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But What About the Wage-Price Spiral?

But What About the Wage-Price Spiral?

  • Michael Schauerte
    Michael Schauerte
  • 01
    2022
    Sep
    5:35 pm
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Foundation of the spiral argument

In nearly every media interview in recent months, Mick Lynch, general secretary of the  National Union of Rail, Maritime and Transport Workers in the UK, has had to field a question about the dreaded “wage-price spiral.” The argument, usually presented as a self-evident fact, is that raising the wages of workers to keep pace with rising prices will only drive prices higher, prolonging the agony for consumers. 

Lynch has countered the argument effectively by pointing out that prices have risen despite stagnant real wages and long predates his and other unions’ industrial actions. He thus exposes the absurdity of blaming workers for price rises. The culprit he identifies are obscenely profitable companies that use tax havens to resist income redistribution. Here his argument gets a bit fuzzy, as he does not explain exactly how high profits drive up prices. But Lynch does make an important point by emphasizing that a pay rise for workers could be taken out of those profits, rather than requiring increased commodity prices. In this way he points to the central point which this article will attempt to explain: wages and profit are in an antagonistic relation, where the gains on one side come at the expense of the other. Thus, a rise in wages – or (contra the “Lynchian” view) in profit – does not necessarily result in higher commodity prices. 

The commentators bleating about a wage-price spiral, in contrast, take it for granted that the burden on companies of paying higher wages to workers would have to be offset by higher prices. The argument seems not only plausible but common-sensical, and the counter-arguments made by Lynch and others, despite raising important points and being rhetorically effective, fall short of exposing its shaky foundation. 

At the basis of the spiral argument is the assumption that commodity prices are the sum of wages, profit, and the means of production, so that if any one of those parts increase in price, the overall commodity price must increase. Again, this seems plausible enough. But more than two centuries ago David Ricardo refuted this sort of value theory by demonstrating how wages and profit are not the component parts of commodity price but the distributed parts of the already existing commodity value. This view is based on the idea that the value of a commodity is fundamentally determined by the amount of labor time needed to produce it. Here we have a labor theory of value – as pioneered by Smith, purified by Ricardo, and perfected by Marx.

The only way to grasp the counter-intuitive idea that wages are the distributed (rather than component) parts of value is to scrutinize the surprisingly deceptive wage and profit forms, which are usually taken for granted. 

The deceptive wage and profit forms

Wages at first glance seem to be payment for labor performed. After all, wages are paid by the hour, week, or month, etc. But if wages are payment for labor, how can we account for the differences in the wages paid for identical types of labor between different places? Autoworkers in Vietnam, for instance, receive a far lower wage than their counterparts in Germany who are performing similar if not identical tasks. If the hourly wage is determined by the nature of labor itself, why do wages vary to such a degree?

Actually, everyone reading this knows why wages in a developing country like Vietnam are lower than in a developed country like Germany. Those differences correspond to the difference in the cost of living, which reflects the prices for food, clothing, housing, transportation, etc. And similar differences exist within a given country between urban and rural areas – or even between different cities. These obvious facts suggest that what fundamentally determines the level of a wage for a given job is not the labor itself but the value of the commodities a worker must consume to continue living and working. A wage must be sufficient to “reproduce” that capacity to work. 

Marx uses the term “labor power” to refer to this capacity that is bought and sold as a sort of commodity on the labor market. Like other commodities, the value of labor power comes down to the labor time needed to produce it, but this is determined indirectly through the socially necessary labor time needed to produce the commodities and services a worker consumes to continue working (and raise a family). The wage is payment for this labor-power commodity. Thus, any rise in the prices of the commodities and services consumed by workers will need to be reflected in a higher wage if they are to avoid a deterioration in the quality of their lives and their capacity to labor. 

There are of course significant differences between the wages paid to workers who perform different types of labor. An airplane pilot or surgeon, for example, receives much more than a store clerk or waiter. But these differences can also be explained from the perspective of labor power, since averaged into its daily value are the educational and training costs that were necessary to acquire certain work-related skills and expertise. In other words, although such wage differences appear to be determined by the labor itself, they are in fact a reflection of differences in the value of labor power. 

