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  • Writer's pictureSergio Focardi

Let us not cry wolf: The problem is not high inflation but stagnant wages

If I understand it correctly from the newspapers, in a recent speech German Finance Minister Christian Lindner argued that financial and economic policies must now prioritize fighting inflation rather than fighting global warming.

There are some obvious answers to these statements. The first is that we are putting on the same level economic policies that should be more or less routine with an environmental catastrophe that is coming (and perhaps has already surpassed it) to the point of no return.

The Minister, and those who support similar ideas, should know that the damage caused by global warming will have devastating effects not only on populations in remote parts of the globe but also on European industry and European populations.

It is extremely worrying that even at the highest levels of one of the most advanced states in Europe, the risk of irreversible climate changes with catastrophic consequences has not been fully understood.

But it is also surprising that it is not understood how economic decisions of great momentum are being made using economic theories that are over a century old and absolutely unsuitable for the current world. In particular we use a concept of inflation and a theory of growth that are not applicable to economies that are complex evolutionary systems. I will try to explain the matter in very simple terms.

I let a concrete example help my discussion. According to data from the FRED – Federal Reserve Economic Data – the Nominal GDP per capita of the United States grew 36 times in the period 1950-2020. According to the same data, this nominal growth is the product of 4-fold real growth and 9-fold inflation. Now, a simple economic intuition suggests that this is unrealistic. In the last 70 years there have been huge qualitative changes and huge innovations from air travel to personal computing.

If you earned today the salary that an equivalent position paid in 1950 you would literally starve. This is not because of inflation but because of the change in products and services that your salary would not allow you to buy.

The problem, well known, is this: in calculating inflation qualitative changes and innovations are not considered. Now, the rate of innovation has grown enormously over the past thirty or forty years. A static calculation of inflation is no longer adequate. When we measure inflation of 6-8% a year we don't really consider major product and service innovations. What is produced today is qualitatively superior in terms of characteristics to what was produced only a few years ago.

Of course it can be objected that the price of everyday consumer products has risen and therefore the average consumer really perceives inflation. This reasoning, however, is misleading. The real problem is that wages have not risen and have not followed the entire economic dynamic. The percentage of consumption due to wage earners has decreased relative to consumption due to profit. Not only that, but social inequalities have increased.

The public perceives inflation because globally wages do not keep pace with the economy.

We cannot measure the inflation of the entire economy with a single number computed on a basket of selected products and services. We must take into account the fact that there are products and services with a high rate of innovation and change for which it is impossible to measure inflation. [1]

To combat inflation, classic measures such as raising the interest rate are now being considered. These measures are detrimental to the entire economy and end up punishing the most innovative companies that we need for the green transition.

It is necessary to update the theory and adopt social measures. If we use the most modern theory of generalized inflation we would find that we are not in a period of great inflation. There are areas of inflation but there are areas of great innovation. It is absolutely necessary to raise wages and bring the consumption fraction due to wages back in line with historical values.

This is a big change both theoretical and practical. In a later post we will discuss occupation another area where big changes are needed.

[1] The theory of growth Qualitative it is Described in detail in the article: Frank J. Fabozzi, Focardi, Linda Ponta, Manon Rivoire, Davide Mazza, "The Economic Theory of Qualitative Green Growth", Structural Change and Economic Dynamics, March 2022

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