Wage Claims, Income Policy and the Path of Output Inflation in a Formerly Centrally Planned Economy

The corporate governance problem of state enterprises in formerly centrally planned economies can give rise to excess wage claims and/or capital decumulation if workers and managers try to appropriate the firm's assets before it is "commercialized" or privatized. Since state enterprises still produce a dominant fraction of total output, these problems can have serious macroeconomic consequences. For example, since the profit tax accounts for a significant proportion of government fiscal revenue, a redistribution of state enterprises' total revenue from profits to wage implies - ceteris paribus - a worsening of the government's fiscal position. In the absence of a developed bond market, this implies higher money creation: monetary policy becomes endogenous with respect to wage claims. Also, if the claims of workers (in the form of wages) and government (in the form of taxes) exceed output, capital will be run down. This can happen, for example, if the government imposes excess wage taxes on state enterprises, but the latter are unable to keep wage increases below the limit. This paper provides a simple dynamic framework to address these issues, and studies the impact of wage controls on the behaviour of the fiscal deficit inflation, private consumption, and output in the presence of "excessive" wage claims. The latter can lead not only to high inflation, but also to suboptimally low levels of capital and putout. If wage levels are initially excessive, simple incomes policy measures, such as a reduction in the degree of wage indexation, can be effective in reducing inflation and the fiscal deficit if nominal wage increases do not provide on average full protection against inflation. Furthermore, in the presence of structurally excessive wage claims and full inflation coverage, linking wages to the path of putout can help reduce the overall output decline. The endogeneity of monetary policy with respect to wage claims implies that wage controls may be necessary to regain monetary autonomy if the Central Bank is to pursue nominal exchange rate stability or a crawling peg.