Understanding that “labor power” and “labor” are two separate concepts is the key to understanding the source of profit. A capitalist can make a profit when the labor time that workers expend in the production process to create new commodities exceeds the labor time that was necessary to produce the commodities (etc.) they consume. For example, if the commodities consumed by a worker required four hours of labor time to produce, but the worker labors for eight hours in the production process, the capitalist who hired that worker is receiving four hours of labor time for free. The fact that profit comes down to “unpaid labor” seems counter-intuitive because the wage, calculated on an hourly basis, conceals that exploitation, making it seem as if it is equivalent to eight hours of labor. 

If profit stems from the labor time expended in the production process exceeding the labor power embodied in the commodities consumed by workers, this means that any increase in the wage to purchase labor power will reduce the amount of unpaid labor pocketed by the capitalist (assuming that labor productivity and other conditions remains unchanged). For example, if wages were increased to the point where they allowed the consumption of commodities that had required five hours of labor time to produce instead of four, the capitalist would only receive three hours of unpaid labor.

It might seem that the capitalist in this case could simply raise the price of the new commodities produced so as to continue siphoning off four hours – and that is indeed the assumption of the spiral argument. But those commodities would continue to require the same amount of labor time to produce and thus have the same intrinsic value as before. Any capitalist who decided to raise the prices of a commodity considerably higher than its value would risk being undersold by rivals, particularly those who had increased the intensity of labor or kept wages in check. Capitalists would not be howling about the price-wage spiral in the first place if wage rises could be so easily offset by higher prices. 

Commodities sold at their “production price”

The labor theory of value provides the most fundamental refutation of the wage-price spiral, but that theory is at a high level of abstraction and does not directly explain the actual prices of commodities. That is, even though the labor time needed to produce a commodity basically determines its value, commodities are not exchanged at prices that are precisely in line with their intrinsic value. So it is necessary to consider what, if any, effect an increase in wages would have on actual prices.  

One important reason why commodities do not tend to be sold at prices corresponding exactly with value is that this could result in vastly different rates of profit depending on the particular production conditions. This point can best be understood by considering a numerical example, such as the following:

Sector A:  9,000c + 3,000v + 3,000s = 15,000

Sector B:  3,000c + 3,000v + 3,000s = 9,000

The intensity of labor is different in each sector, reflecting differences in production conditions. Sector A is less labor-intensive, since three times more capital is invested in “constant capital” (c) to purchase the means of production than is invested in “variable capital” (v) to purchase labor power. In contrast, for the more labor-intensive Sector B, capital is equally divided between constant and variable capital. Each sector  generates 1,000 in “surplus value” (s) and its “rate of surplus value” (= s ÷ v), which expresses the degree of labor exploitation, is 100%:

6,000s ÷ (12,000c + 6,000v) × 100 = 25%

Even though the amount and rate of surplus value is the same, the rate of profit for each sector would be quite different. This is because the rate of profit expresses return on total investment and is thus the result of dividing surplus value by both variable and constant capital. Since the proportion of variable to constant capital is quite different in the two sectors, their rates of profit also naturally differ: 25% in Sector A (= 3,000 ÷12,000) and 50% in Sector B (= 3,000 ÷ 6,000). 

The less-labor intensive sector has a lower rate of profit because “constant capital,” as the name implies, does not generate any new value: it is simply the transfer of the value of the means of production, as is, to the value of the new commodities. In contrast, the “variable capital” pays the wages of workers who are set to work and can then generate more value than the value of their labor power (as already explained). Thus, even though the equations for the two sectors may seem to be the very sort of “composition” theory of value criticized earlier, with three factors seeming to constitute the value of commodities, the variable capital and surplus value can in fact be seen as deductions from the new value created in the production process through the expenditure of labor. Without the additional value created in that process, there would be no source from which to pay wages or to pocket a profit. (And in most cases wages are indeed paid after labor has been performed.) 

It goes without saying that if capital invested in Sector B were to earn twice the return of capital invested in Sector A, investment would naturally gravitate toward that sector . The greater investment in Sector B would increase the supply of commodities above consumer demand, pushing down prices, just as the opposite would occur in Sector A. This in turn would pull down profit in Sector B and push it up in Sector A, thereby evening out the profit rate. In this way, there is a tendency under capitalism toward the formation of an “average rate of profit.”

