8 Measures of Macroeconomic Incomes Policy of a Country

Read this article to learn about the eight measures of macroeconomic incomes policy of a country.

1. Incomes Policy:

While Keynesian model rejected the importance of money supply and treated money as a veil, the monetarists under Friedman insisted that not only does money matter but money alone matters.

Both approaches fall into the same theoretical trap that an economy has a natural tendency to gain stable equilibrium at full employment level.

The post-Keynesians question the validity of both approaches because when a financial or economic disaster takes place, the Keynesians watch the employment rate and the monetarists watch money supply. But the real world economy is a high leverage, one built on a mountain of debt. As such, the new Keynesians or post-Keynesians solution to inflation would be an incomes policy rather than monetary or fiscal policies.

The concept of ‘Incomes Policy’ has gained currency in recent years, especially in developed countries of the west, as a means to fight ‘demand pull’ and ‘cost push’ inflation. The central objective of this policy is to reconcile economic growth and price stability.

The price stability is to be ensured by restraining increase in wages and other incomes from outstripping the growth of real national product. Incomes policy seeks to concentrate on curbing the private consumption expenditure in an effort to reduce the pressure of ‘aggregate demand’ on ‘aggregate supplies’.

This concentration on restraining the private consumer expenditure is justified on the ground that out of the important constituents of aggregate effective demand (private consumption expenditure; government consumption expenditure; investment expenditure in private and public sectors; and the excess of exports of goods and services over their imports in the market) this item is the largest—accounting for about two-thirds to three-fourths in most countries. (In fact, variations from country to country are wide and this is only a rough approximation).

In other words, incomes policy implies deliberate intervention by the authorities in the process of price formation for labour and products aimed at preventing gross money incomes from rising excessively in relation to the growth of national output in real terms.

Need and Working of Incomes Policy:

The necessity for an appropriate incomes policy is being increasingly felt on account of the intensification of the tendencies towards cost inflation, because the proportion of incomes and prices determined in non-competitive markets is likely to increase with increasing industrial employment, growing unionization, collective bargaining and increasing scale of enterprises.

Further, longer experience of consistently high level of aggregate demand as enunciated above may lead to encouragement of a more aggressive attitude on the part of labour and more permissive attitude on the part of the employers towards wage increases, leading to a strengthening of the bargaining position of unions.

The inducement to adopt incomes policy is stronger in some countries than in others, depending’ on the prevailing socio-economic circumstances. The inducement is more where relative price stability is needed to facilitate expansion of employment (either before or when the employment objective is met) or to improve a critical balance of payments position. Disciplinarians in the field of international economics prefer incomes policy to set right chronic balance of payments to a policy of devaluation or deflation.

However, when it comes to guidelines for other types of incomes like profit, rent and interest, its policy prescription is less clear. While the general objective has been laid down in many developed countries like Netherlands, Sweden, France, Norway, UK and USA, no operational incomes policy has been adopted in any country except Netherlands.

In UK first attempt at incomes policy was made during the Second World War and met with a little success due to accompanying circumstances (exceptional in nature) like subsidies, price controls, rationing, compulsory savings, etc., all played an important part in holding down prices.

There was a good deal of suppressed inflation in the economy but towards the end of 1950 wage restraint began to break down and incomes policy was held in abeyance in UK during the 1950s. The labour government which took office in 1964 presented a policy on productivity, prices and incomes as an integral part of its plan for promoting economic growth but later on due to bad economic conditions, balance of payments difficulties and rising prices and on account of various other reasons the policy of a freeze of all prices and incomes ran into difficulty.

The US abandoned wage price controls in 1974. European incomes policy, however did not fare badly, though it proved to be a costly experiment and in the long run not only inflation continued but it also led to distortions in the economy giving rise to more severe inflations in UK, USA and Japan from 1974 onwards. In UK, where a beginning was made, many practical implications came to light during the course of its working. One of these is that in a period of excessive overall demand an incomes policy though useful can play a role only subordinate to fiscal, monetary and other economic policies to fight cost inflation.

Limitations and Lessons:

Some important limitations, implications and lessons have emerged from attempts to operate incomes policy especially in advanced industrial countries.

