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The extent of wage indexation in Indian industries
T. DA-I-I-A CHAUDHURI Calcutta
University
Calcutta,
SARMIIA
CHAUDHURI
Cornell
University
Ithaca,
New
The Extent of Wage lndexation Indian Industries* In this paper, wage equation
we measure is derived
is estimated. From this ation coefficient, which
the extent endogenously reduced-form is a structural
we
derive
the
York
in
of wage indexation in Indian industries. from a macroeconomic model, and equation, parameter.
lndia
value
of the
The then
it
index-
1. Introduction In the context of a neoclassical model with short-term wage rigidities and uncertainty, Gray (1976) has shown that in the presence of both real and monetary shocks the optimal degree of wage indexation is partial indexation. In terms of a similar model, Razin and Lasky (1979) d erive empirically the extent of wage indexation for Israel. Our purpose in this paper is to derive the extent of wage indexation for the organized manufacturing sector in India. Given that the pay package of workers contains an item called “dearness allowance” for protection against inflation, it is of interest to know how wages have moved with prices. The theoretical model that we use is, however, different from the one used by Gray (1976). In our model, the Indian economy is broadly divided into two sectors, industry and agriculture. Excess capacity, administered pricing, demand constraints in industry, and supply constraints in agriculture are the basic characteristics of our model. Within the framework of a macroeconometric model, Chakraborty (1977), Ahluwalia (1979), and Bhattacharya (1984) consider the relationship between wages and prices for the Indian economy. But in these studies, either the wage equation is specified in an ad hoc fashion or is a partial equilibrium exercise. None however attempt to derive the extent of wage indexation. Ideally, the wage
eree
*We for
Journal
are grateful to Amitabha Bose, Dipankar helpful suggestions. Remaining errors
of
Macroeconomics,
Copyright 0 1989 0X4-0704/89/$1.50
by
Louisiana
Summer State
1989, Vol. University
are
Coondoo, ours.
11, No. Press
and
3,
pp.
an anonymous
455-461
ref-
455
T. Datta
Chaudhuri
and Sarmila
Chaudhuri
equation and the extent of indexation should emerge from a general equilibrium model. We attempt to derive this in our paper. The time period for the study is 1960-1980. The data has been compiled from various issues of the Annual Survey of Industries, the Reserve Bank of India report on currency and finance, and the Indian Labour Journal. The plan of the paper is as follows. The model is presented in Section 2. The estimation results are presented in Section 3. Section 4 concludes the paper. The following notations are used in the paper. Y = Output of the industrial sector. A = Agricultural output that is available for consumption by the industrial sector. py = Industrial price index. w = Money wage rate. k = Mark-up rate. a = Labor-output ratio. P = Actual overall price index. P” = Overall price index expected to prevail in period t as perceived in period t - 1. p = Agricultural price index. A4 = Level of money supply. A = Change variable. x = Coefficient of indexation. L = Level of industrial employment. q = Value of industrial output. C = Profit income. Z = Investment demand. s,n = Propensity to consume the industrial good of the industrial workers and the owners of capital, respectively. u,v,j h,v’,v”
= Random t = Time.
2. The Model The economy is agriculture. Following we assume industrial unit wage costs, wa. 456
disturbance
terms.
broadly divided into two sectors, industry and Dutta (EM), Rakshit (1982), and Bose (1985), prices to be fixed by applying a mark-up on We then have
Wage Zndexation
in Zndian Industries
Pr = (1 + k)aw, + u, ,
(1)
where the U~‘Sare normally distributed with zero mean and common variance. Such a price formation equation represents three things. First, the presence of oligopolistic elements in Indian industries; second, the presence of excess capacity; and third, the prevalence of administered pricing. We assume a to be constant. Other materiaI costs are included in k. We specify the wage-formation equation, following Razin and La&y (1979), as wt = w,-1 + x(P, - P,-1) + (1 - r)(E - P,-1) + 0, , O-cX51, where the 0,‘s are distributed variance. Rewriting (2) we get
(2) normally
with zero mean and equal
w, = w,-1 f (E - P,-1) + x(P, - lq + u, .
