Reder on Wage-Price Policy

Reder on Wage-Price PolicyAuthor(s): Benjamin HigginsSource: The Canadian Journal of Economics and Political Science / Revue canadienned'Economique et de Science politique, Vol. 15, No. 2 (May, 1949), pp. 203-206Published by: Wiley on behalf of Canadian Economics AssociationStable URL: http://www.jstor.org/stable/137725 .

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NOTES AND MEMORANDA

REDER ON WAGE- PRICE POLICY

JN his article on "The Theoretical Problems of a National Wage-Price Policy,"' Dr. M. W. Reder utilizes an approach strikingly similar to that

of my article on "The Optimum Wage Rate,"2 and of the chapters on "Wages and Employment" and "Wages and the Price Level" of the recent I.L.O. study, Wages: General Report.3 Like these studies, Dr. Reder's article treats wage-price policy as a major economic problem, takes into account the monetary-fiscal policies with which wage-price policy is combined, and con- siders changes in wages and prices mainly as factors determining effective demand and supply for the economy as a whole. Yet Dr. Reder appears to reach conclusions quite different from those of the other studies. The latter conclude in general that any level of wages is consistent with full employment without inflation, providing appropriate monetary, fiscal, and price policies are carried through; at the same time they contend that there is always some ''minimum gap" wage rate that will minimize the task of government in achieving full employment without inflation. Dr. Reder concludes that except in "a totalitarian state" which "has only simplicity to recommend it," the pressure of strong labour unions for wage increases means that "we may have either to submit to cumulative inflation, with the ever-present prospect of a breakdown of the monetary system, or periodically check inflation with a depression.

D. W, A.D

IN

0 . 11

Fig. 1

The difference in conclusions arises mainly from the implicit assumptions, economic and political, underlying Dr. Reder's analysis. In order to bring out the economic assumptions, it will be necessary to repeat part of his basic analysis. In Figure 1, the general level of output is measured on the Y-axis and the price level on the P-axis. The curves W1, W2, show the volume of

'Canadian Journal of Economics and Political Science, February, 1948, pp. 46-61. 2The Review of Economic Statistics, May, 1949. 3International Labour Office, Geneva, 1948.

203



204 The Canadian Journal of Economics and Political Science

total output that will be forthcoming at the level of wages W1, W2, and at the various prices indicated on the vertical axis. The curves D1, D2, show effective demand for output in general, with budget deficits di, d2, at the various prices indicated on the vertical axis. With a wage of Wi and a deficit of d1, the level of output is Y,, which is assumed to provide full employment. If the wage rate is raised to W2, the maintenance of full employment requires an increase in the deficit to d2, and a rise in prices to P2. "Consequently," Dr. Reder concludes, "if the government is benit on maintaining full employment it will have to permit increases in the price level whenever the level of money wage rates is raised (given the positive slope of the W curves)" (p. 48).

The first implicit assumption is the one underlying the qualifying phrase contained in the brackets of this quotation. The phrase implies that an increase in effective demand will not bring forth increased output except at higher prices. This assumption may be appropriate to full employment conditions, but need not hold at lower levels of employment. Even with full employment of labour, it is conceivable that excess capacity might be so wide spread that an expansion of output would leave marginal costs constant or even reduce them. If so, the maintenance of full employment would not require higher prices even in Dr. Reder's theoretical framework. However, constant or falling marginal costs for the economy as a whole are unlikely under full employment conditions, and the assumption that marginal costs will be increasing at full employment is probably the most realistic one that can be made. It should be recognized, however, that Dr. Reder's analysis may not apply to wage increases in a less-than-full-employment economy.

Secondly, Dr. Reder assumes implicitly that his "D" curves and his "W" curves are independent, and that a redistribution of income from profits to wages will not alter effective demand. In other words, he assumes that the marginal propensity to spend out of wages is the same as the marginal propensity to spend out of profits. In fact, however, the marginal propensity to spend (at home) out of wages is apt to be higher; in Canada it appears to be nearly twice as high. Thus the level of "D," the effective demand with a given deficit, will tend to rise with the level of wages. In Figure 1, when wages rise to W2, the D1 curve may shift upwards to the position indicated by the curve D1, W2. The increase in deficits needed to offset the wage increase and main- tain full employment is obviously less when the increase in private spending is taken into account.