These are as follows:

(a) It has been observed that legal wage and price controls prove effective for a limited short period. In the long-run these controls tend to undermine the function of free price market mechanism in allocating resources. These controls create huge problems of enforcement and supervision.

(b) It appears that an announcement by the government of an annual norm in advance is not very useful or helpful. It too often tends to become a negotiating minimum.

(c) It presupposes the existence of many other factors which have a bearing on the effectiveness of incomes policy like the proper trade union structure, methods of wage negotiation, escalator clauses, etc. It is very difficult that all these sectors will co-operate in the desired manner.

(d) The most important precondition for the acceptance of an incomes policy by labour is some degree of price stability. Income policies have tended to breakdown in times of rapidly rising prices. The main opposition to this type of policy has come from labour organisations on the ground that it is another name for wage-freeze policy; it amounts to freezing the share of workers in the national income when prices continue to rise. A policy which aims at wage-freeze without profit and price- freeze is unacceptable to them.

Such a policy is bound to provoke their violent reaction, unless it simultaneously restricts profits, wages, interest and dividends—a field in which the policy fails to lay down correct guidelines. However, salary and wage income do not constitute the only element in the inflationary pressure. The pressure on prices originates elsewhere also, for example, in faulty budgeting, persistent failure to mobilize savings, mis-investments, misdirection of expenditures, short-sighted pricing policies and so on.

(e) Incomes policy is impaired, if a wage policy permits wages to rise beyond unit labour productivity—in such cases a price policy must accompany, if inflation is to be controlled. Prof. Lipsey tested the effectiveness of the incomes policy and concluded that an incomes policy will not work if the level of unemployment in an economy is greater than 2 per cent.

When an incomes policy operates at a high level of unemployment, the wage changes become insensitive to the level of unemployment. The experience in UK has been that an incomes policy checks, no doubt, immediate inflation in the short period and then the policy wears off and operates in the reverse gear due to price-wage price spiral and a complex system of collective bargaining.

(f) Another implication of the incomes policy is that once it is adopted, there is always the possibility of the government placing too great a stress on it thereby undermining the efficacy of its own monetary and fiscal policies. Monetary discipline is needed along with incomes policy, to counteract inflation and to reduce the velocity of circulation of money. Therefore, direct freeze of prices and wages and income policies are not a substitute for strong monetary and fiscal policies.

The general concept for an incomes policy for India is different from that in the developed countries. In developing countries like India, self-employment of the working force is the rule in contrast to the predominance of wage-employment in the developed countries.

When dealing with incomes policy the emphasis may be on three aspects—income produced, income received and income consumed. With an income distribution pattern as skewed as in India, the finer points of an incomes policy cease to operate. In the context of economic inequality, income can only mean real command over goods and services to maintain the minimum standard of living.

The factor of dissaving by low income households is so high that it renders a wage or incomes policy totally ineffective in curbing inflation in a country like India. The rate of growth of wage and non-wage money incomes in India should be regulated and held, as a general rule, below the rate of growth of national productivity in order to ensure steady economic development with comparative price stability.

According to the report of the Steering Group on Wages, Prices and Incomes Policies of the Reserve Bank of India published in January 1967, it has ruled out the prescription of a target of national minimum income as well as of a ceiling of incomes. The report doesn’t furnish precise answers to many issues of Incomes policy, for with the numerous gaps in statistical information, especially in the field of agricultural income, wage structure, labour productivity, the report laid down only broad guidelines for consideration to an incomes policy, till a more real incomes policy could emerge later on.

Thus, the policy instruments in India for an incomes policy have to be different and more complex than in developed countries. Income policy, therefore, has to be coordinated more effectively with monetary, fiscal and other economic policies. Despite its limitations, if a suitable incomes policy is followed along with the fiscal monetary and other economic measures to control inflation, the result would be easier as well as favourable. Therein lies the importance of incomes policy as a measure of full employment and stability.

2. Wage Adjustment Policy:

Wage adjustment is an important tool of economic stabilization but to follow a suitable wage policy in different phases of the cycle is an uphill task. Maintaining full or near full employment without inflation in the case of strong trade unions and widespread monopoly elements is a tough job. For in a period of rising prices, trade unions can easily secure wage increases, which are further reflected in higher prices accentuating inflationary pressures in the form of wage-price spirals.

