Historical Evidence
Drawing on Milton Friedman's articulation of the concept of a natural rate of unemployment, Volcker used the idea of a tradeoff between inflation and unemployment to battle high inflation in the 80's (Ball, 2009). In the mid-1990's economists believed the NAIRU to be around 6% (Baker & Bernstein, 2013) however, when Greenspan kept interest rate low, the unemployment rate drop to a low of about 4% in 2000. In 2000 there was a slight increase in inflation but the cause for the increase may have been other shocks in the economy, not higher wages (Baker & Bernstein, 2013).
Econometric evidence suggests that the NAIRU exists but fluctuates (Ball, 2009). Two major shifts in the NAIRU occurred in the 1960's and 1990's, a time when workers held lots of bargaining power and a time when workers held little bargaining power respectively.
WS-PS Model (Blanchard, 2005)
Wage Setting
W/P = z - bu
where W/P is real wages
b is the sensitivity of real wages to the unemployment rate
u is the unemployment rate (measure of bargaining power)
z stands for all other variables affecting wage setting
Price Setting
P = (1+m)W
P is price
m is the mark up determined by degree of monopoly
W is nominal wage
Solving for u:
u* = (1/b)([(z-(1/(1+markup)])
which means the natural rate of unemployment (u*) depends on the degree of monopoly and bargaining power of the workers.
The idea of the NAIRU/Wage-Price Spiral rests on the assumption that businesses will pass on the added cost of higher wages to the consumers via the mark-up. Higher wages means higher prices which means real wages won't increase which means workers will expect higher inflation and bargain for even higher nominal wages (and they can because the labor market is tight) which leads to increased prices, and so on.
Even if the degree of monopoly power were zero, the goods market was purely competitive, and the mark-up was zero, there could still be a wage-price spiral if the labor market was tight. The price of the good would just be the cost of making it, which would mean any increase in nominal wages would result in an increase in the price, which would leave real wages unchanged:
Old Price + change in wages = Old Nom Wage + change in wages
In the purely competitive market, there wouldn't be any profit but the WP spiral could still occur. If there were differing degrees of monopoly, different companies would reap different profits due to the magnitude of their mark up which depends on their market share. However, it seems no matter what the value of the mark-up is, firms will strive to keep it constant, prices will always rise to maintain the mark-up meaning profits will remain constant.
NAIRU and the Distribution of National Income
Pollin brings up an interesting thought, what if firms didn't pass on the higher wage costs to consumers, and just took lower profits (Pollin, 1998).
profits = revenue - costs
If a firm faces increased costs, it can raise revenue (prices) to keep profits constant, or it can take the loss in profits. This would distribute more of the national income to labor (which at the moment sounds like something labor could use).
One way to distribute more of the national income to labor is to reduce the mark up. This is a non-obvious reason why full employment is good for workers. Abba Lerner offers a cycle of how full employment can result in reduced degrees of monopoly:
↑employment→ ↑business confidence→ operating at high
level of capacity ↓markup (is possible) → ↑competition (actually decreases mark-up) → reduced degree of monopoly --> more national income going to labor.
Of course, then again businesses might not mind mild unemployment. Marx, Robinson, Stiglitz, and Krugman among countless others have observed unemployment (up to a point) is great for businesses because it functions as a worker discipline device. Workers fear getting sacked so they don't ask for higher wages, better conditions, say no to more responsibilities, etc.
NAIRU Today
The on-going discussion of income inequality is surely a good reason to explore the mechanisms of income distribution.
Apparently there is some talk of monetary tightening on the grounds that we are reaching the NAIRU. I think we should consider history and the quote below, before making such bold claims.
"We understand that as the unemployment rate falls to lower levels, the risk of accelerating inflation increases. But if the rate of inflation is not accelerating, there is the risk that people are being needlessly denied the chance to work and wages for those at the bottom are being held down by bad government policy " (Baker & Bernstein, 2013).
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Baker, D. & Bernstein, J. (2013). Getting Back to Full Employment
Ball, L. (2009). Hysteresis in Unemployment: Old and New Evidence.
Blanchard, O. (2005). Macroeconomics.
Pollin, R. (1998). The Reserve Army of Labor and the Natural Rate of Unemployment: Can Marx, Kalecki, Friedman, and Wall Street all be wrong?
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