The Trouble With Guaranteed Cost of Living Increases

A blog about business and economics.
June 8 2012 9:52 AM

The Trouble With Guaranteed Cost of Living Increases

Bruce Western and Jake Rosenfeld argue at some length that a revival of unionization would benefit most American workers, shaving GDP growth by 0.1-0.2 percent but increasing blue collar workers' compensation by 10-20 percent. 

It's a strong argument. But I always do want to note that there are actual reasons the postwar economic paradigm collapsed. Here for example they discuss the salad days of industry-wide pattern bargaining:

The benefits of unions protected American workers for more than half a century. The landmark development came in 1948, when General Motors and the United Auto Workers negotiated what came to be known as the Treaty of Detroit. The agreement approved an annual cost-of-living wage increase plus an additional annual increase of two percent. The cost-of-living adjustment ensured that wages would at least keep up with inflation. The extra two percent compensated workers for productivity boosts that came along with technological change

Having a cost of living adjustment clause in your contract is obviously excellent for your. I don't have one, and I wish I did. But there's a real problem with running an economy in which such clauses are widespread. Consider a situation in which a shortage arises of some crucial natural resource that's widely used as a production input. What happens here is that workers' productivity declines through no fault of their own. Real wages need to either temporarily fall, or else joblessness needs to temporarily rise. But if a large share of workers have automatic COLA clauses in their contracts, then wages go up as a result of the shortage rather than down. That means joblessness may need to go up quite a lot. But then the wage increases themselves become a source of further inflation. And yet the central bank may well want to try to respond to the increase in unemployment with looser money.

Next thing you know: Stagflation.

And this is more or less what happened in the 1970s with the oil shocks. Most people know about those shocks, the negative impact they had on the economy, and the role of disgruntlement with 1970s economic performance or the big paradigm shift in U.S. political economy occuring around 1980. But it's important to understand that this wasn't just a case of bad luck. Key elements of the postwar economic system were actually unsustainable. This cost-push inflation spiral issue could have been addressed through much more modest changes than the near-total destruction of private sector labor unions that we got. But something had to give. The system of the "good old days" simply wasn't robust enough to supply shocks.


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