It should be noticed, incidentally, that Dr. Reder's analysis makes no distinction between spending for capital goods and spending for consumers' goods. The problem of structure of production is ignored. Since by his own confession he is primarily interested in short-run effects, this oversight is quite serious. It cannot be assumed that any ratio of consumers' goods production to capital goods production is consistent with full employment, in the short run, and that, consequently, effective demand and supply can be equated whatever the distribution of increase between wages and profits. Of course, if Dr. Reder assumes that wage increases always bring completely offsetting price increases, so that no redistribution of income between wages and profits



Notes and Memoranda 205

results, the composition of spending need not change, and the problem of structure of production does not arise.

The third and most important implicit economic assumption is that changes in the deficit affect the level of employment only to the extent that they influence private investment or consumption; the direct contribution to income and employment is ignored. In effect, Dr. Reder assumes that increases in the deficit are produced by cutting taxes. This limitation is quite unwarranted, and is crucial to his argument. In Figure 2, the demand for goods and services by the government, and the supply of goods and services to the government, is added to the private demand for and supply of goods and services. The curve "D1 + E1" shows private plus public effective de-

p

(D.# E,: D,- El)

Fig.~~~,O W.E

f.?

Pt -- ----

Fig. 2

mand, and "W1 + E1" shows supply to private plus public buyers. For diagrammatic simplicity, it is assumed (realistically enough) that goods and services bought by government are either produced by the government itself, or bought on a cost-plus contract, so that wage changes do not affect the supply of goods to government. National income is at Yi, which yields full employment. It consists of private spending Ci + II, and public spending E1. Now let wages rise to W2. In the absence of government action (and ignoring effects of redistribution of income), effective supply would now be W2 + E1, national income would fall to Y2, and the price level would rise to P2, according to the Reder analysis. But suppose that price ceilings are rigorously enforced, effective demand is reduced to D2 by rationing, taxes, etc., while government expenditures are expanded until D2 + E2 = D1 + E1, and accordingly W2 + E2 equals W, + E1. Full employment can then be maintained without a rise in the price level, and all that will have happened is that wages will have risen, profits fallen, the public sector of the national income will have expanded to E2, while the private sector will have shrunk to C2 + 12. Con- sidering the general identity between low incomes and wages and between high incomes and profits, plus the enormous scope for useful government expenditures on social welfare and national development, is such a result undesirable on the face of it?



206 The Canadian Journal of Economics and Political Science

This question brings us to Dr. Reder's political assumptions. The first is that government will not be able to persuade employers to accept any "squeezing" of profits. The use of direct price and wage controls, he says, will be thwarted by "trilateral monopoly" conditions in each industry: "The unions will demand that wage rates be increased; if the controlling authority grants the increase the employers will pay it only if the controlled product price is raised" (p. 61). Why? Why should employers not accept lower profits, especially under the "trilateral" conditions posed, which yield a very large area of indeterminacy? Does Dr. Reder think that when faced with a price ceiling employers would stop trying to maximize profits, and would cut output just for spite, or in hopes of forcing governments to remove the ceiling again? Does he envisage a "capitalist revolt" of some kind?

In any case, there is one obvious and simple solution to such a situation: to replace employers who are paid to maximize profits by employers who are paid to maximize welfare, and who would therefore not object to profit being squeezed; in other words, to establish a socialist state. The socialist state is, of course, the logical extreme of the encroachment of government enterprise on the private sector of the economy depicted in Figure 2. Perhaps "socialism" is what Dr. Reder means by "the totalitarian state." If so, he ought to have said so, in order that his readers would know what he meant. Perhaps socialism and totalitarianism are inseparably linked; but not everyone would agree that they are, and Dr. Reder has not himself provided evidence that such a link exists.

BENJAMIN HIGGINS

McGill University.

A FURTHER COMMENT ON WAGE-PRICE POLICY

BEFORE proceeding to the most important question Dr. Higgins raises-the relation of wage-price policy to political structure-I should like to com-

ment briefly on a few analytical issues. (1) The positive slopes of the W curves do not reflect only that marginal

costs (with constant factor prices) increase with national income, but also reflect variations in money wage rates. The evidence would suggest that (where strong unions exist) wage rates do rise with national income even though there is substantial unemployment. However, this is not very important as virtually the whole argument of my paper is conducted on the assumption of full employment.

(2) It is true that the D and W curves are assumed to be independent; but this does not imply that the marginal propensity to consume' out of wages and out of profits is the same; rather it would imply that the sum of the marginal propensities to consume and invest are the same for wage and non-wage incomes. In the absence of more knowledge about the "investment function" I felt (and feel) reluctant to make any specific assumptions about the relation between the

'Higgins speaks of the marginal propensity to "spend," but from the context I would suppose he means "consume."



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Reder on Wage-Price Policy