Review of the aggregate and sectoral relationship between wages and inflation in South Africa: 1980 -2019

Abstract

In South Africa, it has become apparent that inflation and wages move in the same direction, as whenever there is an expansion in general price inflation, sectoral wages have the same trend as well. Researchers confirm that the reduction in price level induces an increase in income and spending. It is well established in the international literature that firms respond to higher labour costs by reducing employment, reducing profits, or raising prices. Reducing the rate of inflation requires change in the policy regime. Hence, there must be an abrupt change in the government policy for setting inflation targets. While there are many studies done on the effects of inflation on wages, very few have been done on the impact of wages on inflation in South Africa during the 2000s, which this study seeks to address. This study will further conduct sectoral analysis, to check the impact of sectoral wages on the inflation. The study have two objectives; firstly, to examine how the relationship between wages and inflation has evolved over the period 1980 to 2019. Secondly, to investigate the impact of nominal wages on inflation and vice versa in the South African economy during the stated period. In order to assess the impact of wages on inflation, the study employed the simple Autoregressive Distributed Lag (ARDL) cointegration and Engle-Granger cointegration techniques. The outcome of this study is suggestive of a positive relationship between wages and inflation. The investigation of bidirectional causality was carried out by employing the Granger causality test. The results were that the ARDL relationship between prices, wages and import prices is positive. On the contrary, the study found a negative correlation between productivity and inflation. This is in line with the cost-push theory, which states that an expansion in the cost of production, which can be an escalation in the cost of labour in a form of rise in wages, causes the aggregate supply to decrease, resulting in an expansion in the price level as firms push the cost to consumers. However, a causal effect relationship exists between productivity and nominal wages. The test results of the Engle-Granger cointegration showed that inflation and nominal wages are cointegrated. The ARDL long-run form Bounds Test indicated that inflation and nominal wages have a significant long-run relationship. The Granger causality test reaffirmed that in both short-run and long-run nominal wages have the effect on the inflationary process. At a sectoral level, the results showed that there is a strong correlation between price inflation and nominal wage growth in the mining sector. Based on 0.001 p-value for the mining sector wage, the alternative that mining wages does granger cause inflation at 1.0% significance level is accepted. Since inflation worsens real income levels, the evaluation of factors that determine the expansion in prices is very important for policy constitution and to elevate the living standards of people by combating poverty, which is a socio-economic challenge in South Africa.