How does raising wages worsen inflation ?
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The theory is that higher wages -> everyone has more money -> everyone can spend more -> everyone can have higher prices because everybody has more money.
In practice, this isn’t really backed by any real data and it’s doubtful that it would go that way.
edit: Too many replies to answer them. Yes I know that there is some correlation between wages and prices, if you pay everyone 10x their current wage, you will have to raise prices.
It’s a psychological effect as much as an economic one. The incredibly oversimplified version goes something like this:
The bread maker needs more money to pay himself and for the rising cost of his ingredients, so raises the prices.
The person that delivers the ingredients now needs more money to buy the bread, so wages increase and now needs to charge more for delivery.
As the bread maker now needs to pay more for delivery, they raise the price of their bread…
And repeat.
This is the theory that some may talk about that you may be addressing here, but there are deeper aspects than this and it rarely works out this way in real life in the way theory works. It’s not always even or as simple as this so keep it with a grain of salt but…
The cost of living in my area increases. An employee wants to work at a certain bar, but the employee group in their area cant afford to live there anymore even if they wanted to because they cant afford rent/living with the wage the bar is offering. It isn’t economically feasible for them to work at that bar anymore. So now a place has to increase wages to convince anyone to work for them. Since they have to increase wages for their business, they suddenly don’t know how they can keep their business at the same profit so they now “need” to increase their prices if they want to keep their same profits or increase them.
That’s more of a small business aspect of it and not as complicated as it may be on a corporation scale. Greed is definitely a debate that can and does happen in the real world and would depend on a case by case basis
There might be something missing in your question. In theory, if you own a small business, making some money in profit and you want to raise your employee’s wages, you are increasing the cost of running your business, and that money has to come from somewhere.
So you have three options:
1. Just make less profit. So the extra wages come from your profits. Your employees get better wages, and you make less money.
2. Cut costs elsewhere. Maybe get rid of some of your staff and pay the rest the extra money. Maybe stop using those high quality ingredients and start making a lower quality product. Maybe invest in technology (e.g. assembly line) that reduces the overall cost of your production.
3. Raise prices. You can pay the extra wages by raising prices of your product. That way your employees get paid more, and you’re still making the same amount of profit. If everyone does that, it might lead to inflation.
Generally 2 is not an option. It is very situational and requires creative solutions. And in most cases, if that solution existed, it would have already been applied BEFORE the need to raise wages, simply because it increases profits and why wouldn’t you have done that in the first place. Businesses generally want to run as efficiently as they can, so Option 2 is rarely available.
This leaves options 1 and 3. So what’s missing from your question? Profit. Your question *could* be “How does raising wages **without affecting profits** worsen inflation?” And the answer is that goods have to be priced higher in order to cover the costs of the extra ~~profits~~ wages, which can lead to inflation. You COULD in theory increase wages without causing inflation, but that would then lead to a loss of profit.
So the underlying issue here is that “people want to maximise profit” is considered in many economic discussions as a fact of life. We start from the assumption that everyone is trying to maximise profit, and then see what options are available then. In such a system, when “maximising profit” is the foundation of your economic system, yes raising wages will lead to higher prices of goods.
But “people want to maximise profits” is a fact of life in the same way that “people eat meat” is. Yes, it’s true, but it can change. It’s just that changing it requires such a massive system-level upheaval alongside a deep cultural shift, that people are unlikely to take it on any time soon. So for the time being, we will continue to play this tug of war over profits vs wages. People will continue to work for as little as possible in order to maximise profits, and every once in a while, when things get real bad, they fight for a bigger share.
Disclaimer: Just for the record, I’m aware that I wrote all this like I know what I’m talking about. But I’m no expert. This is just a lay person’s best guess as to what is happening, and things are always more complex than that. But this is ELI5 afterall…
Edit: fixed a couple of typos.
The simplest way to describe it is “more money chasing the same amount of goods”. If supply stays constant and demand increases, prices increase.
It’s a ton more complicated than that, and there’s something to be said about how incredibly stagnant real wages have been for the last half-century, especially measured against productivity gains. There are worse things in economics than inflation.
You have 5 apples. Last week only 5 people could afford 5 apples, so the apple tree guy only picked 5 apples. Now 9 people can afford apples. The apple tree only produces 5 apples a day, but he needs 9. Either the price goes up to price out 4 people or the apple tree guy needs to grow more apples. If he can make more money with less work, then why not raise prices if the demand for apples is exceeding supply.
The opposite is true too. If I’ve got 5 apples that will be worth nothing in a week and only 2 people buy them, then I have to reduce my price to increase demand.
It generally doesn’t. But it’s complicated.
So ‘inflation’ is the baseline cost for a basket of goods. The underlying assumption here is that, given a free market, that supply will always match or outpace demand. And ‘raising wages’ begs the question ‘which wages’. Are you raising minimum wage? Are you raising wages for high wage workers because of labor shortages?
The goal here is to to raise the wages of people who can’t afford to buy that basket of goods to expand the economy (which will presumably add jobs, exports, etc.) and not as much the wages of the folks that *can* afford the basket of goods because they’ll over-consume. And in the process to have policies that ensure that goods and service producers won’t rent seek off of the new money in the economy.
