFLATION UNEMPLOYMENT TRADE OFF

The purpose of this paper is to determine empirically the effect of general wage escalation, which is practiced in Israel, on the inflation unemployment trade off. Wage escalation is introduced by including a cost of living allowance variable in the wage equation which turns out to be very significant. It makes the long run Phillips Trade off relation much more inflationary, but does not obliterate it. A comparison with a wage price block for the U.S. suggests that the long run trade off is more inflationary in Israel and that wage indexation is one of the reasons for this bias.     

THE IMPACT OF LABOR CONTRACTS: EVIDENCE FROM BRAZIL

The conventional Keynesian model suggests that frictions created by nominal wage contracts generate a positive relationship between inflation and output. On the other hand, the New Classical/Real Business Cycle theory claims that firms and workers base their employment behavior, and hence output, on the marginal product of labor ignoring the efficiencies of fixed nominal wage contracts. Using Brazilian data, where nominal wages were indexed by law, tests show that fixed nominal wage contracts insignificantly affected output. Thus, the data support the view that fixed nominal wages play an insignificant role in determining the evolution of output. ( JEL E31)     

ISLANDS, INDEXATION AND MONETARY POLICY

This paper develops a synthesized macroeconomic model that incorporates the local-global informational asymmetries of an "islands" economy into a setting characterized by endogenous wage indexation. In such an economy, agents are unable both to filter out the separate influences of demand and supply shocks on observed output prices and to distinguish between the separate price effects of local and aggregate disturbances, so that optimal wage indexation depends upon both the variances of supply and demand disturbances and the information-conditioned forecasts of agents. As a result, optimal monetary policy generally depends upon the variances of local and aggregate supply and demand.     

Labor market contracting and wage dispersion

This paper uses a variety of data sources to document the effect of long-term contracts (LTCs) on wage dispersion. The paper first shows that LTCs are responsible for the decrease in wage dispersion observed as labor markets tighten; absent LTCs (as in most other advanced nations outside North America), this effect does not exist. The paper next examines the relationship between cost-of-living escalators (COLAs) and wage dispersion. COLAs are typically found only in those countries that rely on LTCs, although the incidence of COLAs in these nations is affected by inflation variability. Thus, in the United States, COLAs became much more prevalent in long-term contracts during the 1970s, which caused an increase in wage dispersion, particularly between the union and nonunion sectors. The paper concludes that, despite some suggestions that we ban LTCs and COLAs because of their perverse effects on wage dispersion and other economic outcomes, such a ban would be unwise in light of historically high levels of industrial strife in those nations that rely on these contractual devices.     

Nominal wage rate revisions and measured compensation against anticipated inflation

With discontinuous, front-loaded, revisions in nominal wage rates during wage contracts, compensation against anticipated inflation requires a coefficient α on anticipated inflation in Phillips-type equations α=(2n − 1)/2n, where n is the number of wage revisions. Finite n implies α<1 despite the complete absence of money illusion. In a multiperiod context, conventional equations produce values of α which exceed (fall short of) unity during periods of decelerating (accelerating) inflation — α will approximate unity during constant inflation. A modified Phillips equation is proposed which removes this sample specificity but maintains the dependence of α on n. I am indebted to Clive Southey and an anonymous referee for helpful suggestions.     

UNCERTAINTY AND STICKY-DOWNWARD BUT UPWARD-MOBILE WAGES

The usual search models of unemployment hold that firms do not offer wage cuts to employees in time of slack demand because the employees have alternatives open to them at wages higher than the reduced wage that would be required to maintain full employment. This paper extends these models by considering employees as choosing in conditions of uncertainty and showing that refusal to accept a wage cut is often rational in the absence of a higher alternative wage. Additional implications are derived for union behavior and simultaneous inflation and unemployment.     

Uncertainty and front-end loading of labor agreements

Uncertainty of future prices is offered as an explanation for front-end loading of real wages in nominal wage contracts. Exploitation of mutually beneficial gains from trade between risk-neutral employers and employees implies an expected future real wage that is lower the greater is the uncertainty of future prices, and the observed extent of front-end loading is consistent with plausible values of uncertainty of future prices. I would like to thank, without implicating, M. L. Burstein, George Fallis, and an anonymous referee for helpful comments.     

