Inflation and Wages in Underdeveloped Countries

India, Peru, and Turkey, 1939-1960

Bill Warren

• Publisher: Routledge
• Year: 2005
• ISBN:
  9781135781910
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Published in the year 1977, Inflation and Wages in Underdeveloped Countries is a valuable contribution to the field of Economics.

CHAPTER 1

INTRODUCTION:

The general theme of the movement of income shares during inflation and its relationship to the process of industrialisation is one which has attracted an immense literature in its own right and which represents a confluence of three quite distinct trends in economic thinking: that concerned with the determinants of income distribution in modern manufacturing industry; that concerned with the character of the inflationary process; and that concerned with the characteristics of the industrialisation process.

The justification for yet another venture into this much-explored jungle in this case springs from the fact that the advantages of comparative analysis of national experience have by no means been fully utilised, most of the attempts to date having been restricted to rather general efforts to correlate a number of variables over a large number of countries, generally in a somewhat aggregative fashion and with only cursory reference to historical or institutional dimensions.¹ Moreover, most such studies have attempted to relate inflation to changes in income shares or rates of economic growth taken separately, rather than to establish some more complex relationship between all three.

Accordingly, in what follows we have attempted the comparative analysis of the experience, during inflation, of income redistribution in manufacturing industry in no more than three countries, India, Peru and Turkey, over the two generally inflationary decades which commenced with the beginning of World War II. Despite the limited number of countries considered, no more than a very approximate attempt can be made in a study of this size to trace the channels and directions of causality, and no attempt at all is made to give quantitative precision to the relative importance of the different variables at work on the phenomenon under consideration.

Little is to be gained from yet another survey of the relevant economic literature on theories of income distribution, inflation and industrialisation, even supposing there were space enough for it. However, a few comments on the articulation of these three strands of economic thought with one another are required in order to clarify the issues on which we might expect our comparative data to throw light.

Theories of the relation of industrialisation to inflation (defined as a more or less prolonged rise in the general price level) are bedevilled by the fact that inflation is the net resultant of all the forces at work in the economy as reflected in the movement of the aggregate price level. This being so, it is by no means always clear whether the problem under examination relates to the effects of inflation per se, or, alternatively, to the effects of the conditions giving rise to inflation on industrialisation. It will, of course, never be easy to disentangle these different types of effect from one another in practice. Nevertheless, in principle, there is clearly a group of effects which may reasonably be construed as resulting from inflation, irrespective of the specific causes of the inflation as such; for example, the development of possible tendencies to demonetise and thus indirectly to de-commercialise the economy; or propensities to invest in quick-yielding assets as opposed to those with a longer pay-off period; or, perhaps, the conjuring up by prolonged inflation of new institutional mechanisms to protect formerly unprotected sections of the community—with permanent effects on the economy.

When we turn to consider the effects of the conditions giving rise to inflation on the industrialisation process, a new complication is introduced by the possibility that, since inflation may result from a range of different conditions at different times and places, so the result may be a range of different kinds of inflation. In particular, relative price movements of certain broad categories of commodities may be quite different in different types of inflation. In such circumstances the very concept of ‘inflation’ as a variable to be considered in conjunction with ‘industrialisation’ may prove to be an example of what Dr Myrdal has called ‘misplaced aggregation’.²

We thus have three levels of analysis: first, the effect of inflation per se on industrialisation, irrespective of the conditions giving rise to inflation; second, the effect of the conditions giving rise to inflation on the movement of relative prices (including factor prices) during inflation; and third, the effect of the conditions giving rise to inflation on industrialisation more generally.

In effect, the more formally-ordered hypotheses concerning the relationshop of industrialisation to inflation have been those concerned with the effects on industrialisation of relative price and cost movements during periods of increase in the aggregate price level, the general assumption being that there is a difference in the direction of relative price/cost movements as between situations of rising and falling aggregate price levels.

Two such hypotheses usefully serve both to throw light on the relationship of this level of analysis (effects of relative price/cost movements during a general price rise), to the other two levels of analysis (effects of the price rise per se and the more general effects of the conditions causing the price rise); and to illuminate the articulation between the theories of wage determination and income distribution, theories of inflation, and theories of industrialisation. These are the ‘profit inflation’ (wage-lag) or ‘forced savings’ theory of economic development, and the ‘inflation barrier’ thesis.

The view of inflation as an engine of development via forced savings, in which the rise of final prices (of manufactures), faster than prime costs, shifts resources into the hands of investing entrepreneurs and away from agriculturalists or wage-labourers, has a long patronage, stretching from Earl J.Hamilton, the distinguished economic historian, who has applied it to European economic development in the period of the great inflation of the 16th–18th centuries,³ through John Maynard Keynes⁴ to W.Arthur Lewis who has advocated deliberate inflation as a policy for today’s under-developed economies.⁵

The ‘inflation barrier’ hypothesis, on the other hand, posits inflation as a process which will tend to set a limit to the level of accumulation that can be achieved.⁶ As applied to underdeveloped countries, this view holds that at a certain stage in the process of raising the level of investment, the rise in prices, as resources become fully utilised, forces the entrepreneurs themselves to grant higher money wages in order to maintain the efficiency of their labour forces. The resulting inflationary spiral, in one way or another, limits a further shift of resources towards investment and thereby limits the rate of growth.⁷

The similarities between these two theories point us in the direction of their articulation with industrialisation theory, while their differences orient us towards their articulation with income distribution and wage determination theory.

