Bergström: The limits of wage formation in different phases
Wage formation is always subject to restrictions. The long-term limits are set by the development of productivity and international price increases. These restrictions sometimes have an impact only after major imbalances have developed. They have been expressed in different institutional arrangements. We have seen a number of examples of such arrangements this century, which it may be instructive to study.
The gold exchange standard
applied from 1873 to 1931 except for a period during and after the first world war. Excesses in wage formation led to a loss of gold reserves due to a deficit in the balance of current payments and a consequent policy of restraint and unemployment. There was hardly any corresponding automatic effect in the converse situation.
The gold exchange standard therefore tended towards unemployment and it became too expensive to maintain in countries such as the United Kingdom and Sweden, which abandoned the system and coped with the depression in the 1930s better than the USA, which retained the gold standard.
The Bretton Woods system
which was a feature of the post-war period until the early 1970s was fundamentally gold-based, as the dollar could be exchanged for gold at a fixed rate and the participating countries' currencies had a fixed exchange rate to the dollar.
The difference in relation to the former gold exchange standard was that capital movements were regulated and that there was an international supervisory body in the post-war period that set the rules for loans to countries with deficits and the rules for exchange rate adjustments. These rules made countries requiring loans subject to stringent supervision by the IMF.
Wage formation then had to take into consideration the restrictions imposed by the fixed exchange rate and the balance of current payments. There was an automatic effect that activated sanctions if wage increases developed in such a way as to fundamentally impair competitiveness, leading to a structural imbalance in the balance of current payments.
However, the Bretton Woods system was also lopsided. There were no corresponding sanctions against countries that accumulated surpluses on the balance of current payments by restrictive policies and persistent unemployment, even though Keynes wanted to introduce restrictions of this kind at the Bretton Woods Conference.
The international systems of co-operation, the gold exchange standard and the Bretton Woods system, were focused on price stability as a means to achieve full employment in the somewhat longer term. Prices were also successfully stabilised until the Bretton Woods system broke down in the early 1970s.
The background was and is the idea that low inflation and stability in general - with a balance or surplus in central government finances and foreign trade – leads to maximum sustainable economic growth and full employment.
For those who believe that politicians always act in a disinterested, rational and long-term way, the relaxation of the international restrictions at the beginning of the 1970s did not present a problem.
Of course, it would be possible to design an economic policy for stable prices and full employment while preserving complete national freedom of action! However, the result was chaotic, not least in Sweden.
Initially, the krona was unilaterally linked to the D-mark zone. This was unsustainable due to the difference in the rate of inflation between Sweden and what was then West Germany. In 1977, Sweden went over to stabilising the currency in relation to a trade-weighted basket of currencies. This did not make things easier. In 1991, we moved formally over to stabilisation in relation to the ECU, a basket restricted to the EU Member States.
During this period, we were not bound by any international treaties. The decision was completely in our own hands, subject to self-imposed restrictions on a fixed exchange rate. This could not be sustained. Sweden devalued five times between 1976 and 1982, after which the krona depreciated by around 10 per cent from 1985 to 1987, due to the double weight for the dollar in the "basket of currencies".
Developments were not good therefore during the "free period" from the beginning of the 1970s to the mid-1990s. From 1975 to 1995, the hourly wage for industrial workers rose by 7 per cent per year, while the wage declined by12 Swedish kronor per hour over this twenty-year period in 1995's prices.
What assessment can be made then of the stabilisation policy environment that we are now part of? What are the similarities and differences to previous experiences?
It is one thing to have a floating exchange rate and for the Riksbank to have an inflation target. The inflation target has replaced the fixed exchange rate, as the norm for the social partners on the labour market, for corporate pricing policies, setting rents, etc.
But what view should we take of the international restraints compared with previous conditions?
The stability pact that we abide by, despite being outside EMU, is similar to the Bretton Woods system. It is also lopsided in the sense that there are sanctions against countries that incur budget deficits larger than 3 per cent of GDP. There are no sanctions against countries that pursue restrictive policies, in this way creating budget surpluses. The system is designed to promote growth and full employment through price stability and sound public finances.
This has been the case with all international stabilisation policy pacts and agreements, implicitly as in the gold exchange standard and explicitly as in the Bretton Woods system. As I said earlier, this has been thought to favour fast, sustainable growth and high employment.