LABOR MARKET SHARE CONTRACTS WHEN THE FIRM HAS TWO VARIABLE INPUTS

This paper extends Weitzman's analysis of share contracts. Firstly, a second variable input is introduced into a firm's production technology. Some share contracts give the firm an incentive to reduce worker compensation by manipulating the second variable input. This implies that contracts which possess this property cannot support the same long-run equilibrium as would be achieved with a wage contract. Secondly, a positively sloped labor supply curve is introduced. It is shown that while share contracts reduce involuntary unemployment, they may not reduce total unemployment vis-a-vis wage contracts. The paper identifies the factors which determine relative employment variability.     

Organizational Uncertainty and Labor Contracts in China's Economic Transition

Lifetime employment was a cornerstone of the Chinese socialist system constructed under Mao. In this system, organizations served the function of social security, and as a result, many organizations were overburdened with bloated work forces and retirees that drew from organizational coffers well into old age. Labor contracts fundamentally alter this system, as they allow firms to end the socialist institution of lifetime employment. Yet there is significant variation on the institutionalization of labor contracts in organizations. Based on a sample of 81 firms in industrial Shanghai, I show that organizations that are experiencing uncertainty in the economic transition are more likely to institutionalize labor contracts on an organizationwide basis. There are two types of organizational uncertainty in the economic transition: economic uncertainty and administrative uncertainty. In cases of economic uncertainty, firms that lost money in 1990 and firms that are burdened by large forces of retired workers are more likely to place their workers on labor contracts. In the case of administrative uncertainty, firms that are at the highest levels of the industrial hierarchy are also significantly more likely to place their workers on labor contracts. Although these upper level firms were the most protected under the command economy, they are being forced to handle the greatest among the responsibilities in the economic transition, and as a result, they experience the greatest sense of being set adrift by the state.     

TRADING UNCERTAINTY, ENFORCEMENT AND LABOR UNIONS

It is shown that when contracts can be perfectly enforced, trading uncertainty leads to discrimination among workers with the same skills and experience. In this case anti-discrimination laws lead to inefficiencies. In the absence of perfect enforcement, anti-discrimination practices may be used as enforcement devices and need not lead to inefficiencies. In particular, firms may wish to precommit to an anti-discrimination policy, say by inviting in a labor union, in order to offer credible insurance to its workers. This leads to an equilibrium in which union workers get a higher wage than non-union workers, but unions do not have monopoly power.     

A test of uncertainty,expectations, and error response in two strike models

An information-uncertainty form of the Hicks strike model is used to test earlier work on the role of forecasts and uncertainty in determining strike activity. The expected zero coefficients for economic forecasts appear in preferred equations, but the expected positive coefficient for inflation uncertainty often appears as significantly negative. Alternative formulations and reasoning make the results appear somewhat more plausible. The performance of the Hicks model is contrasted with an updated Ashenfelter and Johnson model, which performs and predicts well without any untidy coefficients. Both models predict better than naive forecasting. Certain data and concept refinements are added to the testing of both analyses to bring them closer to the spirit of their models and to established research in wage determination and macroeconomics.     

INFLATION DYNAMICS AND SUBJECTIVE EXPECTATIONS IN THE UNITED STATES

We estimate a forward‐looking New Keynesian Phillips Curve (NKPC) for the United States using data from the Survey of Professional Forecasters as proxy for expected inflation. We obtain significant and plausible estimates for the structural parameters independently of whether we use the output gap or unit labor costs as a measure of marginal costs. Moreover, when estimating a Phillips curve where lagged inflation enters due to price indexation by nonreoptimizing firms, we obtain significant parameter estimates of the sign predicted by theory independently of the marginal cost measure used. (JEL E31)     

WORKER EFFORT DECISIONS AND EFFICIENT GENDER—SPECIFIC WAGE—TENURE PROFILES

Despite theoretical arguments that predict the opposite, empirical estimates of workers' returns to tenure tend to be greater for female than for male workers. This paper develops an agency model of wage contracts to explain this empirical finding. If male and female workers differ only in the expected length of their working lives, efficient wage-tenure profiles are steeper for women than men as a direct result of their shorter working life. This result implies that returns to tenure for women and men will become comparable as women's and men's labor force attachments converge.     

