The Wage-Price Spiral Made Really Simple

In western countries, both wages and prices tend to rise over time even if the average buying power remains about the same. When I was old enough to begin working, minimum wage in New York State was US$2.35, but then the price of gasoline was nowhere near $1 per gallon. What is the point of wages and prices continuing to rise over time if they remain similar in comparison to one another so that there is no real change in buying power?

In the posting "The Wage And Price Disparity", I explained that the reason both wages and prices are high in some countries while both are low in others, is related to the proportion of workers in the economy that are engaged in actually producing something.

In another posting on this blog, "The Extreme Inefficiency Of Wealth Production" I pointed out that only a small proportion of workers in western countries actually produce something when they go to work. When a significant proportion of workers do work that does not actually produce something, both wages and prices will tend to be higher.

If a majority of workers in an economic system are working at actually producing something, both wages and prices will be relatively low. This is because factory owners will naturally want to pay their workers low wages in order to maximize profit. But if most workers work in production, and therefore earn only low wages, they will not have much money to spend on the goods that they work at producing. This means that the price of the goods will have to be low as well, or else they will not sell.

Suppose that there is some type of breakthrough in the productivity of the goods so that instead of, say, 80% of workers working at actually producing something, now only 40% of workers are required to produce the same amount of food and manufactured goods as before. The redundant 40% cannot be allowed to be idle, because if they are not earning wages then they will not have the money to spend on goods, as they did before, and the system will go into recession.

The redundant 40% will end up as service workers in some capacity. This sector will offer useful services: lawyer, financial adviser, beautician, etc. but will not actually produce anything tangible. The workers in this non-production sector will depend on the spending of workers in the productive sector. Money paid to the workers in the non-productive sector will then be used to buy both the tangible goods and food of the productive sector, as well as the services of the non-productive sector.

Here is my principle concerning the relationship between productive and non-productive work in an economy: Those sectors of the economy that produce goods or food must directly or indirectly pay all of the wages of workers in the non-producing sectors. We could refer to the two as the "tangible" and the "intangible" sectors. It is the productive sector of the economy that came first, and is the "primary economy". The non-productive sector came later, and can be referred to as the "secondary economy".

The money in circulation forms a mirror image of the sum total of goods and services being produced. The value of a unit of currency primarily depends on the amount of money being printed relative to the total production.

Now that we have 40% of the workers engaged in the "secondary economy", we have more total goods and services being produced to be sold. To avoid deflation, more currency is called for. Since we still have the same total number of workers, this means that each worker in the economy will have to be paid more in order to support the new services being offered by the secondary economy.

Remember that the economy does not "know" exactly how much pay workers, as a whole, must get in order to be able to afford the new services being produced. The economy operates by trial and error and only "understands" absolute value, the total volume of goods and services sold and the relative pay of wages and salaries. When the now-rising wages paid out in the economy reach the point at which the economy is balanced, meaning that the total earnings and profit is just enough to buy all of the goods and services produced, the total wages, salaries and, profits do not "know" enough to stop increasing.

So, the economy seeks equilibrium by raising prices, according to the law of supply and demand. When equilibrium is reached, wages and prices have both increased. A primary reason for this spiral is that this inflation is anticipated and many workers get raises and cost of living adjustments automatically, making it a self-perpetuating cycle.

The process of innovation, which enables the same amount of goods to be produced with fewer workers, is an ongoing process so that as fewer workers are engaged in actual production, both wages and prices continuously increase. Therefore, my hypothesis is that the combined increase in wages and prices over time is a direct function of the decrease in the number of workers engaged in work that actually produces something tangible.

This does not mean that it is necessarily "bad" to have a lot of workers engaged in non-production work, the services provided are valuable and enhance the quality of life. However, the secondary economy will drive up both wages and prices in the economy as a whole, so that production work will tend to migrate to countries with a lower wage-price index which, of course, will feed a spiral in the first country by driving up both wages and prices even more.

This is just one of the conundrums of the free-market system.