The ongoing wave of social and economic crises has left many individuals struggling to make ends meet in recent years, prompting governments to take action to mitigate the effects of growing inflation. According to a recent report from Ius Laboris, a global association providing legal services in employment, only a limited number of nations have an automatic wage indexation system which adjusts wages in line with rising inflation. However, experts have called for caution, warning of the risk of spiraling wage prices that such systems bring about when applied automatically
The cost of living crisis (a decrease in real available income) is a global issue that affects people from all walks of life, regardless of income, age, or background. It is a growing concern for many households, as inflation has skyrocketed to its highest level in the past 40 years and the energy crisis has added hugely to bills. These have both led to a dramatic increase in the price of goods and services, significantly slashing purchasing power.
Skyrocketing inflation vs falling wages
The International Monetary Fund projects that global inflation will fall from 8.8% in 2022 to 6.6% in 2023 and 4.3% in 2024, but will still remain above pre-pandemic levels of about 3.5%. This means that the cost of living will continue to increase, making it harder for people to afford the things they need.
In addition, the situation is exacerbated by stagnant wages which have failed to keep pace with inflation in many countries. According to estimates, advanced G20 nations have experienced a sharp decline in real wages, with a drop of 2.2% recorded in the first half of 2022. Meanwhile, real wages in emerging G20 nations continued to show growth, albeit at a slower rate of 0.8%, a decrease of 2.6% from the levels seen in pre-pandemic 2019. Hence, governments across the world are implementing measures to ease the burden on households and businesses. One such measure is wage indexation which adjusts wages in response to changes in the cost of living.
Wage indexation
Wage indexation is a system whereby wages, in both the public and private sectors, are adjusted based on changes in prices. The European Central Bank describes this as a way to keep salaries and social benefits in line with inflation. The form of wage indexation varies by company or industry, with one example being “automatic wage indexation” where wages are automatically adjusted if a predetermined index surpasses a specific threshold.
Automatic wage indexation serves several purposes. Firstly, it helps to preserve the purchasing power of workers and minimizes income disparities. It promotes unity among workers and sectors, facilitates wage negotiations, and fosters social harmony. At the global level, wage indexation stabilizes the economy, supports private consumption, and provides a steady increase in public revenue.
In some cases, governments only implement wage indexation for minimum wages to mitigate the impact of inflation on low-paid workers. Other forms of wage indexation are not automatic, but instead, serve to inform wage negotiations.
A recent study by Ius Laboris analyzed data from 27 countries and found that only Luxembourg and Belgium have automatic wage indexation systems in place. Five out of 27 countries have wage indexation for minimum wages only and in British Colombia, Canada, and France, the inflation rate is only considered when setting minimum wages in the private sector.
Source: Inflation, Wages and the Risk of a Wage-Price Spiral in 2023, Ius Laboris
Risks of wage indexation
While wage indexation can play a crucial role in combating the cost of living crisis, it can also have an adverse effect on the economy, as it comes with an increased risk of a wage-price spiral.
The wage-price spiral is a theoretical situation in which both consumer prices and nominal wages rise simultaneously, creating a spiral of increasing prices and inflation. While this concept has not frequently been observed in practice and has lasted only a short time when it has occurred, the risk of a wage-price spiral is higher in countries where automatic wage indexation exists for all wages.
In contrast, countries that only index the minimum wage are less likely to enter into a wage-price spiral, as the role of minimum wages in aggregate wage growth is relatively limited. Even if a significant increase is made to the minimum wage, this will have little impact on inflation as the proportion of minimum wage earners in the total number of workers is comparatively low.
The latest Global Wage Report 2022 – 2023, published by the International Labor Organization, shows that nominal wages are not currently keeping pace with inflation as measured by the consumer price index. The gap between the two continues to widen, mainly in high-income countries, where real wages fell in 2022 while productivity increased.
Commenting on the risks, Deborah Ishihara, Legal Practice Development Manager at Ius Laboris, told Development Aid:
“For the moment, the risk of a wage-price spiral is relatively low, and countries should be able to continue increasing wages in line with the cost of living without undue fear of generating one. But as inflation and uncertainty are ongoing, keeping a close eye on the impact of automatic wage indexation is essential, and governments may need to make adjustments to ensure long-term stability and prosperity.”