Wages are dampening inflation, not supercharging it

20 October 2022

Workers are often blamed for inflation. When they irresponsibly demand higher wages, inflation goes up. To fix the problem, workers are disciplined with higher interest rates and higher unemployment.

“You don’t become a low inflation country with high wage inflation and wage inflation is looking pretty high in the United States,” former Treasury Secretary Larry Summers said at a recent conference. He said a recession to bring down inflation was almost inevitable.

The demand for a recession to crush worker wages assumes, first, that wages are driving inflation. It assumes, further, that inflation is the most dangerous threat, always, and that suffering by workers and lower-income people is righteous or at least a tragic necessity.

Both assumptions are questionable. Wage growth is not the main driver of inflation. A recession can easily be worse in terms of human suffering than continued inflation. If we want to lower inflation, we should do so in ways that do not immiserate workers and that make the lives of most people better rather than worse.

Inflation harms middle- and low-income people. Affluent people’s resources are often tied up in fixed-rate mortgages and retirement savings, which are less vulnerable to short-term price hikes.

Low-income people in contrast spend most of their paycheck on immediate needs, like gas, food and shelter, all of which have spiked in price in the last few years. As a result, domestically and globally, high inflation is harming the poorest and increasing inequality.

So controlling inflation is important. But boosting interest rates to slow growth and increase unemployment is worse than the problem.

The 1981-1982 recession, engineered by then-Fed chair Paul Volker, is often celebrated for controlling inflation. For those who lived through it, however, it was a brutal experience. Unemployment rose to 11 percent, the worst figure in the post-World War II era.

Manufacturing industries suffered especially. The construction industry hit 22 percent unemployment. The car industry went to 24 percent. To some extent, they never recovered. Much US productive capacity was abandoned as money flowed into financial industries.

Unions were also weakened in the long term. The recession created a crisis in Latin America, where nations like Mexico had taken out loans in dollars and subsequently were unable to repay. A recession can lead not just to widespread pain as unemployment rises, but to domestic shocks and international instability.

Recessions and inflation harm the most vulnerable. This can feel like an impasse. But currently, the trade-off between high prices and suppressing wages and employment is a false choice. That’s because wage growth isn’t the main driver of inflation.

Analysts at the Center for American Progress point that there is no correlation between wage growth and inflation based on industry. Natural gas, for example, has seen the greatest price acceleration from 2018-2019 to 2021-2022, but wages have fallen slightly.

Workers did experience real wage growth early in the pandemic. But since mid-2021, wages have fallen behind inflation. This means wages are actually dampening inflation pressure, not supercharging it.

If wage pressure isn’t causing inflation, what is?

There are two big drivers. One is the Russian invasion of Ukraine. Russia is a major supplier of oil and gas, and sanctions and production disruptions have caused fuel prices globally to spike.

Ukraine-Russia is an important region in food supply. It supplies 30 percent of global wheat exports and 65 percent of sunflower exports. Sunflower oil shortages pushed margarine prices up 32 percent between September 2021 and last month. Butter rose 27 percent in the same period compared to a 13 percent increase in food overall.

Addressing these inflationary factors is difficult, but the Biden administration has already taken steps to do so.

The omnibus Inflation Reduction Act passed earlier this year creates powerful incentives for moving to green energy, which can address energy costs in the mid- and long-term. The Biden administration is also working to end the war in Ukraine, and to forestall other Russian wars of aggression, by providing aid to Ukraine.

Republicans have framed help to Ukraine as wasteful and useless. But if we want to get gas and food prices under control and stabilize the world economy, the best way is to defeat Putin quickly in such a way that he is deterred from launching further wars of conquest.

Another major driver of inflation is the ongoing covid pandemic. Covid globally affects supply chains. China’s strict lockdown policies have created numerous international bottlenecks.

In addition, the covid creates worker shortages that drive prices up. One study suggested workers disabled by long covid could account for 15 percent of unfilled jobs. There remains a massive shortage of healthcare workers thanks to covid infections and burnout.

Politicians and the public claim to want an aggressive response to inflation. But the pandemic drives inflation. The US has surrendered to the disease, even though it racks up about 300-400 deaths a day.

The world economy is struggling with a global pandemic and a major regional war. There’s no easy or quick way to fix that.

The US should continue to help Ukraine, and it should do more to fight the covid pandemic. But inflicting more pain on workers and the most vulnerable by inducing a recession isn’t the answer.

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