Incomes Policy in Trade Cycles: Concept, Working and Limitations

Let us make an in-depth study of the Incomes Policy:- 1. Concept of Incomes Policy 2. Working of Incomes Policy 3. Limitations and Lessons.

Concept of Incomes Policy:

The concept of ‘Incomes Policy’ has gained currency in recent years, as a means of counteracting ‘demand pulls’ and ‘cost push’ inflation.

The central objective of this policy is to reconcile the objectives of economic growth and price stability.

Price stability is to be ensured by restraining increases in wage and other incomes from outstripping the growth of real national product. Incomes policy seeks to concentrate on curbing private consumption expenditure in an effort at reducing the pressure of ‘aggregate demand’ on ‘aggregate supplies’.

The concentration on restraining private consumer expenditure is justified on the ground that among the constituents of aggregate effective demand, it is the largest accounting for about two-thirds to three- fourths of the total expenditure in most countries. To repeat, incomes policy implies intervention by the authorities in the distribution of wages and other incomes aimed at preventing demand from rising excessively in relation to growth of national output.

Working of Incomes Policy:

There is a growing need for incomes policy 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, continuous experience of a high level of aggregate demand may lead to more aggressive claims on the part of labour and more permissive attitude on the part of employers towards wage increases.

The inducement to adopt incomes policy is stronger where relative price stability is needed to facilitate expansion of employment or to improve the critical balance of payments position. Policy-makers prefer incomes policy in order to correct a chronic balance of payments to a policy of devaluation.

However, when it comes to providing guidelines for controlling other types of incomes such as profit, rent and interest, its policy makers are not very clear. While the general objective has been laid down in countries like Netherlands, Sweden, France, Norway, U.K. and U.S.A., no operational incomes policy has been adopted in any country except Netherlands. In U.K. the first attempt at incomes policy was made during the Second World War and it met with a little success.

The other policy measures like subsidies, price controls rationing, compulsory savings all played an important part in holding’ down prices. There was a good deal of suppressed inflation in the economy. The labour government which took office in 1964 adopted a policy on productivity, prices and incomes as an integral part of its plan for promoting economic growth but soon due to bad economic conditions, balance of payments difficulties and rising prices, the policy of freezing all prices and incomes ran into difficulty.

The European incomes policy however, did not fare badly though it proved to be a costly experiment. Not only did inflation continue but it also led to distortions in the economies giving rise to severe inflation in U.K., U.S.A. and also in Japan. From this, one of the policy implications is that in a period of excessive overall demand, an incomes policy can only play a role subordinate to fiscal, monetary and other economic policies in fighting cost-inflation.

Limitations and Lessons:

Some limitations of incomes policy have come to light in advanced industrial countries.

These are as follows:

1. It has been observed that legal wage and price controls prove effective for a limited period, and in the long-run these controls tend to undermine the functioning of market mechanism in allocating resources. These controls face serious problems of enforcement.

2. It appears that an announcement by the government of an annual incomes norm in advance is not very helpful because it tends to become a negotiating minimum.

3. It presupposes the existence of many other factors which have a bearing on the effectiveness of incomes policy like proper trade union structure, methods of wage negotiation, escalator clauses, etc.

4. The most important precondition for success of an incomes policy by workers is some degree of price stability. Incomes policies have tended to breakdown in times of rapidly rising prices. The main opposition to this policy has come from labour organizations on the ground that it is another name for wage-freeze policy; it amounts to freezing the share of workers without profit-freeze and price-freeze is unacceptable to them. Such a policy is bound to provoke violent worker reaction.

It has been argued that salary and wage incomes do not constitute the only element in the inflationary pressure. The pressure on price originates elsewhere also as, for example, in faulty budgeting, persistent failure to mobilize savings, mis-investments, misdirection of expenditures, short-sighted pricing policies and so on.

5. Incomes policy working is impaired if a wage policy permits wages to rise beyond what is warranted by labour productivity. Therefore, a price policy must accompany a wage policy if inflation is to be controlled. Prof. Lipsey studied the effectiveness of 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 rates become insensitive to the level of unemployment. The experience in the UK has been that an incomes policy checks cost inflation in the short period. In the long period the policy wears off and operates in the reverse gear generating a price-wage-price spiral.

6. Another implication of the incomes policy is that once it is adopted, there is always the possibility of the government relying too much on it and undermining the efficacy of its own monetary and fiscal policies. Therefore freezing of prices, wages and incomes is not a substitute for strong monetary and fiscal policies.

The general concept of an incomes policy for use in India is different from that used in the developed countries. In India, self-employment of the working force is common 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 the income distribution pattern being skewed as is the case in India, the fine instrument of an incomes policy ceases to operate. In the context of economic inequality, income can only mean real command over goods and services so as to maintain the minimum standard of living. The habit of dissaving by low-income households is so high in India that it renders a wage policy totally ineffective in curbing inflation.