CoLA not the answer to beating inflation

3 mins read

Adjusting wages to meet inflation with automatic mechanisms such as the Cost-of-Living Allowance will not solve the real problem of income inequality with low-earners not seeing their earnings improve for a decade, argue economists.

Social partners have recently agreed to renew the Cost-of-Living Allowance agreement to cover 66.7% of inflation, up from 50%, with economists unconvinced that linking wages directly to inflation would do much for people in real need.

In Cyprus, the pool of low earners is slightly smaller than in 2012, despite the island being hit by unprecedented inflation, breaking the record in July last year at 10.9%.

According to official data, just under half of the workforce is paid less than €1,500 monthly.

Some 48.9% of the workforce receives gross salaries up to €1,500, while another 10% get between €1,500-1,750.

The equivalent data in 2012 showed 49.4% of employees taking home gross salaries of up to €1,500 and 9.3% between €1,500-1,750.

Although economists do not have any answers on how wages should change with inflation, they appear to be on the same page on the importance of wage growth within the limits of inflation and productivity.

Talking to the Financial Mirror, economist Sofronis Clerides said the focus should be on combatting income inequality rather than introducing ways to reinstate employee purchasing power lost to hiking inflation.

“There is no doubt that wages should reflect changes in the cost of living with inflation, but an automatic across-the-board adjustment is not the way to go about it,” said Clerides.

The professor of economics explained that CoLA does not cover the whole workforce,

Total employees are approximately 430,000, of which 77,000 belong to the public sector and will be reaping the benefits of the new CoLA deal.

Of the remaining 353,000, only 28%, or approximately 100,000, are entitled to CoLA.

This includes employees covered by a collective agreement, such as the hotel and construction industry, the manufacture of medicines, and some professions.

Clerides argued that the CoLA institution does not benefit everyone equally.

“Employees who are better compensated, such as civil servants and high-end employees, such as managers, will see their income increase more in the amount of money added to their bank account at the end of the month”.

Furthermore, Clerides noted that inflation does not affect everyone similarly.

“Low earners spend most of their income on food and energy, which saw inflation rates of more than 20% in the past year.

“Higher income employees will spend their earnings on a much wider variety of products, for which they also have alternatives”.

He argued that even if an automatic adjustment like CoLA would restore purchasing power, income inequality would not go away but would be enhanced.

“Higher compensated employees will be earning even more in absolute numbers, with a large part of their earnings going to savings instead of the real economy”.

Ioannis Tirkides, Chief Economist at the Bank of Cyprus, argued that the issue lies with how income is distributed by the economy’s growth.

“First, the distribution of total economic income, or GDP, between wages and profits has shifted in favour of the latter.

“Second, within wage income, the distribution has changed in favour of higher earners”.

Tirkides said the problem is how to reverse these trends to ensure decent income levels at the lower end without exacerbating inflationary pressures and expectations.

“To ensure a fairer income distribution, the gains from growth are distributed as evenly as possible, real incomes should rise in line with the economy over time, and income inequality should narrow from current high multiples”.

Income distribution

He believes the distribution of income in Cyprus, just as in the rest of the EU, has changed following the global financial crisis of 2008-09, in favour of profits and at the expense of wages in most, but not all, cases.

“Europe as a whole is a more egalitarian society than the United States or the United Kingdom.

“For example, between 2009 and 2022, the share of wages in total income at the EU level fell very modestly compared with more pronounced movements at the country level”.

In Cyprus, the share of compensation of employees in total GDP falls by 5.6 percentage points, from 47.8% in 2009 to 42.1% in 2022.

The share of profits increased by 7.8 percentage points to 46.1% of GDP.

Tirkides said: “Ideally, averaged over a period of time, we would like wages to grow in line with inflation and also to capture some, but not all, of the gains from productivity.

“This will ensure that as the economy grows in real terms, real living standards also improve”.

The economist said that between 2003-09, total compensation in Cyprus captured all inflation and all productivity gains, with a consequent reallocation in favour of labour wages and away from profits.

Wages rose by 4.2% per year, roughly in line with the sum of consumer inflation of 2.9% and productivity growth of 1.2%.

“This was reversed over the 2010-22 period.

“Earnings growth was much slower at 1.3%, as was inflation at 1.2%.

“But while inflation was fully absorbed in the adjustment of earnings, productivity growth, at 0.9% per year, was not”.

As he said, this explains the reallocation of income in favour of profits in the latter period.

Tirkides said that the link between wages and inflation is not easy to quantify, as it would depend on the sources of inflation between demand and supply drivers, sectoral differences in inflation and productivity, and the share of wages in total operating costs.

“It is clear that to improve living standards, real wages should rise in line with inflation and capture some of the productivity gains.

“But if, at the same time, we want to reduce the income differentials that underpin the rather large income inequalities, the lower income groups need to be protected against inflation.

“The solution to our dual problem requires discretionary approaches in strengthening minimum wage legislation and using the tax system for tax credits and allowances and a system of activity-based income support”.