Summary of WP/92/74
“Wage Claims, Incomes Policy, and the Path of Output and Inflation in a Formerly Centrally Planned Economy” by Gian Maria Milesi-Ferretti
The so-called corporate governance problem of state enterprises in formerly centrally planned economies--the possibility that the behavior of state-owned firms will not be in the state’s best interest--can give rise to excess wage claims and/or capital decumulation if workers and managers try to appropriate a firm’s assets before it is privatized. Insofar as state enterprises account for the highest percentage of total output, these problems can have serious macroeconomic consequences. For example, because the profit tax contributes significantly to government revenue, a redistribution of state enterprise revenues from profits to wages generally implies a worsening of the government’s fiscal position, which, in the absence of a developed market for government bonds, implies higher money creation. Thus, monetary policy becomes endogenous with respect to wage claims. Moreover, if the claims of workers (in the form of wages) and government (in the form of taxes) exceed net output, capital will be run down--for example, when the government imposes an excess wage tax on state enterprises, but this tax does not provide sufficient discipline to hold wage increases below the limit.
This paper provides a simple dynamic framework within which to examine these issues and analyzes the impact of wage controls on the fiscal deficit, inflation, private consumption, and output in the presence of “excessive” wage claims. The latter can lead not only to high inflation, but also to suboptimally low levels of capital and output. Simple incomes policy measures, such as a reduction in the degree of wage indexation, can be effective in reducing inflation and the fiscal deficit if nominal wages do not provide, on average, full protection against inflation, and wage claims are only temporarily high. In the presence of structurally excessive wage claims and full inflation coverage, linking wages to the path of output can help to limit the overall output decline. The endogeneity of monetary policy with respect to wage claims implies that wage controls may be necessary to regain monetary autonomy.