The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861–19571

Abstract

When the demand for a commodity or service is high relatively to the supply of it we expect the price to rise, the rate of rise being greater the greater the excess demand. Conversely when the demand is low relatively to the supply we expect the price to fall, the rate of fall being greater the greater the deficiency of demand. It seems plausible that this principle should operate as one of the factors determining the rate of change of money wage rates, which are the price of labour services. When the demand for labour is high and there are very few unemployed we should expect employers to bid wage rates up quite rapidly, each firm and each industry being continually tempted to offer a little above the prevailing rates to attract the most suitable labour from other firms and industries. On the other hand it appears that workers are reluctant to offer their services at less than the prevailing rates when the demand for labour is low and unemployment is high so that wage rates fall only very slowly. The relation between unemployment and the rate of change of wage rates is therefore likely to be highly non-linear. It seems possible that a second factor influencing the rate of change of money wage rates might be the rate of change of the demand for labour, and so of unemployment. Thus in a year of rising business activity, with the demand for labour increasing and the percentage unemployment decreasing, employers will be bidding more vigorously for the services of labour than they would be in a year during which the average percentage unemployment was the same but the demand for labour was not increasing. Conversely in a year of falling business activity, with the demand for labour decreasing and the percentage unemployment increasing, employers will be less inclined to grant wage increases, and workers will be in a weaker position to press for them, than they would be in a year during which the average percentage unemployment was the same but the demand for labour was not decreasing. A third factor which may affect the rate of change of money wage rates is the rate of change of retail prices, operating through cost of living adjustments in wage rates. It will be argued here, however, that cost of living adjustments will have little or no effect on the rate of change of money wage rates except at times when retail prices are forced up by a very rapid rise in import prices (or, on rare occasions in the United Kingdom, in the prices of home-produced agricultural products). For suppose that productivity is increasing steadily at the rate of, say, 2 per cent. per annum and that aggregate demand is increasing similarly so that unemployment is remaining constant at, say, 2 per cent. Assume that with this level of unemployment and without any cost of living adjustments wage rates rise by, say, 3 per cent. per annum as the result of employers' competitive bidding for labour and that import prices and the prices of other factor services are also rising by 3 per cent. per annum. Then retail prices will be rising on average at the rate of about 1 per cent. per annum (the rate of change of factor costs minus the rate of change of productivity). Under these conditions the introduction of cost of living adjustments in wage rates will have no effect, for employers will merely be giving under the name of cost of living adjustments part of the wage increases which they would in any case have given as a result of their competitive bidding for labour. Assuming that the value of imports is one fifth of national income, it is only at times when the annual rate of change of import prices exceeds the rate at which wage rates would rise as a result of competitive bidding by employers by more than five times the rate of increase of productivity that cost of living adjustments become an operative factor in increasing the rate of change of money wage rates. Thus in the example given above a rate of increase of import prices of more than 13 per cent. per annum would more than offset the effects of rising productivity so that retail prices would rise by more than 3 per cent. per annum. Cost of living adjustments would then lead to a greater increase in wage rates than would have occurred as a result of employers' demand for labour and this would cause a further increase in retail prices, the rapid rise in import prices thus initiating a wage-price spiral which would continue until the rate of increase of import prices dropped significantly below the critical value of about 13 per cent. per annum. The purpose of the present study is to see whether statistical evidence supports the hypothesis that the rate of change of money wage rates in the United Kingdom can be explained by the level of unemployment and the rate of change of unemployment, except in or immediately after those years in which there was a very rapid rise in import prices, and if so to form some quantitative estimate of the relation between unemployment and the rate of change