Full text of Economic Commentary (Federal Reserve Bank of Cleveland) : Collective Bargaining and Disinflation, February 13, 1984

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wage increase. This development
suggests that Ford and GM will
seek reinstatement of the annual
improvement factor in their September 1984 talks. The automobile
industry's recent experimentation
with profit-sharing may be superior
if substituted for the annual improvement factor approach. Not
only do the firms reduce their risk
exposure, but the profit bonus paid
to employees does not add to the
wage base.
In addition to the inflation implications of past practices in the
industry, some analysts would
argue that the costs of U.S. car
producers are too high compared
with those of their foreign competitors- If this were true, even a
6 percent per year compensation

••

settlement in the auto industry
would not improve its competitive
position. Unless U.S. automobile
producers are willing to gamble
that a large dollar depreciation
would equalize domestic and
imported car prices, they would
need to press hard for reductions in
unit costs or even more protection
from foreign automobile producers.

Conclusion
Labor compensation trends are
important determinants and indicators of long-run price trends.
Although recent wage developments
indicate a substantial reduction
in unit labor costs, there is little
assurance that these developments
will endure. In fact, experience

suggests that a lasting moderation
in unit production costs would be
difficult to achieve.
Though wage- and price-setting
decisions are inherently private
ones in our society, public policy is
affected by the outcomes and, in
turn, can influence the outcomes of
such decisions. Because this is an
election year, public policy actions
may be limited more than usual.
To the extent that decisions are
made, we would prefer that microeconomic policies would be used to
enhance competition in individual
markets (i.e., automobiles) and that
macroeconomic policies would be
used to prevent the acceleration in
inflation to which wage negotiators
inevitably react.

Federal Reserve Bank of Cleveland

February 13, 1984

Collective
Bargaining and
Disinflation
by Mark S. Sniderman

and Daniel A. Littman

See Susan A. Loos, "The Japanese Cost Advantage in Automobile Production," Economic
Commentary, Federal Reserve Bank of Cleveland,
forthcoming.

Federal Reserve Bank of Cleveland
Research Departmen t
P.O. Box 6387
Cleveland, OH 44101

••

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Labor relations and collective bargaining have changed markedly in
recent years. Although economic
recessions usually bring deescalation of wages and increased labor
concessions, an inordinate number
of labor concessions occurred in the
recession years of 1981 and 1982.
Economy-wide wage growth dropped
to its slowest pace since the early
1970s. At the same time, roughly
one-half of the 3.3 million workers
settling union contracts in 1982
accepted wage freezes or cuts. An
even larger number acceded to costsaving changes in work rules and
fringe benefits. Concessionary
labor contracts were settled in
highly visible key industries, such
as automobiles and steel, and traditional bargaining patterns among'
unions deteriorated. Strike activity dropped to a postwar low, and
unions lost more than one-half
of their representation elections.

••

Mark Sniderman is an assistant vice president
and economist and Dan Littman is an economist,
both with the Federal Reserve Bank of Cleveland .
A my Kerka provided research assistance for
this article.
The views stated herein are those of the authors
and not necessarily those of the Federal Reserve
Bank of Cleveland or of the Board of Governors
of the Federal Reserve System.

Meanwhile, many employers seemed
more willing to accept the notion
that their firms' survival depended
on improving productivity and cutting costs.
Wages tend to be the most slowly
adjusting set of prices in the economy, and union wages tend to
adjust to inflation and competitive
factors even more slowly than
nonunion wages. The inertia stems
from the multi-year duration of labor
contracts. Because of their high
visibility, union wage settlements
may provide standards for nonunion wage decisions: For the economy as a whole, a sharply lower
trend in wage increases helps to
restrain inflation, improving the
choices facing policymakers who
are confronted with other problems
in the economy.
It is, of course, difficult to judge
how many of the changes in the
current bargaining climate will
continue in the 1984-85 period,
because it is difficult to separate
the 1981-82 experience into cyclical
influences and longer-term structural aspects affecting U.S. industries. Downward wage adjustments
have occurred before; significant
labor-contract concessions appeared in the textile industry in
the 1950s, in the meatpacking
industry in the 1960s, and in public
employee unions in the mid-1970s.