On the other hand, wages are rigid in the downward direction and trade unions vehemently oppose wage cuts in an inflationary situation. Whereas more rapid wage increases, as labour productivity increases, may be desirable; drastic wage reduction in depression may be ruled out, as also rigid wage maintenance.

A rational wage policy for full employment must take into consideration the basic fact of dual nature of wages, being costs to entrepreneurs and income to workers, who have a high propensity to consume and whose demand constitutes a major portion of the effective demand in the economy.

Truly speaking, wages have to be linked with productivity and an increase in wage-rates should be allowed only with increases in productivity. “It is necessary to note that under the economic conditions of underdeveloped countries, any rise in the level of real wages is at the cost of higher volume of employment and of investment in the short period, and a higher potential trend in investment and employment in the long period. Measures of wage-increases are permissible only after a state of full employment has been reached. Hence, it would not be prudent to initiate in this respect the economic policies in vogue in developed countries.”

Thus, wage adjustment as a source of raising employment has severe theoretical and practical limitations in advanced economies and more so in underdeveloped countries. Therefore, steps to raise employment must emanate from sources other than wage adjustment policy?

3. Price Adjustment Policy:

Those, who regard price variations in booms and slumps as major causes of instability, advocate a policy of price flexibility as one of the important weapons of stabilization and promoting full employment. They argue that it would curb profit inflation, reduce the magnitude and duration of depressions by reducing the disparities between controlled and uncontrolled prices, and that it is an indispensable adjunct to any monetary policy directed to maintain a managed price level. But to lay down and to follow a suitable price policy is by no means an easy task.

It has its own limitations both in advanced and underdeveloped economies. Thus, a policy of price flexibility (i.e., absence of price- cost rigidities) as a solution for instability is considered inadequate. A downward price adjustment may increase output and employment in particular industries with elastic demands without having any favourable effects on the economy as a whole.

Again, if prices of commodities and factors fall simultaneously, leaving the price-cost relation unaffected, the inducement to invest will get a setback and saving would be encouraged owing to the rise in the value of money, without affecting in any way the volume of output and employment. Moreover, rise in the marginal efficiency of capital takes place on account of a fall in factor prices without a corresponding fall in the prices of goods and is offset by a fall in the aggregate demand, without affecting employment in any way.

Even if price flexibility could affect income, output and employment, it would be temporary, unless proper monetary and fiscal measures are adopted. Price-cost flexibility may be important in certain sectors of the economy where price movements are of strategic importance. Thus, Keynes rightly remarks, “The right remedy for the trade cycles is not to be found in abolishing booms and thus keeping us permanently is a semi- slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom.”

4. Price Control—Price Support—Rationing:

Prof. Irving Fisher suggested price control to fight inflation and promote stabilization. Many countries adopted price control and rationing during war and post-war periods to cope with the unusual situation of inflation and price support to arrest a downward trend of prices. Price control aims at fixing the upper limit beyond which prices may not rise. This measure becomes popular during periods of runway inflation and profiteering. It has a few limitations.

It may lead to shortages, ques and inequality in the distribution of goods. Keynes favoured the reduction of purchasing power through taxes and forced savings. This, price control must be accompanied by restriction on the purchasing power. Rationing is disliked on the ground that it leads to wastage of resources and impairs freedom of consumption. Price support, on the other hand, aims at not allowing prices to fall below a certain minimum during depression.

Whenever prices tend to fall below a certain minimum, the government comes to the rescue of the producers by entering the market as a single bulk purchaser statutorily fixed prices. This policy has been followed in underdeveloped economies to support the prices of agricultural commodities. The success of such a policy depends on the possession of vast resources, up-to-date and efficient administration.

5. Automatic Stabilizers:

It is possible to bring about automatically, to some extent, some stabilizing effects through government expenditure or revenues, as the economy expands or contracts. This feature is described as ‘built-in’ or ‘automatic’ stability and the expenditure or revenues in question are called built-in or automatic stabilizers. Adoption of a system of automatic compensatory measures to come in operation under clearly defined circumstances constitutes an important element of successful macroeconomic employment policy.

