PROFESSOR RUSSELL ON WAGES POLICY: A COMMENT*

DONALD WHITEHEAD La Trobe University

In his recent article “Wages Policy in Australia”, Professor E. A. Russell made an attack upon productivity-geared wages policy.1 The gravamen of his charge was that advocates of this policy were sacrificing the interests of Australian wage earners because of a pointless insistence upon price stability. He recognized that advocates of the policy had qualified and complicated their recommendations in a number of ways. Nevertheless he believed that they had taken insufficient notice of the adverse by-products of their pres- criptions because they were unaware of their quantitative significance. Accordingly, Russell attempted to construct a quantified account of the operation of a productivity-geared wages policy on the assumption that it worked perfectly: that is, that the rate of growth of average money earnings (not simply minimum awards) moved in line with average domestic prod- uctivity.2 He then sought to show that over lengthy periods the operation of this policy would dramatically reduce the rate of growth of real wages and transfer income away from the wage earner to other income groups, especi- ally rural and urban profit earners. These effects came about in his model because of the upward movement of international prices. Fortunately for those he has attacked, i t can be shown that Russell’s exercise is marred by surprising and serious errors, the effects of which are so gross that, when they are removed, Russell’s calculations merely spell out what has been commonly supposed to follow as a result of the operation of a wages policy of the type he describes.

Writing of the period 1952-53 to 1963-643-one in which many economists believe that a productivity-geared wages policy would have been appropriate -Russell comments:

“The effect of ‘wages policy’ over this period would have been to limit increases in real wages per person to a little over eight per

* I am indebted to Mr. J. Robinson for discussion and to Professor F. G. Davidson for

1 E. A. Russell, “Wages Policy in Australia”, Australian Economic Papers, IV, 1965. 2 Advocates of productivity-geared wages policy have advanced their prescriptions in a

much more flexible form than this model implies. However, it is helpful to accept this caricature of their approach as an illuminating exercise.

3This note is confined to the period 1952-53 to 1963-64 since, as Russell acknowledges, no one has suggested that-in the absence of supplementary measuresstrict pro- ductivity gearing would have been appropriate during the period of the Korean wool boom. However, similar errors of method invalidate Professor Russell’s calculations for the earlier period.

224

comments.

1966 PROFESSOR RUSSELL ON WAGES POLICY-A COMMENT 225

cent in the 11 year period, while productivity was believed to be growing at 1.5 per cent a year.”‘

This conclusion-which is central to his whole argument-is derived in an erroneous manner, is inconsistent with his own calculation of shares and- on his assumptions-is repugnant to common sense.

Russell’s demonstration that the operation of productivity-geared wages policy would have depressed the growth of real wages in an unwarranted manner depends upon his calculation that the domestic price level would have increased substantially even if average money earnings had moved in line with domestic productivity. His calculation of the domestic price level fell into two parts. First, he calculated the increase in money costs that would have occurred if a productivity-geared wages policy had been in operation. Secondly, he divided the resulting index of money costs by the index of domestic output to estimate the change in the domestic price level that would have occurred. His conclusion was that the domestic price level would have risen by 8 . 5 per cent as against an increase in average money earnings of 17.8 per cent. The crucial blunder in the cakulation consisted of adding into the rise in money costs the very rapidly rising value of imports while omitting the rapidly rising volume of imports from the volume side of the index. That is, Russell should have used the index of changes in the volume of goods and services available for purchase within Australia and not the index of changes in the volume of goods and services produced in Australia as the appropriate index with which to divide his index of money costs. In addition, the basic form of his calculations can be improved in at least one other important respect. The price index he wishes to derive is intended as a deflator for money wages, so that the movement in real wages can be calculated and compared with the movement of productivity. Accord- ingly, it is better to remove the price of non-rural exports which remains in Russell’s index of prices and this has been done in the amended calculations in this note.

Set out below in Table I is a revised version of Russell’s calculation. In addition, his original calculation has been included in the Table with the money amounts expressed in dollars to facilitate comparison; the indexes of changes in volume, direct costs, work-force, productivity, and real wages that were implicit in his original calculation have been included also. In the corrected calculation, the opportunity has been taken to incorporate revis- ions to the underlying data but i t must be emphasized that these revisions are not in themselves quantitatively important in their bearing upon the calculation of changes in the price level during this period.