INFLATION DYNAMICS AND LABOR MARKET SPECIFICATIONS: A BAYESIAN DYNAMIC STOCHASTIC GENERAL EQUILIBRIUM APPROACH FOR JAPAN'S ECONOMY

Which labor market specification is better able to describe inflation dynamics, a widely used sticky wage model or a recently investigated labor market search model? Using a Bayesian likelihood approach, we estimate these two models with Japan's data. This article shows that the labor market search model is superior to the sticky wage model in terms of both marginal likelihood and out‐of‐sample forecast performance, particularly regarding inflation. The labor market search model is better able to replicate the cross‐correlation among inflation, real wages, and output in the data. Moreover, in this model, real marginal cost is determined by both hiring cost and unit labor cost that varies with employment fluctuations, which gives rise to a high contemporaneous correlation between inflation and real marginal cost as represented in the New Keynesian Phillips curve. (JEL E24, E32, E37)     

WAGES,EMPLOYMENT, AND STATISTICAL DISCRIMINATION: EVIDENCE FROM THE LABORATORY

We report results from laboratory experiments designed to examine statistical discrimination. Our design expands upon existing research by generating data both on wage contracts and unemployment rates of directly competing worker groups. We find some evidence for statistical wage discrimination against workers having an identical expected productivity but a higher productivity variance. However, those same subjects are less likely to be unemployed, suggesting that our employer‐subjects view hiring choice and wage contracts as substitutable. A clear implication is that field data discrimination estimates based on wages alone may overestimate the true impact of such discrimination. (JEL C90, J71)     

UNCERTAIN EFFECTS OF MONEY AND THE LINK BETWEEN THE INFLATION RATE AND INFLATION UNCERTAINTY

In the postwar period high rates of inflation are associated with high levels of inflation uncertainty. In this paper I argue that the inflation rate and inflation uncertainty are linked by forecasters' uncertainty about the impact of money growth on the price level, and I present evidence indicating that this has been the case. As long as the impact of money growth on the price level remains unpredictable, then even predictable money growth will cause inflation uncertainty with its accompanying adverse effects on employment and output.     

Understanding political pricing of labor services: The Davis-Bacon Act

Examples of divergence between the intended (stated) and actual consequences of government intervention in the marketplace abound. In this paper, two legislative attempts to specify wage rates on government contracts are analyzed. The Davis-Bacon Act has been successful in forcing government contractors to pay the prevailing union wage rate. In contrast, the Walsh-Healey Act has been ineffective in establishing minimum wage scales on most government contracts. Analysis indicates that the success of one and the failure of the other is due to differences in enforcement costs, special interest group support, the concentration of opposition, and the narrower scope of Davis-Bacon.     

CENTRAL BANKING AS A POLITICAL PRINCIPAL-AGENT PROBLEM

Due to their ties with elected leaders, central bankers may pursue policies that are not in society's best interests. Consequently, the relationship between the public and the central bank can be characterized as a principal-agent problem. An inflation and stabilization bias arise as a result of this agency problem and the magnitudes of these biases depend on the political environment. Various institutional proposals for eliminating these biases are examined, and we find that central bank independence and performance contracts work best. However, we argue that central bank independence is preferable for resolving the agency problem.     

Minimum wage effects by gender

Recent criticisms have led some to dismiss time-series analyses in the debate over the minimum wage. We investigate previous time-series studies showing that raising the minimum wage has a smaller impact on females than males. We reanalyze the data in light of recent developments in time-series methods and find that the minimum wage has a similar significant negative impact on both males and females. We conclude that, following a 10 percent increase in the minimum wage, both male and female employment drops from between 2 and 4 percent over a two-year period. This employment decrease slowly erodes as economic growth and inflation cause the minimum wage to fall below the market-clearing wage. We thank David Card and Alan Krueger for generously providing the data.