National wage agreements have been a major contributing factor in moving the Republic to a high-growth, low-unemployment economy. But now that the economy is at full employment, that economic paradigm has served its purpose and should not have formed the basis of the new Programme for Prosperity and Fairness (PPF).
Wage agreements involved the trade unions accepting low wage increases in return for tax cuts at budget time. This inter-linking of income policy and fiscal policy improved cost competitiveness while stimulating economic output. The resulting economic growth has been such as not only to finance the tax cuts and the increased public sector pay bill but also to reduce the national debt.
This model worked well against a backdrop of excess capacity and high levels of unemployment. But having achieved the objective of full employment, the wage model is redundant and its continued use could have a harmful, destabilising influence on the economy. On the fiscal side of the agreement, the difficulty is that the model is forcing the Government to increase public spending and reduce taxes at a time when it should be doing the opposite.
On the income side, the PPF would appear to be much more costly than any of the previous four wage settlements. The basic pay deal involves a cumulative 15.75 per cent wage increase over 33 months which is double what was on offer under Partnership 2000. Include the guaranteed tax cuts, early settlement incentives and social inclusion clauses, all of which add another 10 per cent, and the overall package is well in excess of what was offered in previous wage agreements.
The fiscal and income policies contained in the PPF amount to a demand-side stimulus combined with an adverse supply-side shock. The result is an ambiguous effect on economic growth and a guaranteed increase in inflation.
The problem with this interpretation, however, is that it is not at all clear that the pay award will actually reduce cost competitiveness. This uncertainty arises because the trade unions have again negotiated for nominal, and not real, earnings. If inflation were to increase over the next three years, then the effect could be to reduce labour costs and actually improve cost competitiveness.
Suppose, for example, the current inflation rate of 3.4 per cent were to persist for the duration of the new agreement, then the real increase in wages would work out at 2.2 per cent per annum. Clearly, inflation can quickly wipe the gloss off the bottom-line pay award. Against a backdrop of full employment, significant gains in productivity and company profitability, real pay increases of this order would not unduly affect competitiveness. By negotiating a nominal pay award, the unions have shifted the issue of forecasting inflation to centre stage. So far, the trade unions record in this regard has been woeful. There have been numerous occasions when inflation exceeded the basic pay award resulting in a decline in real earnings. This happened as recently as the last pay phase under Partnership 2000.
The unions could argue that the Irish inflation rate is determined by the average inflation rate in the EMU zone. The European Central Bank (ECB) has an inflation target of less than 2 per cent and this should be taken as the norm. But this approach is too simplistic as it effectively assumes that domestic factors, such as the PPF, have no bearing on Irish inflation. Because of the pressures building up in the Irish economy it is virtually impossible to say what the inflation rate will be over the next three years.
The trade unions could have bypassed the whole forecasting problem simply by negotiating for real, rather than nominal, wages. Real wages would ideally be related to productivity. Then as the inflation data became available, employers would adjust the figures at the end of each phase of the agreement to ensure real increases for workers. A real wage settlement is also consistent with the Republic's membership of EMU whereas a nominal wage agreement is not. A real wage agreement allows the economy to adjust to favourable or adverse economic shocks.
National wage agreements served the economy well over the last 12 years but, having achieved success, the model has lost its relevance and it is now a flawed paradigm on which to build for the future.
Dr Anthony Leddin is Senior Lecturer in Economics at the University of Limerick.