(2’)
This shows that at the time of wage fixation, the expected price change is fully accounted for and is given by a coefficient of unity in front of (e - Ptml). It is the difference between the actual and the expected price level that workers seek to protect themselves by indexation. In our empirical analysis we will use the cost of living index, P,, faced by industrial workers, which is constructed as a weighted average of PF and e. We thus have (3) where the jt’s are normally distributed with zero mean and equal variance. With respect to formation of price expectations, we specify the following: e = P,el + f(P,-, - Pt-2) + gAM, + h, ;
(4)
where h,‘s again are normally distributed with zero mean and equal variance. We assume that together with past movements in the cost 457
T. Datta
Chaudhur-i
and Sarmila
Chaudhuri
of living index, changes in the current level of money supply also affect expectations. The lagged values of the variables are exogenous to the model. Further, if we assume that pt’ and AM, are fixed exogenously, then (l), (2), (3), and (4) solve for w,, P,, e, and P,‘. In particular the solution of w, is given by wt-1 + Ml wt = -
- 4 - Q-1
D
D
+j-(x- w-2 +-xf-e D D +
dl
-
x)AMt
+
o,
t>
D
(4
where D = 1 - ~$1 + k)a. We estimate this equation and report the result in the following section. It is easily seen that the value of x, that is, the coefficient of indexation, can be derived from the estimated coefficients of w,-~, P,-l, and Prv2. In the next stage we endogenously determine p;‘, keeping AM, exogenously fixed. This is where the structural nature of the economy gets explicitly specified. The extent of industrial employment is assumed to be dependent on demand and is given by
Y, = l/aL, The
value
of industrial
output,
. 91, is given
9t = P:Yt .
(5) by
(6)
Turning to sources of demand for this industrial good, which is both consumable and investable, we assume that industrial workers and the owners of capital spend a fraction of their incomes on this good. We further assume that agricultural landowners spend all of their income on this industrial good while agricultural workers spend nothing on this good. Thus we have
458
Wage Inderation qt = sw,L, + nC, + I, + eA,-l
in Indian .
Industries (7)
It is assumed for simplicity that the owners of capital do not consume the agricultural good. Further we have the following equalities.
(1 - s)w,L, = P;QA,-, .
(8)
c, = qt - wtLt .
(9)
Equation (8) determines the rental income of landlords, which is dependent on industrial wage income and s. Equation (9) is the definition of profits. Adding Equations (6), (7), (8), and (9), we get the savings investment equality; that is,
I, = (1 - n)C, .
(10)
The solution method of this model is as follows. We have nine equations, (l)-(6) and (8)-(lo), in ten unknowns (P,, e, wt, PT, L,, Y,, qt, e, I,, and CJ. We fix the value of I, and determine the rest. This brings out the fact that the industrial sector faces a demand constraint. From (lo), I, determines C,. Substituting (l), (S), (6), and (8) in (9), we have C, = (k)(F$)(A,-Jl - s). Thus, given I,, C, gets determined and so does p;‘. Or in other words, investment demand determines industrial profits, which in turn determine the wage bill and the agricultural price level. Once Pf is determined, from Equations (l), (2), (3), and (4 we can determine P,, P:, w,, and PF. The solution of w, in this model is given by
w _ wt-I I Ml - 4 - xclpt-1+ .fb - w-2 t D D D +
xr(1 - 41, + dl A,-,(1 - n)kD
- x)AMt + v,, t. D
09
We also estimate this equation in the following section. Here again we see that the value of x can be derived from the estimated coefficients of w~-~, Ptel, and P,+.
459
T. Datta
Chaudhuri
and Samila
Chaudhuri
3. The Results In this section, we present the estimation results. We estimate Equations (A) and (B) with and without the variable AM,. The estimated equations and the values of the indexation coefficient are given in the following.
w, =-13.9 + 0.63~,-~ - O.l6P,-, + O.lOPt-z (2.33)* (-0.17) (0.126) + 0.638P; (1.96)* R== 0.84,
O.OlAM, (-1.05) DW= 1.94, x=0.095.
w, = -5.6 + 0.53~,-~ 0.37P,-, + 0.29P,e2+ 0.67P: (2.1)* (-0.42) (0.37) (2.09)$ R2= 0.83, w, =-23.8
DW = 1.81, x = 0.15.
+ 0.78~,-~ -
(3.8)* + 0.09Z,/A,-1
(3.93)* R2=0.9,
-
O.OSP,-,+ 0.47P,-, (-0.08) (-0.76)
O.OlAM,, (-1.17)
DW = 1.86, x = -0.53.
0.23Pt-I + 0.66Pt-2+ 0.091,/A,-, , w, =-16.34 + O.~W,-~(-0.347) (1.084) (4.04)* (3.55)* R2 = 0.89,
DW=2.12,
x= -0.61.