At the root of both the ‘profit inflation’ and the ‘inflation barrier’ theories lie two assumptions: first, that inflation itself is the product of an aggregate excess of demand over supply of resources on the economy (or a competition for aggregate resources between consumption demand and investment demand); and second, that the principal obstacles to industrialisation are to be located on the supply rather than on the demand side. These points are not, of course, unconnected, since if inflation is characteristic of a situation in which investment and consumption demand are competing for the aggregate resources of the economy, then the nascent industrial sector is most unlikely to be restricted by the limitations of the market, or its slow growth.

Both these assumptions can, of course, be challenged. Evidence of substantial excess capacity in the modern manufacturing sector in many parts of the underdeveloped world; attempts to circumvent small national markets by regional arrangements and to reduce barriers to the penetration by underdeveloped countries of the markets of the industrialised market economies; the predominance of the market in many so-called ‘planned’ economies—all suggest alternative assumptions about the obstacles to industrial expansion. Similarly, the development of theories of inflation which postulate general price rise as being the result of cost pressures—whether the result of sectoral supply bottlenecks or of rising wages—leaves open the possibility that inflation need not be concomitant with aggregate pressure of demand on resources.

There is, however, a crucial difference between the ‘profit inflation’ and the ‘inflation barrier’ theories which in principle permits the latter to be reformulated in such a way as to be compatible with some version or other of a cost/structural theory of inflation. Whereas the ‘profit inflation’ theory is predicated upon an excess demand for manufactures, the ‘inflation barrier’ theory is predicated upon an excess demand for working class consumer goods, i.e. of what may be considered, at one remove, to be inputs into the modern manufacturing sector. Now if these inputs, or a substantial proportion of them, are produced under significantly different supply conditions from the outputs of manufacturing industry in general, then the ‘inflation barrier’ theory can without difficulty be reformulated in terms of a cost-structural theory of inflation, i.e. an inflation which does not necessarily presuppose an excess aggregate demand over supply in the economy. To be specific, such an inflation might originate in food supply bottlenecks in the agricultural sector which spread to the industrial sector via rising wage costs and which may act to retard the expansion of the manufacturing sector by a limitation of the market.⁸

The difference between the ‘profit inflation’ theory and the ‘inflation barrier’ theory emerge more clearly when we examine their articulation with theories of the determination of wages movements and income shares. In the former theory, the inflation raises the profit share because wages lag behind final prices, whereas in the latter theory it is the fact of the rise of wages pari passu with that of final prices (in the aggregate version of the theory) which both causes the inflation and sets a limit to the rise in the level of investment.

In both cases wages are assumed to be the only input or else the movement of non-labour input-costs (hereafter referred to as raw material costs) are assumed to be such that the same result would have been obtained in terms of changing shares of value added had all costs been labour costs. The ‘profit inflation’ theory may be based either on a general model which stresses the fact that the demand for labour is derived demand so that, on certain assumptions, prices of final goods may be expected to rise before prices of labour; or, alternatively, it may be based upon what are considered to be the specific characteristics of the market for labour and for manufactures at the specific time and place under consideration, i.e. certain assumptions about the contingent, as opposed to the inherent, character of these markets. In the latter case, the wage-lag hypothesis may be based upon either the specific demand-supply relationships in the two markets, or on the relative flexibility of response of wages and prices to changes in demand, or a combination of both. Typically, then, the wage-lag hypothesis will rest upon the fact that the demand for labour is derived whereas that for manufactures is not, upon a relatively greater excess of demand over supply for manufactures as compared with labour, and upon the supposed relative inflexibility of wages as compared to final prices in response to demand changes.⁹

By contrast, the ‘inflation barrier’ theory, implicitly rejecting the wage-lag as a phenomenon during inflation, does so not on the basis of postulating a relatively better market situation for labour than for manufactures, or on the basis of denying the derived character of demand for labour as opposed to that for manufactures, but by rejecting any view that wages are directly determined by market forces. Instead, the view is substituted that wages are in effect an administered price determined by the employer in the light of considerations of productive efficiency.¹⁰ Both views, however, have in common that wages rise, if at all, in order to assure or improve the quality or quantity of the flow of labour inputs into manufacturing industry, i.e. the general wage increase is in a sense the result of the aggregated internal productive demands of the firms. It is possible, however, as versions of the cost-inflation theories imply, that external pressures on the firm of an institutional and/or social-political character may push up wages irrespective of the situation in the labour market, or indeed in the product market, thus permitting us to envisage a third possibility—that of an increase in labour’s share of value added during inflation.

If the assumption is dropped that raw material costs do not vary in such a way as to disturb the income redistribution effect which would otherwise be achieved were labour the sole variable input, then a new range of possibilities opens up. In particular, Kalecki has developed a theory that the wages share of gross value added alters as a result of differing relative movements of raw material costs and labour costs, assuming constant percentage profit margins, so that, as raw material costs rise faster than labour costs, the result under a cost-plus pricing system with constant percentage gross profit margins is to raise final prices faster than wages, so that labour’s share in value added declines.¹¹ It is not difficult to construct an alternative model incorporating the effects of the movement of raw material costs, in which the share of labour in value added might rise on the assumpt...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Dedication
• Contents
• List of Tables
• List of Abbreviations
• Preface
• 1 Introduction
• 2 India: Prices and Income Redistribution in Organised Factory Industry, 1939–61
• 3 The Movement of Money Wages in India, 1939–61
• 4 Inflation and Income Redistribution in Peru, 1939–58
• 5 Inflation and the Behaviour of Money Wages in Peru, 1939–58
• 6 Inflation in Turkey: Inflation and Income Redistribution, 1939–58
• 7 Money Wages and Inflation in Turkey, 1939–58: Income Redistribution and the Behaviour of Money Wages during Inflation
• 8 Inflation and Income Redistribution in the Modern Manufacturing Sector in Underdeveloped Economies—Some Conclusions
• 9 Some Implications
• Bibliography
• Index