It might be argued that we should
not be particularly surprised by
the magnitude of recent wage deescalation, given the fact that the
1981-82 period witnessed the deepest and most prolonged postwar
downturn and the greatest slowdown in price inflation since the
mid-1950s. Although the 1981-82
labor-relations experience has been
perceived by some analysts as a
permanent break from the past,
there are reasons to be careful
about reaching such a conclusion.

Wage Behavior over
the Business Cycle
A number of theories explain the
process of wage-setting and, more
importantly, how wage-price
spirals are initiated and sustained.
Regardless of one's view of the
entire inflation process, it is useful
to examine the behavior of wages
over the business cycle (see figure
1). The turning points and trends
shown here suggest that wages
are not the driving force of wageprice spirals. The substantial
Increases in consumer prices in
1973'-74 and 1978-79 preceded, and
were much larger in magnitude
than, the increases in economywide wage rates. Although union
wage costs are somewhat more
responsive to sharp changes in
inflation, they appear to be more

Fig.l
Wages for All Workers and
Union Workers
Four-quarter moving average
Percent change
14
13
CONSUMER
PRICE INDEX

12
11

!~UNION
! \ WAGES

: :

8
ADJUSTED
HOURLY,
E~RNINGS

A j

IV·

5
4
3
2
1

SOURCE: Bureau of Labor Statistics.

sluggish than total hourly earnings
in response to longer price trends.
Also, union wages resist downward
adjustments to disinflation. Second,
observe the moderation of unionlabor wage rates relative to
economy-wide wage rates in the

mid·1970s. Escalation of .union
labor rates responded slowly to the
rapid price increases of the late
1970s, while economy-wide wage
increases responded more promptly.
A third and very significant point
is the current steep adjustment in
economy-wide wage rates, from
about 10 percent to 4 percent, relative to the adjustment after the
1975 downturn.
In the 1973-83 period effective
union labor wage rates increased at
an average annual rate of 8 percent. Because productivity growth
was small in this period, the 8 percent annual labor cost trend flowed
directly to price pressures, consistent with an 8 percent rate of inflation. Cost pressures strongly influence prices when the trend in wages
is above trend productivity growth.
In a given year, the economy's
union labor rates will change for
any of three reasons: deferred wage
increases contained in previously
negotiated contracts, cost-of-living
adjustments (COLAs), and wage
increases contained in current
settlements. The weighted sum of
these three components, where the
weights reflect the proportion of
the union labor force receiving each
type of wage adjustment, equals
the economy's effective union wage
increase. These weights shift over
time, because different industries
follow different bargaining practices, and because over time the
rate of inflation affects the prevalence of COLAs. The behavior of
these three components over the past
ten years illustrates the dynamics of
the overall wage adjustment
process (see figure 2).
Over the business cycle, deferred
increases are the primary source of
the observed cyclical lags in union
labor rates. Deferred increases
prevent downward adjustment in
the early stages of recession, while
they dampen wage increases in the
early stages of economic expansion.

The contribution of deferred
increases to total wage changes
appears to fluctuate moderately
around a mean of 3 percentage
points per year, with little change
in the mean over this period. Although deferred increases averaged
4 percentage points in 1981, they
will contribute an unusually low
1.8 percentage points in 1984
because of concession activity in
the past few years.
In the early part of the 1970s,
COLAs contributed only 1 percentage point per year to union
labor costs; even during the worst
ravages of inflation at the end of
the decade, COLAs contributed just
above 3 percentage points per year.
Because they generally are tied
to increases in the Consumer Price
Index, COLAs move coincidentally
with inflation, i.e., respond to inflation with only a short delay. Because of the large decline in the
inflation rate in 1982, COLA contributions became small again
during 1983. Most forecasters now
anticipate that consumer prices
will rise from the current 4 percent
rate to perhaps 5 percent in mid1984 and somewhat more by yearend. In 1983 the combination of
effective COLAs and deferred pay
increases amounted to union labor
rate changes of 5 percent per year.
Being highly sensitive to the business cycle and price inflation,
effective current settlements probably are the first place where
upward wage pressures are apparent. Effective current settlements
contribute 3 percentage points per
year on average to total union
wages. As shown in figure 2, current settlements declined markedly
since 1981, although most analysts
believe that current settlements
will begin to increase soon.

