Should salaries be indexed to inflation, as the “rebellious” MPs are proposing?

It is not visible on the pay slip, but is felt at the end of the month: the rise in prices eats away at household disposable income month after month

Should salaries be indexed to inflation, as the “rebellious” MPs are proposing?

It is not visible on the pay slip, but is felt at the end of the month: the rise in prices eats away at household disposable income month after month. And brings back into public debate the proposal to index salaries to inflation, that is to say, to change remuneration according to the consumer price index.

Fueled by the post-Covid-19 economic recovery and tensions over energy linked to the war led by Russia in Ukraine, the rise in consumer prices took off in the summer of 2021. The government now estimates that France is “coming out of the inflationary crisis”. While the year-over-year price increase was 6.2% in October 2022, it fell back to 4% a year later. But geopolitical tensions, from the Middle East to Ukraine, are raising fears of a new surge in prices.

For their “parliamentary niche”, the “rebellious” deputies defended, Thursday, November 30, a bill to index most salaries to inflation, without receiving support from either the majority or the National Rally.

How useful would this device be in the current situation? What would the risks be? Why is the minimum wage a special case? The round of salary indexation in four questions.

In 1952, to fight against inflation which exceeded 20%, the head of government at the time, Antoine Pinay, voted to freeze prices, index wages to changes in wages and create a guaranteed inter-professional minimum wage (smig). But, after the two oil shocks of 1973 and 1979, a new inflationary episode – the rise in prices exceeded 13% in 1980 – forced companies to revise their pay slips upwards. In doing so, they fuel a “price-wage” spiral, with salary increases favoring an increase in production costs, and therefore purchase prices for goods and services, in turn leading to additional increases in remuneration…

In 1983, the indexation mechanism fell victim to the “turn of rigor” during François Mitterrand's first seven-year term: it was abandoned as part of the austerity policy led by the government of socialist Pierre Mauroy. In a few years, the rise in prices was brought under control and the inflation rate no longer rose above 4%.

This victory of “competitive disinflation” is often taken as an example by opponents of the wage indexation system. In reality, the control of inflation in recent decades owes as much to wage moderation as to severe monetary policy corrections, tightening rates and access to credit. “When inflation appeared, monetary policy quickly became very restrictive, which disrupted growth, caused unemployment to rise, and therefore caused inflation to fall rapidly,” describes Patrick Artus, economist at Natixis.

To protect the lowest paid workers, the inter-professional growth minimum wage (smic), which serves as the basis for the entire architecture of low wages in France, remained indexed to the consumer price index. It is reevaluated every January 1 based on the lowest wages, and each time inflation is above 2%; but it can also benefit from exceptional “boosts” – the last ones date from 2012, 2006 and 2001.

By definition, employees cannot be paid less than the minimum wage, but the latter being “hooked” to the inflationary locomotive, it increases faster than low wages, which are slow to be revised by the professional branches. Concretely, these remunerations at the bottom of the scale could benefit from significant increases if they were also indexed to inflation or if the scales were revised in the light of this improvement in the minimum wage.

“This creates a phenomenon of flattening salaries at the bottom of the hierarchy, in the private as well as in the public sector,” explains Jérôme Gautié, professor of economics at Paris-I-Panthéon-Sorbonne. With the corollary a strong feeling of downgrading of the least well-off employees, who also suffer from the surge in prices.

“Current inflation comes largely from the rise in the prices of energy and food raw materials, hitting the poorest and most deprived hardest,” laments economist Jézabel Couppey-Soubeyran, lecturer at Paris-I-Panthéon-Sorbonne University.

Raising wages in response to rising prices risks fueling the famous “price-wage” spiral and harming competitiveness, warn business leaders and some economists. Even the indexation of the minimum wage is called into question: the group of experts which advises the government each year on the revaluations to be carried out, recommends decorrelating it from the evolution of consumer prices, estimating that a general increase to all low wages would have damaging consequences on labor costs, competitiveness... and ultimately employment. A contested argument, to the extent that companies benefit from significant exemptions from social security contributions on low salaries (up to 1.6 minimum wage).

At the National Assembly, in the Social Affairs Committee, the “rebellious” text was attacked by the right at the end of November. In particular, the Les Républicains group tabled an amendment – ​​adopted – aimed at removing the mechanism indexing salaries to inflation, on the grounds that inflation has significantly slowed down at the end of the year and that such a system would threaten to “reproducing the inflationary spiral”.

Several European Union countries have had an indexing system: Belgium, Cyprus, Denmark, Spain, France, Italy, Luxembourg, Malta, the Netherlands and Slovenia. Three of them (France, the Netherlands and Slovenia) have retained it only for the minimum wage. Belgium, Cyprus, Luxembourg and Malta still have a mechanism for indexing all (or the majority) of salaries, whatever their level. But for them too, the question of sustainable indexation in a period of hyperinflation arises.

In Belgium, the index which is used to calculate the indexation of salaries, social benefits and rents would increase by 9% in 2022, compared to 2% in 2021 and 0.99% in 2020, according to the Federal Bureau of plan. This surge raises fears of a chain reaction on the wage bill for the private sector and a loss of competitiveness, highlighted by the Organization for Economic Cooperation and Development in its latest recommendations.

Despite anticipated difficulties for businesses, the end of this mechanism does not seem to be on the agenda. For Gabriel Colletis, professor of economics at the University of Toulouse, “the indexation of wages to prices only exists as a social achievement. There is a sort of social peace that has been found with this compromise and it cannot be undone like that.”