The result of the revised calculations is that under the assumptions of the model the domestic price level would have risen by 2.7 per cent over the 11-year period. This price increase was’ caused by a deterioration in the

4 Op. cit., p. 21.

226 AUSTRALIAN ECONOMIC PAPERS

TABLE I

The Price Effects of a “Wages Policy” in Australia, 195264

Part A: Russell

1952-53 1 Actual $M

Direct Costs Wages and Salaries Imports of Goods and Services Farm Products Sold in Australia

Total Direct Costs

D W Costs Volume G.N.P. Prices Workforce Money Wages Real Wages Domestic Productivity

4,240 1,200

700

6,140 Index Nos.

100 100 100 100 100 100 100

Part B: Revised Russell

Direct costs Wages and Salaries Imports of Goods and Services Farm Products Sold in Australia

Total Adjusted for mark-up Minus Non-rural Exports

Total direct costs

Direct costs Volume O.N.E. Prices Workforce Money Wages Real Wages Domestic Productivity Effective Productivity

1952-53 Actual 8M

4,238 1,204

732

6,174 7,983

376

7,607 Index Nos.

100 100 100 100 100 100 100 100

1963-64 under “Wages Policy“

SM

10,050 Index Nos.

163.7 150.9 108.5 128.1 117.8 108.6 117.8

1963-64 under “Wages Policy”

8M

6,923 5667 1,004

10,594 13,698

520

13,178 Index Nos.

173-2 168.7 102.7 131.6 124.2 120.9 124.2 119.8

DEC.

Note: The methods used to obtain the results given in this table are explained in the Appendix.

1966 PROFESSOR RUSSELL ON WAGES POLICY-A COMMENT 227 terms of trade, which resulted in a greater volume of exports being required to pay for imports, thus reducing supplies to the domestic market in relation to incomes generated. Thus, as a result of the operation of productivity- geared wages policy during this period, real earnings would have risen in line with effective productivity, which is what wages policy theorists and-if I understand him-Russell would accept as a rule of thumb measure of equity. The price level would have been almost completely stabilized, no unwarranted redistribution would have taken place from the wage earners and, in general, the policy prescriptions of the advocates of wages policy are completely vindicated by the results of the exercise. Russell has been hoist with his own petard.

There are two reasons why it is surprising that Russell did not realize the basic error in his calculations. First, he appears to attribute domestic price increases in his model to rising international prices. However, in the period 1952-53 to 1963-64 the price of exports fell by 11 per cent and the price of imports rose by 11 per cent so that on balance their effect on the domestic price level was likely to be small.6 Secondly, Russell’s conclusion about real wages is di5cult to reconcile with his calculation concerning the effect of wages policy on the shares of national income during this period. He calcu- lated that if wages policy had been in operation the share of wages and salaries in national income would have remained constant rather than in- creasing by an additional 2 per cent at the expense of farm income.6 There seem to be errors in his calculation of shares, but for the present purpose the important point is the contrast between his two main conclusions. On the one hand, he suggests that wages policy would lead to a modest failure to increase wages share in national income by two per cent. On the other, he suggests that wages policy would have caused real wages to advance by only half average domestic productivity.

Although Russell has completely mis-represented the influence of wages policy proposals for real wages, he is undoubtedly right to call attention to the problem of rising international prices for the workings of wages policy- just as most advocates of wages policy have done. The point is that over the period with which we are concerned, the attempt to move Australian earn- ings so that Australian price movements conformed with relevant inter- national price movements-presumably some ratio of Australian export and import prices-would have led to wage movements similar to those pres- cribed by advocates of productivity geared wages policy. On the other side of the ledger it is important to see what Professor Russell has omitted. It is

5These changes in export and import prices are based on the series published by the Reserve Bank. If the “implicit” indexes in the National Accounts are used the point is strengthened. According to these series, export prices fell by 10 per cent during the period, while import prices rose by only one per cent.