Fig.2
Effective Union Wages and
Their Components: 1973-83
Four-quarter moving average
Percent change
11
10
9
8
7
6
5
...•:\ CURRENT

:::
r:: / ""
-,

...

o
SOURCE: Bureau of Labor Statistics.

Automobile Industry Talks
Over long periods, prices in the
automobile industry and the nation
as a whole follow the trend in unit
production costs. These costs in
turn depend on resource costs and
productivity. Since labor accounts
for nearly three-fourths of gross
income in the motor vehicle industry, labor productivity and compensation trends are extremely important determinants of automobile
price trends (see table 1).

The transportation equipment
industry has established a productivity growth trend of 3 percent per
year over the past 30 years. Output
changes have been more volatile
than productivity over cyclical
subperiods, reflecting the ability
of the industry to regulate labor
hours effectively. The productivity performance of the industry,
when compared with 30 other U.S.
industries, has fluctuated wildly
during the past three decades. This
record makes a long-term trend
hard to discern over short periods
of time.'
Based on industry trends, it
seems that the best productivity
growth the industry could expect
in an economic expansion would be
4 percent to 5 percent per year. In
light of the most recent industry
performance, a 3 percent average
would be a more realistic standard
for a sustained period of time.
Using this 3 percent productivity
trend as a guide, if future automobile price increases are to be no
more than 3 percent per year, total
labor compensation per hour can
increase by no more than 6 percent
per year, on average. This goal will
not be easy to achieve, for several
reasons. First, the automobile industry agreements typically begin with
a 3 percent annual improvement
factor wage increase. This contract
provision stems from the long-term
3 percent productivity growth trend
in the industry. Second, even if the
overall inflation rate in the country
were to remain around 4 percent,
the automobile workers probably
would recover about 90 percent
of that amount through COLAs,
adding another 3.5 percent per
year to labor costs in the automobile industry. Thus, COLAs and
the annual improvement factor together are likely to total more than
6 percent, without considering any
deferred amount. It seems clear
~

1. See John W. Kendrick, Interindustry Differences in Productivity Growth, Washington, DC:
American Enterprise Institute, 1982.

Table 1 Price and Unit Labor Cost
Increases in the Motor
Vehicle Industry"
Average percent change

Period

Prices

Unit
labor
costs

1957-60
1960-66
1966-69
1969-73
1973-79
1979-82

2.0
1.1
3.6
3.5
9.2
5.7

1.0
1.2
5.2
4.7
10.0
7.7

5.1
3.8
2.4
3.8
2.6
2.4·

1957-82
1977-82

4.3
7.0

5.7
13.9

3.2
1.0

Productivity

a. The motor vehicle industry includes motor
vehicles and car bodies, truck and bus bodies,
motor vehicle parts and accessories, and truck
trailers.
SOURCE: U.S. Department
of Commerce,
Bureau of Labor Statistics, national income
and product accounts.

that the 3 percent annual improvement factor is not compatible
with additional current increases of
any large magnitude. In light of
recent productivity trends, the
annual improvement factor should
be reduced or abandoned .
Uniformity in the bargaining cycle
of the automobile industry contracts
was broken in the autumn of 1979,
after Chrysler Corporation independently negotiated contract concessions amid rumors of the firm's
impending failure. Ford and GM subsequently agreed to concessions in
1982, including elimination of the
3 percent annual improvement
increase. Chrysler and the United
Auto Workers (UAW) bargained
again in September 1983; the
resulting 25-month agreement
called for a $2.42 hourly wage
increase and may become a bellwether for 1984 bargaining.
Chrysler's September 1983 agreement with the UAW reinstated the
usual 3 percent annual improvement increase, along with a COLA
cla use and a large discretionary