The figures in parentheses show the computed t-values. An asterisk (*) indicates that the coefficients are significant at the 1% level of significance. A high value of R2 shows that the postulated relationships are meaningful. Further, it can be observed that only the coefficients of wt-r, pt’, and Z,/A,-, are statistically significant. As already mentioned, the value of the indexation coefficient depends on the coefficients of w,-~, P,-l, and P,+ Since the coefficients of the last two variables are statistically insignificant in all four equations, one can
Wage lndexation
in lndian
Industries
conclude that the extent of indexation in Indian industries has been almost nil. Even if we take the estimated values, the different values of k suggest that the extent of indexation has been very low. The aforementioned observations indicate that although the money wages of workers in the manufacturing sector have moved upward with increases in agricultural prices, the extent of indexation with respect to unexpected inflation has been negligible. This is one of the probable reasons as to why money wages of the workers have failed to keep pace with the rate of inflation.
4. Conclusion In this paper, we specify a wage equation for manufacturing workers in India. We then estimate it and derive the value of the coefficient of indexation. Our analysis shows that the value of this coefficient is almost equal to zero, thus implying that the money wages of workers in India have failed to keep pace with the rate of inflation. Received: February 1987 Final version: November 1988
References Ahluwalia, Isher J. Behaviour of Prices and Outputs in India: A Macroeconomic Approach. New York: Macmillan, 1979. Bhattacharya, Barid B. Public Expenditure, Znflation and Growth. New York: Oxford University Press, 1984. Bose, Amitabha. “On the Macro-Economics of Development Models.” Indian Institute of Management. Calcutta, India, July 1985. Mimeo. Chakraborty, Shanti K. Behaviour of Prices in India, 1952-1970. New York: Macmillan, 1977. Dutta, Amitabha K. “Stagnation, Income Distribution and Monopoly Power.” Cambridge Journal of Economics 8 (March 1984): 25-40. Gray, Jo Anna. “Wage Indexation: A Macroeconomic Approach.” Journal of Monetary Economics 2 (April 1976): 221-35. Rakshit, Mihir K. The Labour Surplus Economy: A Neokeynesian Approach. New York: Macmillan, 1982. Razin, Asaf, and J. La&y. “Partial Wage Indexation: An Empirical Test.” Znternational Economic Review 20 (June 1979): 485-94. 461
University
Calcutta,
SARMIIA
CHAUDHURI
Cornell
University
Ithaca,
New
The Extent of Wage lndexation Indian Industries* In this paper, wage equation
we measure is derived
is estimated. From this ation coefficient, which
the extent endogenously reduced-form is a structural
we
derive
the
York
in
of wage indexation in Indian industries. from a macroeconomic model, and equation, parameter.
lndia
value
of the
The then
it
index-
1. Introduction In the context of a neoclassical model with short-term wage rigidities and uncertainty, Gray (1976) has shown that in the presence of both real and monetary shocks the optimal degree of wage indexation is partial indexation. In terms of a similar model, Razin and Lasky (1979) d erive empirically the extent of wage indexation for Israel. Our purpose in this paper is to derive the extent of wage indexation for the organized manufacturing sector in India. Given that the pay package of workers contains an item called “dearness allowance” for protection against inflation, it is of interest to know how wages have moved with prices. The theoretical model that we use is, however, different from the one used by Gray (1976). In our model, the Indian economy is broadly divided into two sectors, industry and agriculture. Excess capacity, administered pricing, demand constraints in industry, and supply constraints in agriculture are the basic characteristics of our model. Within the framework of a macroeconometric model, Chakraborty (1977), Ahluwalia (1979), and Bhattacharya (1984) consider the relationship between wages and prices for the Indian economy. But in these studies, either the wage equation is specified in an ad hoc fashion or is a partial equilibrium exercise. None however attempt to derive the extent of wage indexation. Ideally, the wage
eree
*We for
Journal
are grateful to Amitabha Bose, Dipankar helpful suggestions. Remaining errors
of
Macroeconomics,
Copyright 0 1989 0X4-0704/89/$1.50
by
Louisiana
Summer State
1989, Vol. University
are
Coondoo, ours.
