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

IMF Working Papers, September 1, 1992

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The corporate governance problem of state enterprises in former socialist economies can give rise to excessive wage claims and/or capital decumulation.
The paper highlights dynamic links between wage behavior, the fiscal deficit, inflation and the capital stock.
Wage controls are analyzed as a response to the corporate governance problem.
Key result: in the presence of excessive wage claims, a system of wage controls can help to limit capital decumulation and reduce inflation because wage moderation implies higher government revenues from the profit tax and therefore lower money creation.
More specifically: when wage levels are initially excessive a reduction in the degree of wage indexation is effective in lowering inflation if nominal wages do not provide, on average, full protection against future inflation.

Corporate governance deficiencies → excessive wage claims and/or capital decumulation.
Excessive wage claims affect:
- Fiscal deficit (through lower profit tax base and potentially higher transfers).
- Inflation (via increased money creation to finance deficits).
- Capital stock (via capital decumulation when enterprises fail to retain earnings or invest).
Wage controls and lower wage indexation operate through:
- Wage moderation → higher profits → higher government revenues from profit tax.
- Higher profit tax revenues → lower need for money creation → lower inflation.
Condition for effectiveness of reducing wage indexation:
- Nominal wages must not provide, on average, full protection against future inflation.

Implement wage moderation measures (including limits on wage indexation) in contexts where wage levels are initially excessive.
Use wage controls as part of a broader strategy to:
- Limit capital decumulation in state enterprises.
- Reduce inflation by lowering fiscal-driven money creation.
Recognize the role of profit taxation: strengthening profit tax receipts can amplify the anti-inflationary effect of wage moderation.

Subject: Consumption, Income, Inflation, Labor, National accounts, Prices, Private consumption, Real wages, Wages
Keywords: Central and Eastern Europe, Consumption, incomes policy, indexation parameter, Inflation, nominal wage, Private consumption, rate of inflation, real wage demand, Real wages, target real wage, wage control, Wages, WP