6 O p . cit., p. 22. G1

228 AUSTRALIAN ECONOMIC PAPERS DEC.

difficult to see how any one can be under the misapprehension that advo- cates of wages policy are pursuing price stability simply and solely for its own sake. Most of them have made it abundantly clear that they wish to achieve greater price stability primarily as a means of achieving more rapid and more stable growth by averting the need for credit squeeze policies. It is difficult to believe that their real wages would not stand a good deal higher today if the two credit squeezes of the period could have been avoided. This is apart, of course, from the inequity and suffering that is borne by a small group of workers when such anti-inflationary weapons are employed. Wages policy is advocated primarily because it is a more effective, less costly and less inequitable instrument for controlling cost inflation than monetary and fiscal policy.7 If Russell prefers these methods of controlling the economy he should note explicitly the costs of his chosen policy instruments. Certainly he must state his preference or suggest an alternative instrument, since the minimum award rises that he considers so benign do not appear blameless in the cycle of cost inflation and credit squeeze.

7 There are, of course, merits in wages policy other than the avoidance of cost inflation. ProbabIy one of the most important and neglected is the contribution that it can make to more harmonious industrial relations. This contribuion can occur in at least iwo ways: first, by the avoidance of discontent due to price increases following inflationary wage increases; secondly, by ceasing to encourage industrial pressure through granting higher award wages because of the higher prices and average earnings which are themselves the result of industrial pressure for non-award wages.

1966 PROFESSOR RUSSELL ON WAGES POLICY-A COMMENT 229 APPENDIX

NOTES TO TABLE I Part A

All series in this part are taken directly from Russell’s article, except that (a) money amounts are expressed as dollars and (b) the index numbers relating to changes in direct costs, volume of G.N.P., work force, real wages and domestic productivity, which are implicit in Russell’s calculations, have been made explicit. Part B

1. The money values of wages and salaries, imports of goods and services, and farm products sold in Australia differ from those in Part A in that (a) the latest estimates have been used, and (b) actual changes in productivity have been used as the index to which wages and salaries are geared. In respect of (b), it may be remarked that Russell’s procedure of adopting a 1.5 per cent per annum estimate of productivity growth seems difficult to justify. Since his purpose is to trace the effects of a perfectly functioning wage policy, it is odd that he incorporates in his calculations a systematic underestimate of productivity growth. Moreover, even if productivity were understated for the purpose of wage determination, this understatement would not affect the volume index, since what is relevant here is the growth that actually occurred, not an ex ante estimate of growth.

2. Values of wages and salaries, imports and exports in 1952-53 are taken or derived from the Australian National Accounts: National Income and Expenditure, 1948-49 to 1964-65. Estimates of changes in the volume of G.N.P. and the various implicit price indexes are calculated from the same source.

3. Wages and salaries in 1963-64 = wages and salaries in 1952-53 adjusted for the increase in real G.N.P. The increase in real G.N.P. is calculated by reference to the increase in the work force and the increase in domestic productivity. The method of calculation is identical to that used by Russell.

4. Imports of goods and services refer to goods and services which enter the Australian price level: imports f.o.b., transportation and “other imported goods and services”.

5. Farm products sold in Australia in 1952-53 = gross value of rural production less seed and fodder and exports of rural origin. These series are taken from Trends in Australian Rural Production and Trends in Australian Rural Exeorts (both published by the Bureau of Agricultural Economics).

6. Farm products sold in Australia in 1963-64 = farm products sold in Australia in 1952-53 adjusted for changes in the volume of farm products for food use consumed in Australia (Commonwealth Year Book 1965, p. 1240) and for changes in the domestic price level as calculated in Table I.

7. A constant mark-up has been applied to Australian costs, but not to exports, which already include a profit component.

8. Exports of goods and services refers to those domestically produced goods whose costs are included in the total of direct costs, i.e., exports f.o.b., transportation and “other goods and services” less exports of rural ongin.

9. The workforce is the number of wage and salary earners in civilian employment as stated in the Monthly Review of Business Statistics.

10. The index of domestic productivity is the index of G.N.P. per head of the workforce in 1959-60 prices.

11. The index of effective productivity is the index of domestic productivity adjusted for changes in the t e r n of trade. The terms of trade are calculated from the Reserve Bank indexes of import and export prices.

t

G2