11, No. Press
and
3,
pp.
an anonymous
455-461
ref-
455
T. Datta
Chaudhuri
and Sarmila
Chaudhuri
equation and the extent of indexation should emerge from a general equilibrium model. We attempt to derive this in our paper. The time period for the study is 1960-1980. The data has been compiled from various issues of the Annual Survey of Industries, the Reserve Bank of India report on currency and finance, and the Indian Labour Journal. The plan of the paper is as follows. The model is presented in Section 2. The estimation results are presented in Section 3. Section 4 concludes the paper. The following notations are used in the paper. Y = Output of the industrial sector. A = Agricultural output that is available for consumption by the industrial sector. py = Industrial price index. w = Money wage rate. k = Mark-up rate. a = Labor-output ratio. P = Actual overall price index. P” = Overall price index expected to prevail in period t as perceived in period t - 1. p = Agricultural price index. A4 = Level of money supply. A = Change variable. x = Coefficient of indexation. L = Level of industrial employment. q = Value of industrial output. C = Profit income. Z = Investment demand. s,n = Propensity to consume the industrial good of the industrial workers and the owners of capital, respectively. u,v,j h,v’,v”
= Random t = Time.
2. The Model The economy is agriculture. Following we assume industrial unit wage costs, wa. 456
disturbance
terms.
broadly divided into two sectors, industry and Dutta (EM), Rakshit (1982), and Bose (1985), prices to be fixed by applying a mark-up on We then have
Wage Zndexation
in Zndian Industries
Pr = (1 + k)aw, + u, ,
(1)
where the U~‘Sare normally distributed with zero mean and common variance. Such a price formation equation represents three things. First, the presence of oligopolistic elements in Indian industries; second, the presence of excess capacity; and third, the prevalence of administered pricing. We assume a to be constant. Other materiaI costs are included in k. We specify the wage-formation equation, following Razin and La&y (1979), as wt = w,-1 + x(P, - P,-1) + (1 - r)(E - P,-1) + 0, , O-cX51, where the 0,‘s are distributed variance. Rewriting (2) we get
(2) normally
with zero mean and equal
w, = w,-1 f (E - P,-1) + x(P, - lq + u, .
(2’)
This shows that at the time of wage fixation, the expected price change is fully accounted for and is given by a coefficient of unity in front of (e - Ptml). It is the difference between the actual and the expected price level that workers seek to protect themselves by indexation. In our empirical analysis we will use the cost of living index, P,, faced by industrial workers, which is constructed as a weighted average of PF and e. We thus have (3) where the jt’s are normally distributed with zero mean and equal variance. With respect to formation of price expectations, we specify the following: e = P,el + f(P,-, - Pt-2) + gAM, + h, ;
(4)
where h,‘s again are normally distributed with zero mean and equal variance. We assume that together with past movements in the cost 457
T. Datta
Chaudhur-i
and Sarmila
Chaudhuri
of living index, changes in the current level of money supply also affect expectations. The lagged values of the variables are exogenous to the model. Further, if we assume that pt’ and AM, are fixed exogenously, then (l), (2), (3), and (4) solve for w,, P,, e, and P,‘. In particular the solution of w, is given by wt-1 + Ml wt = -
- 4 - Q-1
D
D
+j-(x- w-2 +-xf-e D D +
dl
-
x)AMt
+
o,
t>
D
(4
where D = 1 - ~$1 + k)a. We estimate this equation and report the result in the following section. It is easily seen that the value of x, that is, the coefficient of indexation, can be derived from the estimated coefficients of w,-~, P,-l, and Prv2. In the next stage we endogenously determine p;‘, keeping AM, exogenously fixed. This is where the structural nature of the economy gets explicitly specified. The extent of industrial employment is assumed to be dependent on demand and is given by
Y, = l/aL, The
value
of industrial
output,
. 91, is given
9t = P:Yt .
(5) by
(6)
Turning to sources of demand for this industrial good, which is both consumable and investable, we assume that industrial workers and the owners of capital spend a fraction of their incomes on this good. We further assume that agricultural landowners spend all of their income on this industrial good while agricultural workers spend nothing on this good. Thus we have
458
Wage Inderation qt = sw,L, + nC, + I, + eA,-l
in Indian .
Industries (7)
It is assumed for simplicity that the owners of capital do not consume the agricultural good. Further we have the following equalities.
(1 - s)w,L, = P;QA,-, .
(8)
c, = qt - wtLt .
(9)
Equation (8) determines the rental income of landlords, which is dependent on industrial wage income and s. Equation (9) is the definition of profits. Adding Equations (6), (7), (8), and (9), we get the savings investment equality; that is,
I, = (1 - n)C, .
