March 18, 2022 Reading Time: 4 minutes

In the 1970s, everybody, even small children knew that a cola was a soft drink, a treat you would like, but could do without. A COLA, or cost of living adjustment, by contrast, was the staff of life because it provided hope that a worker’s real, or inflation-adjusted, income might not decline as prices soared.

Due to the Great Moderation, the long period of macroeconomic stability that developed nations enjoyed (from 1982 until 2007 according to the Federal Reserve), COLAs faded from view outside of a few niche areas, like Social Security. They became unnecessary because recessions were short, shallow, and seldom and inflation remained low and slow.

With inflation now high and trending higher, with no end in sight, American workers, and their employers, need to bring COLAs back, arguably out of fairness to workers but really out of efficiency. All that is needed is to raise employees’ cash compensation by some reasonable measure of inflation every month or quarter, preferably after a catch-up raise.

Yes, COLAs exacerbate cost-push inflation. Workers receive more nominal dollars, so more nominal dollars chase goods, bidding up their prices. But the American people did not cause inflation or inflation expectations to rise, the US government and its minion, the Federal Reserve, did. Workers pay a high price for inflation in formal taxes and do not need to suffer the inflation tax as well.

And American workers know their real wages are dropping, and they fight back in several ways that hurt employers and overall productivity. 

The Great Resignation is a complex phenomenon, but much of the massive job shuffling seems to be about better working conditions, which is often just code for the need for higher pay. Many workers felt ill-used during the first phase of the pandemic and sought redress in the form of higher pay. Work was, or at least seemed, riskier than before so the upward pressure on equilibrium wages when lockdowns ended was unsurprising.

Then inflation began to pick up steam and workers not only wanted more cash, they needed it to “make ends meet.” Many employers would not, or could not, comply, even though they knew that Help Wanted signs were here, there, and everywhere. So unprecedented numbers of employees went Johnny Paycheck and told their bosses to “Take this job and shove it, I ain’t workin’ here no more.”

Most presumably received higher pay at their new jobs, while their previous employers struggled to fill the posts they vacated. Stories abound of employers who allowed workers who made, say, $12/hour before the pandemic to leave when they asked for $13/hour, only to hire a new worker at $14/hour, plus considerable training and other onboarding costs. How could so many businesses be so daft?

Many employers interpret state labor laws to mean that they have to develop formulas regarding the pay of current employees. Employers promise that if workers stay employed for so long, they will get nominal raises. Often, employer pay rules are inflexible. New employees, though, often can join the team at market, creating odd situations where trainees earn more than the people training them. That is not just awkward, it can lead to some real Johnny Paycheck-like scenarios that explain why I recently had to wait a half an hour to get a crappy taco!

More damaging to productivity are the workers who do not storm off in the middle of the lunch rush but just slow down. They appear late, or not at all, and barely work when they bother to show because they don’t care if they get fired. Some have been known to call out because they can’t afford gas to get to work, hoping that bossman will cough up the corporate gas card. Others rob their employers blind.

Some employers pay what are known as “efficiency wages,” compensation higher than strictly necessary to fill slots. They hope to save in the long run through lower turnover and more honest and productive employees. But inflation gallops along so fast that efficiency wage premiums, and the benefits they bring, evaporate quickly.

So what is stopping widespread voluntary adoption of COLAs? Ignorance, inertia, and accounting. Executives tend to be older, so few people in positions of authority half a century ago are still in command. A few dimly recall that inflation affects accounting but who in the business world has recently read classics like Sidney Davidson, Clyde P. Stickney, and Roman L. Weil’s, Inflation Accounting: A Guide for the Accountant and the Financial Analyst (New York: McGraw-Hill, 1976)? They better bone up because asset depreciation and valuation, cost of goods (first in, first out vs. last in, first out), and lots of other accounting concepts start to get hinky as inflation settles in.

Budgeting has to change too. How can employers budget for COLA when the rate of inflation is unknowable? One technique is to look at market expectations of inflation, like the TIPS spread. Then double it and build it into the wage budget. Worst case, employers over budget. Best case, they keep their employees working hard and smart.

Robert E. Wright

Robert E. Wright

Robert E. Wright is the (co)author or (co)editor of over two dozen major books, book series, and edited collections, including AIER’s The Best of Thomas Paine (2021) and Financial Exclusion (2019). He has also (co)authored numerous articles for important journals, including the American Economic ReviewBusiness History ReviewIndependent ReviewJournal of Private EnterpriseReview of Finance, and Southern Economic Review. Robert has taught business, economics, and policy courses at Augustana University, NYU’s Stern School of Business, Temple University, the University of Virginia, and elsewhere since taking his Ph.D. in History from SUNY Buffalo in 1997. Robert E. Wright was formerly a Senior Research Faculty at the American Institute for Economic Research.

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