In our example, the average rate of profit between could be calculated by adding them together and dividing the total surplus value by the constant and variable capital, as follows:

Sectors A + B: 12,000c + 6,000v + 6,000s = 24,000

Profit rate: 33.3 % (= 6,000 ÷18,000 × 100)

If these two sectors constituted the whole of production in society, prices would revolve around a level equivalent to the “cost price” (c + v) plus average profit. Marx called this the “price of production.” 

The average profit would be 4,000 in Sector A (= 33.3% of 12,000) and 2,000 in Sector B (= 33.3%of 6,000), so that the production price in each sector would be as follows (“p” = “profit”):

Sector A:  9,000c + 3,000v + 4,000p = 16,000

Sector B:  3,000c + 3,000v + 2,000p =  8,000

The production price thus rises above value in Sector A and below it in Sector B. 

It may seem silly to have spent so much time discussing the labor theory of value if it turns out that commodities are sold at their production prices, rather than value. However, the “law of value” is still operating – albeit now in an indirect way – since the average rate of profit is premised on the amount of surplus value that exists, and total value equals total production price, just as total surplus value equals total profit. (The connection between value and production price, clarified by Marx, is something that eluded Smith and Ricardo – the former often slipped back into a composition theory of value, while the latter tried to directly apply his labor theory of value to explain prices.) 

Effect of wage rise on production prices

Based on the concept of production price, it is now possible to consider more closely what effect a wage increase would have on prices. An increase in wages by 20%, for example, would alter the proportion between variable capital and surplus capital. Variable capital would increase from 3,000 to 3,600, while surplus value would shrink proportionally from 3,000 to 2,400. In other words:

Sector A:  9,000c + 3,600v + 2,400s = 15,000

Sector B:  3,000c + 3,600v + 2,400s = 9,000

On this basis, the average rate of profit would fall from 33.3% to 25%, as the result of dividing the total surplus value by the sum of the total variable and constant capital:

4,800s ÷ (12,000c + 7,200v) × 100 = 25%

The new average rate of profit would be the basis for new production prices: 

Sector A:  9,000c + 3,600v + 3,150p = 15,750

Sector B:  3,000c + 3,600v + 1,650p = 8,250

As a result of the wage increase, the production price for Sector A thus decreases from 16,000 to 15,750, while the production price for Sector B increases from 8,000 to 8,250. (However, the combined production price of both sectors remains equal to value, at 24,000.)

Recall that Sector B was the more labor-intensive sector, where production price was lower than value, while the opposite was the case in Sector A. This example thus shows that in production sectors with a relatively high proportion of variable capital, such as Sector B, a wage increase may increase prices, but it would tend to decrease prices in less labor-intensive sectors. 

The fact that prices would go up in some sectors and down in others should already call into question the nightmare scenario of a wage-price spiral. But to give the spiral argument the best chance of success, we can assume that the majority of the goods consumed by workers are produced in Sector B, where the production price rises after the wage increase. 

The higher prices of goods in Sector B would counteract the wage increase somewhat. But the unlikelihood of this leading to spiraling prices should be clear if we consider the difference in scale between the 20% wage increase and the increase of production price in Sector B. In our example, wages (variable capital) rose from 6,000 to 7,200, whereas the production price only rose from 8,000 to 8,250. Moreover, considering that at least some goods for workers would be produced in Sector A, where the production price fell, the possibility of an inflationary death spiral seems even less likely.

However, a rise in wages would further increase demand for commodities consumed by workers, so it is probable that the market price of such goods would rise above production price. Such a price rise, however, would simply be the result of temporary disequilibrium between supply and demand, only continuing as long as supply and demand were out of balance. And goods consumed primarily by capitalists would be likely to fall in price as a result of the opposite case where supply exceeds demand. 

In short, the price-wage spiral (presented as a self-evident fact) is just a self-serving argument wielded by the capitalist class to defend their ill-gotten profits. 

Note. This is an unabridged version of an article that appeared in the September 2022 issue of The Socialist Standard.