(10)
The solution method of this model is as follows. We have nine equations, (l)-(6) and (8)-(lo), in ten unknowns (P,, e, wt, PT, L,, Y,, qt, e, I,, and CJ. We fix the value of I, and determine the rest. This brings out the fact that the industrial sector faces a demand constraint. From (lo), I, determines C,. Substituting (l), (S), (6), and (8) in (9), we have C, = (k)(F$)(A,-Jl - s). Thus, given I,, C, gets determined and so does p;‘. Or in other words, investment demand determines industrial profits, which in turn determine the wage bill and the agricultural price level. Once Pf is determined, from Equations (l), (2), (3), and (4 we can determine P,, P:, w,, and PF. The solution of w, in this model is given by
w _ wt-I I Ml - 4 - xclpt-1+ .fb - w-2 t D D D +
xr(1 - 41, + dl A,-,(1 - n)kD
- x)AMt + v,, t. D
09
We also estimate this equation in the following section. Here again we see that the value of x can be derived from the estimated coefficients of w~-~, Ptel, and P,+.
459
T. Datta
Chaudhuri
and Samila
Chaudhuri
3. The Results In this section, we present the estimation results. We estimate Equations (A) and (B) with and without the variable AM,. The estimated equations and the values of the indexation coefficient are given in the following.
w, =-13.9 + 0.63~,-~ - O.l6P,-, + O.lOPt-z (2.33)* (-0.17) (0.126) + 0.638P; (1.96)* R== 0.84,
O.OlAM, (-1.05) DW= 1.94, x=0.095.
w, = -5.6 + 0.53~,-~ 0.37P,-, + 0.29P,e2+ 0.67P: (2.1)* (-0.42) (0.37) (2.09)$ R2= 0.83, w, =-23.8
DW = 1.81, x = 0.15.
+ 0.78~,-~ -
(3.8)* + 0.09Z,/A,-1
(3.93)* R2=0.9,
-
O.OSP,-,+ 0.47P,-, (-0.08) (-0.76)
O.OlAM,, (-1.17)
DW = 1.86, x = -0.53.
0.23Pt-I + 0.66Pt-2+ 0.091,/A,-, , w, =-16.34 + O.~W,-~(-0.347) (1.084) (4.04)* (3.55)* R2 = 0.89,
DW=2.12,
x= -0.61.
The figures in parentheses show the computed t-values. An asterisk (*) indicates that the coefficients are significant at the 1% level of significance. A high value of R2 shows that the postulated relationships are meaningful. Further, it can be observed that only the coefficients of wt-r, pt’, and Z,/A,-, are statistically significant. As already mentioned, the value of the indexation coefficient depends on the coefficients of w,-~, P,-l, and P,+ Since the coefficients of the last two variables are statistically insignificant in all four equations, one can
Wage lndexation
in lndian
Industries
conclude that the extent of indexation in Indian industries has been almost nil. Even if we take the estimated values, the different values of k suggest that the extent of indexation has been very low. The aforementioned observations indicate that although the money wages of workers in the manufacturing sector have moved upward with increases in agricultural prices, the extent of indexation with respect to unexpected inflation has been negligible. This is one of the probable reasons as to why money wages of the workers have failed to keep pace with the rate of inflation.
4. Conclusion In this paper, we specify a wage equation for manufacturing workers in India. We then estimate it and derive the value of the coefficient of indexation. Our analysis shows that the value of this coefficient is almost equal to zero, thus implying that the money wages of workers in India have failed to keep pace with the rate of inflation. Received: February 1987 Final version: November 1988
References Ahluwalia, Isher J. Behaviour of Prices and Outputs in India: A Macroeconomic Approach. New York: Macmillan, 1979. Bhattacharya, Barid B. Public Expenditure, Znflation and Growth. New York: Oxford University Press, 1984. Bose, Amitabha. “On the Macro-Economics of Development Models.” Indian Institute of Management. Calcutta, India, July 1985. Mimeo. Chakraborty, Shanti K. Behaviour of Prices in India, 1952-1970. New York: Macmillan, 1977. Dutta, Amitabha K. “Stagnation, Income Distribution and Monopoly Power.” Cambridge Journal of Economics 8 (March 1984): 25-40. Gray, Jo Anna. “Wage Indexation: A Macroeconomic Approach.” Journal of Monetary Economics 2 (April 1976): 221-35. Rakshit, Mihir K. The Labour Surplus Economy: A Neokeynesian Approach. New York: Macmillan, 1982. Razin, Asaf, and J. La&y. “Partial Wage Indexation: An Empirical Test.” Znternational Economic Review 20 (June 1979): 485-94. 461