Higher wages are good, not just for the employee but for the economy and the stockmarket as well.

Neither Bertie Ahern, Charlie McCreevy, the Governor of the Central Bank nor Des Geraghty, want you to get a big real (after inflation) pay rise. They would prefer if you took a deal that saw your gross wage rise roughly in line with inflation. How strange!

Many newspaper editorial writers appear to share this bizarre view. I’m not putting words in mouths. I’m just repeating what I have heard in recent days.

The baying, in Orwellian unison, of our new economic mantra “competitiveness good, pay rises bad” reached fever pitch last week. The choreographed response to the news that inflation was back again suggested a pervasive level of conformity. The air was thick with talk of inflationary pay increases and fears that labour market tightness (ie, not enough workers) would threaten the boom. Commentators were askance, asking rhetorically, with productivity (output per worker) falling, how could we possibly remain competitive?

What would a Martian make of all this? Is it not peculiar that the prospect of higher wages should be entertained with such trepidation? After all, what is the purpose of the boom? Is it not to make people better off? What’s the problem with giving employees more income and giving those still on the dole the chance to work? Shouldn’t this be the end and competitiveness the means? But listening to the received wisdom last week, the opposite appears to be the case.

Last night, still perplexed, I was in a trendy Dublin restaurant with a stockbroker who was lamenting the plight of the ISEQ index (we’ll come back to this later), parroting the competitiveness mantra and worrying that the beginning of the end was in sight. Straining to hear over the din, I realised there and then what all the inflation fuss is about.

Once upon a time, back in the late 1970s boom, when many of today’s commentators, politicians, central bankers and trade unionists learned their economics, the economy could be allegorised as a fashionable restaurant. You know, one of those places which have sprung up all over Dublin recently, where tables are packed too tightly together and you can hear your neighbours’ conversations.

As the place fills up, people get a bit tipsy and it becomes harder to hear your own conversation, so you begin to talk louder. With more wine, the din increases. In time, you’re shouting. As is everyone else. Next morning you wake up hoarse and you wonder why.

Soon, the restaurant gets a name for being loud, rowdy and uncomfortable. People begin to desert the place for the new emporium down the street. The original restaurant faces a choice: either it keeps some of its tables vacant on purpose, reducing the noise level, thus keeping its crowd or it risks losing most of its business to the competitor. If it can’t keep the noise level down, it will lose clientele and, more than likely, go bust.

Back to economics. If we substitute people shouting for prices and wages in the economy and we think of the overall din as the economy-wide level of inflation and if we regard the vacant tables as being for the unemployed and the restaurant as the economy itself, we get the picture. Similarly, we should look at punters moving from one restaurant to the next as companies and capital moving from one location to another (ie, competitiveness).

With this analogy in mind, going back to the 1970s and 1980s, Ireland failed to keep the noise level in our restaurant down (inflation), so diners left (companies and capital going elsewhere) and the restaurant went bust (the 1982-88 slump).

Fastforward from the 1970s and 1980s to today and the restaurant is full again but the crowd is different. The proprietor is again worried about the noise but forgets that he has just installed an amazing, state-of-the-art sound absorption system in the floors and ceiling which has improved the acoustics no end. The new system, together with the new crowd more tolerant, allows the restaurant be full every night thus, leaving everyone happy. There is a bit of ebb and flow but nothing dramatic. The real worry is that with the new young crowd so heavily in debt, the proprietor has to deal with bounced cheques.

Let’s go back to our analogy. Regard the new sound system as the single currency or EMU which controls the noise level or inflation. This is because when a country stops printing its own money, as we did last year, the chances of hyperinflation are zero and the level to which inflation can rise is very limited. With the din controlled, people do not need to shout so loudly.

The change from the old to the new crowd can be looked upon as the move in Ireland from a situation where labour was plentiful and capital scarce (ie, 1970s/1980s), to a situation where labour is scarce and capital plentiful (2000).

When labour is scarce as it is today, the return to labour (wages) can and should be higher. In contrast, when capital is plentiful as it is today, measured by very low interest rates, the return to capital (profits) should definitely be lower.

Possibly, a failure to grasp this fundamental shift in the economy explains the rather apocalyptic noises about inflation threatening the boom. Moderate wage inflation will, if anything, preserve the boom and ensure a softer landing. It is also possible that the people making noises about inflation do understand the shift in the economy, but are not exactly happy with what this shift implies.

We need to go back to my stockbroker friend and his dilemma about the ISEQ index. He has done well since the early 1990s: commissions up, business booming and a bit of privatisation to keep everyone happy. Also years of low wage inflation made this country a profits mecca, boosting share prices.

In chart 1 we can see what has happened to the division of the national cake. In 1987, the share of profits in the national cake was 25 per cent, with wages at 75 per cent. For every �1 of output from this economy, 25 pence went to the employer and 75 pence to the employees. Since then things have changed dramatically. Artificially low wages for almost a decade, as a result of the partnership model, have ensured that for every �1 produced here, 42 pence now goes to the employer and only 58 pence to the employees.

The implication of this is quite startling. Relative profits have increased by 68 per cent since the beginning of partnership, while relative wages have actually fallen by 29 per cent.

This lop-sided division of the national cake is unprecedented in the western world. For example, in the US, the split is 31 per cent to the employer and 69 per cent to the employee. In Britain it is 30/70 and in Japan the same figures show a 29/71 split.

It is probably fair to contend, given the international comparisons, that the golden age of Irish profits is close to an end. In a democracy it is almost impossible for profits to continue growing at the expense of wages forever. The calls for higher wages simply reflects that democratic process.

Therefore, not only does wage inflation have to rise to reward labour, but the figures show getting back to a normal, western-style split like in the US is very possible and highly likely.

Just in case you think McWilliams has lost the plot and become an unreconstructed Marxist, let me explain why higher wages not only make sense from an equity point of view, but also from a free market angle. Today, labour is now scarce and much more valuable than capital.

Countries are no longer envied for their capital as was the case in the past, they are envied for their labour. The free market should be allowed to operate, pushing wages up and profits down.

For the stockmarket, this implies that until we have moved some way towards wage inflation, Irish stock will, in the main, stay stagnant. Certainly, company specific news will drive individual shares, but the macroeconomic story is unlikely to be supportive. The reasoning here is very simple. Investors are forward looking. By selling Irish stocks last year, professional investors implied that wage inflation was coming and that profits would have to fall (indeed, both the Irish and Portuguese stockmarkets of the two fastest growing EMU economies are suffering from the same plight).

Professional investors will not buy again until the process is over. The process will naturally take time. However, it will take infinitely longer if politicians and commentators continue to scream and shout about the dangers of wage inflation. The impeccable logic of the argument centres on the fact that the longer wage inflation remains artificially low, the longer investors will stay on the sidelines waiting for the inevitable explosion in wages and the more drawn out the pain in the ISEQ.

Ironically, if Irish stockbrokers want to limit redundancies in their own business, they should be supporting immediate hikes in wages across the board now to get it over and done with.

When I explained this to my stockbroker friend, he went through the five well-known psychological stages of bereavement. During our first course, there was haughty denial at the prospect of the Irish market not recovering. This gave way to anger. By our main course he was bargaining, “what if we had privatised earlier or more aggressively”.

As he tucked into his cheese, bargaining had given way to depression but finally, as we swilled back a couple of brandies he was struggling with acceptance.

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