Social partnership agreements, which at their core have traded off tax cuts for wage restraint, have served the Republic's economy well, fostering job creation and private sector investment.
Part of the legacy of the 1980s was substantial unused capacity, burdensome taxes, and wage setting arrangements that were pricing workers out of jobs. Responding to these obstacles, the early agreements contributed a good mix of demand stimulus and institutionalised wage restraint. Unfortunately, the formula is much less well suited to today's overheating economy.
The dilemma faced by the social partners as they met recently at Dublin Castle is not a mystery. On one side excessive domestic demand growth is fuelling inflation, especially in the service sector of the economy. On the other side inflation is being ratcheted up by a price-wage spiral, as employers respond to booming demand by raising their margins and workers try to protect their living standards by pushing for compensatory wage increases.
If the Government offers further tax cuts to compensate workers for higher prices, this fuels demand. But if the Government doesn't offer tax relief, workers will push for higher wages, driving the spiral still further.
What's needed to break the cycle sounds difficult. Workers' living standards need to be protected from rising prices, while avoiding adding further to domestic demand, and without raising the costs to employers.
What solutions are being offered?
The Government is seemingly at a loss for what to do, short of token price controls and exhortations against "profiteering". On the surface, the employers are demanding that the agreement be honoured, though they can't really believe that the unions will stand by and accept meagre improvements in living standards in a rapidly growing economy. Most of the innovative thinking appears to be coming from the unions, who are also, not surprisingly, the ones who demanded the review of the latest partnership agreement.
But most of their policy suggestions are unlikely to help. The idea of temporarily reducing excise taxes and public charges is superficially appealing, particularly if the affected items are included in the cost-of-living index. However, such reductions put more money in people's pockets, adding to demand and thus price pressures.
It also stores up price increases for a not necessarily more inflationary benign future.
Raising employers' PRSI contributions to fund extra childcare and health services is also a questionable policy at this time, as it, like direct wage increases, increases labour costs, and further fuels the price-wage spiral.
The most interesting proposal being forwarded by the unions is for pension bonds. Details are scarce but these Exchequer issued bonds would go to PRSI contributors, the unemployed and pensioners, and would offer a rate of return equal to the growth rate of GNP. Pensioners could cash in their bonds immediately, but workers would, presumably, have to wait until retirement.
These bonds offer a possible way to ease the inflation dilemma. They should have a limited impact on demand; they don't raise employer costs; and they might be accepted as a deferred yet concrete replacement for wage increases by workers.
Although pension bonds could provide a useful tool for macroeconomic management in the context of social partnership, they are less than ideal as longterm pensions policy.
One problem is that they take the form of a government IOU, and thus do not add to national saving, although they will lead to a larger budget surplus if they substitute for tax cuts that would otherwise be forthcoming
A second problem is that they do not improve the work incentives, since they are not related to earnings. A potentially better plan would be to have real, earnings-related Government contributions to individual pension accounts.
Notwithstanding these objections, the danger of a damaging price-wage inflationary spiral becoming embedded in the Republic's economy is alarming.
Innovative policy solutions that recognise and respond to the underlying dilemma are urgently needed. The pension bond proposal, which has the merit of being relatively simple to implement, deserves consideration.
John McHale is associate professor of economics at Harvard University jmchale@harvard.edu
