The relationship between trade unions, wage setting and inflation

There is a debate on the relationship between trade unions, wage setting and inflation in the Irish Times this week. One letter (Declan Mansfield, December 3rd) argues that ‘house prices always rise after wage rises’ and that this is a ‘law of economics as gravity is to physics’. There is absolutely no evidence to support this assumption. Between 1987-2007 house prices rose by a staggering 380 percent whilst real wages rose by approx 60 percent. Most of the increase in disposable income occurred through a reduction in tax bands and an increase in tax credits. Ireland’s housing bubble was not caused by wage increases but an over supply of cheap money. This oversupply of money was made available through low ECB interest rates and pro-cyclical fiscal policies by government. So, the argument that wage increases led to the increase in house prices is equivalent to saying two plus two equals forty four. It is an argument when tested by empirical evidence proves false. Reckless behaviour in the private financial market is the cause of our economic woes not the remuneration of productive labour. Economics, like all the social sciences, is based on uncertain collective social behaviour. It is not a predictive science.

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4 responses to “The relationship between trade unions, wage setting and inflation

  1. @aidan
    “Economics, like all the social sciences, is based on uncertain collective social behaviour. It is not a predictive science.”
    Not by any means an economist – but I would have thought that if the main function of economics was not to predict the effects of various monetary policies and decisions , it would be a pretty much useless excercise. Isn’t that a bit like saying that meteorolgy has nothing to do with weather forecasting?

  2. @ A Mc Grath

    Its a good analogy and a fair point. Economics can get close to prediction but it, like most of the social sciences, has to resign itself to causal explanation after the event. From this it can deduct under what conditions similar events will occur. But, given that human behaviour is so uncertain it would be erroneous to assume it can predict events in a strict linear way akin to the hard sciences. What often counts as prediction in economics is prescription. It prescribes market mechanisms to coordinate behaviour.

  3. @aidan
    I don’t really believe that anyone thinks that economics can predict events in a strict linear way, as you say, but it should certainly do a bit better at prediction of events than mainstream economists did prior to the recent crisis. Apropos of that point somebody posted a link to this paper the other day on irisheconomy site. It drew no response from the eminent economists posting on that site but I found it really interesting, and to a large extent an indictment of modern academic economics. You might have some views on this. The basic point is that the economists who predicted the crisis accurately were “flow of funds” as opposed to “equilibrium” school. He makes the point that “flow of funds” economics is ignored by the universities.
    It is quite long so I skipped through a lot of it – especially where it got too technical for me. What appealed to me was that those who predicted correctly (e.g Peter Schiff and Steve Keen etc) seem to rely more on common sense and less on abstruse modelling.
    http://mpra.ub.uni-muenchen.de/15892/1/MPRA_paper_15892.pdf

  4. Declan Mansfield

    Hi Aidan,

    I don’t normally reply to commentary on letters I’ve written, believing that, within the constraints of space allowed by newspapers for letters, I’ve made my point and that it’s up to readers to make of my argument what they will. Like everyone else, sometimes I get it right and sometimes I get it wrong. However, my sister sent me a link to your blog site and having read the criticisms you make about my letter, I thought I might reply to your main charge – which in précis is ‘the argument that wage increases led to the increase in house prices is equivalent to saying two plus two equals forty four. It is an argument when tested by empirical evidence proves false’.

    According to David Smith, the Economics Editor of the Sunday Times, the relationship between wages and house prices is “[o]ne of the enduring economic relationships. House prices rise because incomes do”. Here is the quote in full from his book Free Lunch: Easily Digestible Economics (p.14). “One of the most enduring economic relationships is that between house prices and people’s incomes. The house price/earnings ratio – the ratio of average house prices to national average earnings for full-time workers – is around 3.5 over the long run, usually fluctuating between three and four. If average earnings are [pounds] 20,000 a year – they are actually a little bit above that at the time of writing – average house prices will be around [pounds] 70,000. It is easy to see why this relationship should exist. Suppose house prices had not risen and were stuck at their 1930s level. Someone on average earnings could buy several houses in the London suburbs a year, instead of buying one and paying for it over twenty-five years of a mortgage. We are back to supply and demand. In this case rising demand does not mean that everybody wants to own a string of houses. It does mean the amount they can afford to pay for their semi has increased hugely and, more importantly, so has the amount others can afford to pay. Competition among buyers, all of whom have been able to pay more over time, pulls house prices higher”.

    You can’t get a more emphatic statement than that, or one that makes more obvious sense. Whether it’s true or not I’ll leave to economists to decide. But, the idea that there is no evidence for my original assertion is, as you can see, and to use your own word, false.

    The very best of luck with your blog and your PhD.

    Best regards,

    Declan Mansfield.

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