The question is whether the stability pact will sometimes actually become an "instability pact"? On two occasions, Sweden incurred budget deficits of over 10 per cent of GDP. Many of the EU Member States have had considerably larger deficits in their central government finances than 3 per cent of GDP. Already during the spring, the stability pact came under strain, when Italy was granted an exemption from its stability plan by the EU.
Strict adherence to 3 per cent might be at the price of rising unemployment and a real decline in GDP. For this reason, there is a special procedure for exceptional situations where exemptions from the 3 per limit may be allowed.
Will the present arrangement, free capital movements, the inflation target and the stability pact, be long-lasting? Hardly, at least not all of its components. I have already raised questions about the EU stability pact.
Capital movements have led to foreign exchange crises almost every year in the 1990s from the Nordic countries and the United Kingdom in 1992 to Brazil this year. It is innocent people – poor farmer and workers and middle class wage-earners that are forced to pay for the mistakes of governments and irresponsibility by banks. The international order for capital movements is incomplete.
Stabilisation policy regimes have typically lasted for a couple of decades. During this period, reality changes revealing problems with the existing arrangements.
The periods associated with free capital movements, the gold exchange standard from 1873 to 1931 and the present arrangement during the 1990s have been and are still associated with mass unemployment and widening income gaps. The exception is employment in the United Kingdom and the USA. The question is whether these undesirable conditions have to do with the regime itself or whether they will pass over after a period of adjustment?
I would very much like to see an international study of economic development before and after deregulation. Deregulation took place at different times in the Untied Kingdom, USA, Germany and Sweden. However, these times can easily be identified; in Sweden at the end of the 1980s. How did GDP, unemployment, inflation, and equality develop before and after these deregulations?
Already a decade after the domination of norm-based policy, when there was a strong emphasis on price stability to bring down high inflation, central bank policies can now be formulated as "flexible inflation targeting", which means that capacity utilisation is taken into consideration in the banks' target functions in one or another way.
There may not be any great difference in practice, but central bank policies are nowadays described in a way that takes into consideration employment and other aspects of capacity utilisation. However, price stability remains the overall goal and responsibility of the central banks.
We are now on the threshold of the first really serious test in Sweden of the success of the low inflation policy. I do not believe for a moment that we shall fail with the inflation target. It will not give way. However, I am concerned about the consequences of maintaining the inflation target. Will unemployment continue to fall?
Major imbalances have developed in the labour market. I can point out some flagrant examples. Only a few of the training places for science and mathematics teachers in the education system are filled. There are a number of other areas with similar imbalances in the public sector.
Science and mathematics graduates can become engineers or work as industrial scientists. The starting salary in teaching is from 14 000 to 16 000 Swedish kronor. Industry offers considerably more and much better opportunities for development, at least for the competent.
Can such imbalances be corrected without sparking off a compensation spiral and wage inflation? The price of failure can be very high. The credibility of a low inflation economy can in fact be very easily lost but it can only be restored very slowly. The Riksbank is therefore anxious to safeguard the confidence that has been attained.
The rating institute Moody’s sets a question mark beside the functioning of the labour market. The same applies to the IMF and OECD. They wish to see changes made in unemployment insurance and in the legislation on security of employment, changes that would be perceived as deteriorations at least by most employees.
The problem is that the labour market can never be a market in the full sense. It is also a social institution, with norms and rules that have ethical roots.
Every trade union has solidarity and greater equality between its members in its programme. There is therefore a conflict between the labour market as a forum for clearing markets and the labour market as a social institution with ethical rules and social norms. During the crisis years in the 1990s, the Government was criticised for its consolidation of central government finances, as the policy of restraint created mass unemployment. However, Keynesianism had lost credibility. And this was a reality. With free capital movements, and central government finances with large deficits, expansion of expenditure would only lead to higher interest rates, while restraint, while creating unemployment initially, would eventually pay off by the stimulation of demand from falling interest rates, which has in fact been our recent experience.
However anti-keynesianism seems to have become rooted in the public mind. There is no other explanation for the bizarre phenomenon of reducing taxes and increasing central government expenditure solely because the budget is in surplus in another way. The surpluses are a result of the cyclical upswing.
It is the real economy – the balance in the national economy – that is to determine levels of expenditure and taxation, not the budget surplus. Perhaps what is happening now can be interpreted as a deliberate recasting of Gunnar Myrdal's slogan from the 1940s: "High taxes and low interest rates" to "Slightly lower taxes and slightly higher interest rates"?