Such a policy consists in causing government expenditure to increase in contraction and fall in expansion and government revenues to rise in expansion and fall in contraction. Automatic stabilizers aim at a surplus budget in boom and a deficit budget in slump, unless balanced budget is insisted on by the government.

“The automatic compensatory measures should embody the following necessary features first, they should be capable of raising effective demand promptly and throughout the economy; secondly, they should be of quantitative nature so that their effect on demand and employment could be estimated with a fair degree of reliability ; thirdly, their quantitative magnitude should be sufficient to reduce the level of unemployment (taking into account both the primary and secondary effects).”

Automatic or built-in stability is found in the income-tax, both personal and corporate, the unemployment insurance schemes, to some extent in social security payments, and in price supports to agriculture. But these automatic stabilizers should not be regarded as more than a first line of defence, as without other measures these alone are not likely to be very effective especially in backward economies, where neither the personal income-tax nor is the social security system widely developed.

6. Stimulating Consumption:

Advanced countries do not depend upon investment only to raise effective demand. They place heavy reliance/on the expansion of consumer demand through instruments of fiscal policy ; for example, by changing the incidence of taxation, by expanding programmes of social security and transfer payments, by increasing social expenditures on education, health, etc., and by means of other supports to personal consumption. Stimulating consumption, therefore, forms an integral part of a macroeconomic employment policy.

7. Organisation of Labour Market:

Some unemployment is caused by the lack of correspondence between supply and demand for different kinds of workers in different occupations; such unemployment can be reduced by spreading information and effecting recruitment through employment agencies and providing training and retaining facilities for developing skill and promoting the occupational mobility of labour. It is now realized that, “systematic organization of the employment market is an essential condition for the permanent control of the problem of unemployment. It has a vital part to play in eliminating unemployment caused by friction in the working of the economy or by structural changes in the industry.”

Milton Friedman has also supported this programme of spreading information about job opportunities and training facilities. He expressed the opinion that unemployment in advanced countries could not be removed by macroeconomic monetary, fiscal and income policies alone unless accompanied by information on jobs and organization of labour markets.

Further, seasonal unemployment can be eliminated by adopting suitable techniques for integration of different industries and dovetailing agriculture and industry. The remedy lies in such improvements as will enable land to be productively employed for a longer period, for example, by proper combination and rotation of crops and by mixed farming. Where this is not possible, employment for agriculturists has to be found in other occupations for the rest of the year. Supplementary occupations and diversification of industries can go a long way to reduce unemployment.

8. International Measures:

Finally, it may be important to emphasize that the “lasting success of any national full employment macroeconomic policy depends upon effective monetary, trade and political co-operation amongst nations, especially among major industrial nations on which so many countries depend for their internal prosperity via their foreign trade relations. In an open system, fluctuations in the level of income and employment in one country tend to spread to another………… for this reason nations are more conscious today than ever before of the international character of the modern problem of deficient aggregate demand and, therefore, of the need for multinational monetary and commercial co-operation for world prosperity.”

The existing IMF, IBRD and other agencies of the United Nations are evidence of the World’s desire to maintain permanent economic stability through co-operative efforts. Insofar as the present economies continue to be open economies, foreign trade is bound to play an important part.

The necessity of coordinating the domestic, incomes, fiscal and monetary measures with international measures to maintain full employment becomes obvious. International trade helps the attainment of international equilibrium by eliminating undue trade barriers. Depression in one country is passed on to the other country through the mechanism of foreign trade.

The experts appointed by UNO in their report recommended the following international measures to promote full employment:

(i) To create a workable system of international trade for a stable and expanding world economy, thereby providing conditions required for the elimination of undesirable trade barriers and for the restoration of the convertibility of currencies.

(ii) To accelerate the orderly economic development of the underdeveloped areas of the world. In order to achieve this, the industrially advanced countries should follow a more conscious policy of aid.

(iii) To prevent the international propagation (spread) of fluctuations in effective demand with a view to stabilizing internal trade. This can be done by maintaining external disbursements on current account in the face of internal fluctuations of effective demand.

(iv) To provide a mechanism for maintaining internal and external balance by facilitating the system of international payments.