Wage Claims, Incomes Policy, and the Path of Output and Inflation in a Formerly Centrally Planned Economy


WP/92/74-EA

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 redistri-
bution 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.