Opposite What Economists Believe, Rising Wages Signal Easing Inflation

In the closing months of 2020 as the horrid lockdowns related to the coronavirus began to ease, the American people started to live again. With restaurants in some cities re-opened for – gasp – actual dining, husbands and wives even started going out to dinner again.

Amid this substantial exhale, the cost of babyitting services soared. Not only could babysitters charge more per hour, they could demand more perks while on the job.

Was this indicative of “inflation”? Not remotely. If parents are paying more for babysitters, then logic dictates they have fewer dollars for nights out at dinner. Economics is about trade-offs, though you wouldn’t know it from reading the newspapers.

A recent Wall Street Journal headline went like this: “Pay Gains Shrink In New Sign Of Easing Inflation.” The assumption made in the headline and in the front-page article’s body was that more money in people’s pockets as it were had been driving up demand, and with it, prices. See above to see why what’s so broadly believed in the economics profession is so devoid of common sense. If workers are earning more dollars in compensation, then at least in the near-term, someone else has fewer dollars. Money doesn’t grow on trees. Tradeoffs yet again.

After which, it’s surely necessary to stress the basic truth that fingering rising pay as the cause of inflation is like saying tanned skin causes the sun to shine. Causation is plainly reversed. No doubt a shrinking dollar could instigate demands for wage increases, but the “inflation” would be the currency devaluation, while the higher wages would at best be the consequence. Figure that higher wages once again couldn’t bring about higher prices given the previously stated truism that the extra dollars supporting increased worker “demand” would occur in concert with reduced demand for those supplying the extra dollars.

All of which raises a basic question about rising wages to begin with: aren’t they a good thing? To say they’re inflationary doesn’t just miss from a price standpoint. Thinking about periods of booming growth in countries like the U.S. known for booming growth, can’t we broadly assume that the good times occur in concert with greater earnings? The question hopefully answers itself, which is important.

If it’s agreed that booming growth correlates with rising compensation, we can then ask what causes the growth in the first place. It’s not consumption as economists imagine simply because consumption is what happens after we’ve produced. It’s all hopefully a reminder of what’s obvious: rising productivity born of investment is economic growth, while consumption is what happens after the growth.

Looked at through the prism of wages, their increase is logically a consequence of investment. Of unspent wealth being directed toward work enhancements (think machines, computers, faster WiFi, etc.) that increase the productivity of workers. And when workers are more productive their value grows, thus driving up wages.

It all speaks to a basic truth seemingly ignored by economists who routinely mistake rising prices for inflation: rising pay is a consequence of more, not less investment. When unspent wealth is put to work, the productivity of workers grows. Kind of basic, and indicative of another tradeoff. When we favor savings and investment over consumption, workers win. They do simply because wealth is directed toward their betterment on the job, only for rising pay to reflect the betterment.

Crucial here is that savers seek a tradeoff for giving up near-term consumption: they want greater consumptive ability down the line. We save and invest our dollars now given the implicit belief that delayed consumption now will result in greater amounts of dollars at our disposal in the future. Put another way, a broad propensity to save is the surest sign of a lack of inflation; as in why save dollars that are rapidly shrinking in terms of their exchangeability?

Please keep all of this in mind with rising wages top of mind. Improving pay doesn’t just happen as much as it’s a consequence of more savings that enable the wage boosts. In other words, what economists view as a cause of inflation likely signals just the opposite.