Currently, wages are only responsible for 5% of inflation, 40% is increased costs of materials, and 55% is profits. That’s not normal. Normally, it’s 65% wages, 25% materials, 10% profits. When most of the inflation is returning to workers, you generally end up closing wage gaps. The folks up the income ladder can afford to absorb the inflation – a lot of wealth is non-productive anyway, so returning it to the economy is actually beneficial, and the folks down the income ladder can afford to buy goods they previously couldn’t afford. The inflation were coming out of just cycled money back to the investor class.
And inflation can be hard to pin down. A lot of the last wave of inflation was just gas prices and rent. The former had no relationship to wages, and the latter didn’t either. It’s not that contractors are lacking workers to build houses, they don’t even lack capital to build. They lack permission because cities are refusing to zone for new construction. Even food price increases aren’t really wage either, but lack of water in California forcing farmers to fallow fields. Inflation for eggs is due to the avian flu killing so many chickens, that’s also not labor related. You do have wage related inflation in things like fast food, but that’s a pretty small part of the basket of goods.
Inflation can be caused by a myriad of factors. One of many is raising wages above productivity increases. It’s unfair and incorrect to say that raising wages is always the main cause of inflation, it can be a very minor factor and even be completely counteracted by other factors. However, it’s pretty naïve to think that raising wages flat-out doesn’t cause inflation.
https://www.investopedia.com/terms/i/inflation.asp
In theory yes. But the opposite can also lead to inflation.
Raising wages causes inflation by companies raising prices because the metric to calculate the price of a product changes when consumers get richer, namely the “how much are they willing to spend” metric. If the customer is willing to spend more, charge more. Thus, inflation rises.
However, lowering wages causes inflation because people are buying less, and therefore companies are selling less, so therefore have to raise prices to break even. Of course there are other things they can do like the infamous “shrinkflation”, wherein the price remains the same, but the size of the product decreases.
Basically, it’s a bit rough and nebulous… unless either reach a critical level, there is no point worrying about whether wages are going to cause inflation, because in all likeliness, they’re probably not…
A great example is *right now*. The economy is in a very weird position that it hasn’t really been in before. Obviously we are in a period of high inflation. The trick governments around the world use is to tighten money through measures like raising interest rates and an easing of supply shortages to start. This round of inflation is mostly due shortages (chips, cars, labor, some commodities). If that doesn’t work then a recession will be engineered to dampen (or reverse) wage growth, ease demand, and in effect reset the economy. Historically periods of high growth lead to inflation and the only tried and true way to stop it has been to cool off the demand side through some form of austerity.
The problem is, wage growth has been stagnant for at least a decade… And austerity has been in place for many people already… And shortages are mostly gone, but prices have not gone down… so there is “nothing to reign in”… It’s already at the lowest point it can go, and we’re still inflating… So governments around the world are basically asking people to accept a massive L for yet another decade, while coincidentally corporations are raking in massive profits. Basically, you can’t apply austerity to people who already have the austerity debuff… *That* causes lots of problems.
Lots of governments ignored this though, and decided to press on with Austerity 2.0 (or even 3.0+ in some countries) making people poorer, angrier, and more radical. Which sounds like “okay, this sucks for everyone. But it could be a necessary evil, right?” Well, maybe… But then you realize that pretty much all corporations are posting record profits… The rich are certainly getting richer. So why aren’t we?
What I’m *trying* to say is, the usual tricks governments have isn’t going to work, because the people they do the trick on are already milked dry. Attention has turned to the greed of corporations as being the cause of the inflation, and of course, politicians are hesitant to act and punish the rich and powerful… Because they’re rich and powerful… And of course, every day people are gaslit into advocating for faceless billionaires because… ???? So there isn’t even a majority national feeling anywhere that greed needs to be reigned in…
It doesn’t really, at least not for long. it is a myth. What it does is redistribute inflationary impact.
Inflation over time is due to increases in the money supply that exceeds the increase in goods and services to buy (stuff to spend it on). Like if you snapped your fingers and doubled everyone’s bank account, eventually things would just cost twice as much. That is the source of inflation. Money supply can be changed for a couple of reasons, but wage price spirals is not one of them.
The idea behind wage price spirals is that workers see inflation, demand higher wages to offset, businesses cave and then raise prices to pay for the high wages, resulting in more wage demands and higher prices again. This concept is rooted in anti-union rhetoric.
What actually happens is that competition will cap price increases and the wage increases get taken out of business margins. Other than competition, there is also a relative redistribution of purchasing power from business owners and non-workers to workers. Total demand in the economy doesn’t change, supply doesn’t change much (maybe a bit upwards since more people join workforce), it’s just that workers get to enjoy more relative to everyone else.
Wage price spirals are not positive feedback loops – they are negative feedback loops. Businesses can’t raise prices forever and people who don’t work don’t benefit from higher wages. Any wage-price spiral is short term in nature and self-correcting, though it might take a few quarters to sort out.
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