23

I'm not sure that question is appropriate here, if it is not I will delete it.

Question: I heard that in USA prices are rising, but salaries are not. This looks strange to me. It means that companies get more money for selling stuff and services, and paying the same to their workers. So my question is: where goes that delta? Where does that increment of price goes?

  • 5
    If you expect salaries to rise corresponding to inflation, you should expect a decrease during deflation. Would you be willing to accept that ? – DumbCoder Apr 19 '11 at 13:16
  • 3
    @DumbCoder I can't say for USA, but in Russia (where I live) deflation never happened in last 20 years. But I guess it would be fine, since I would be able to buy same amount of goods/services for my salary. – Andrey Apr 19 '11 at 13:21
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    @DumbCoder: Sure they do -- you get laid off. – duffbeer703 Apr 19 '11 at 13:57
  • Wages are "sticky". They tend to go up, but very seldom go down (at least in real pre-inflation terms). Companies are generally much more willing to do layoffs than to cut wages. No; this stickiness doesn't really help the economy recover much. For more information consult your favorite macroeconomics textbook on the topic "sticky wages". – user296 Apr 19 '11 at 14:22
  • @Andrey - You say so because you haven't faced the situation. People cringe when they get laid off and have to take a lower paying role just to have something to eat. Purchasing power never comes into question because because human beings are greedy and nobody wants anything deducted from his pay cheque whether inflation/deflation. – DumbCoder Apr 19 '11 at 14:27
15

Where goes the Delta? To the sea, of course.

Your question is very valid and for once, I think most of the answers are too involved into mechanical details and are badly missing the big picture.

At the risk of over simplifying things, let me try to describe the situation in broad strokes:

Inflation: the volume of money grows faster than production (including services).

Deflation: production increase faster than the volume of money.

Imagine an economy with 10 products and $10. 1 product = $1.

In an inflationary scenario, money available increase: $20 for 10 products. 1 product = $2.

In a deflationary scenario, money available decrease: $5 for 10 products. 1 product = $0.5.

So far, it's pretty textbook. Now onto the stuff that you don't usually read in textbooks:

Time.

Say 10 people are attending an auction, each with $10 bucks. 10 items are for sale. $100 and 10 items. Item price is $10. Now, if just before opening the bidding, you go around and give each person $40, every one has $50. Each product sells for $50. That's the picture people have of inflation. Prices have increased, but everybody has more money, so it comes down to the same thing.

Now, let's bring this example closer to reality: You have to distribute $400, so the total amount of money is $500, which means that the normal price of each item should be $50. Now, imagine that instead of giving money to everyone at the same time, you started by giving $40 to 1 guy who was hanging out in front. The auction starts. While you go around distributing the money, the first guy manages to buy 2 items at $10 each. Now, there is $480 in the market, and only 8 items, making each item $60 on average. The next guy to get money manages to snap 2 items at $15. 6 items left and $450 in play. Each item now costs $75....and keep increasing in price as things move along.

People who get the money early buy items under their real value, and people who get paid at the end pick up the tab, because by then, there are only a few items left.

Back to reality, while inflation means that wages eventually increase (and they do), actual purchasing decrease for most people due to this simple trick. Employees are pretty much at the end of the chain.

Income tax Another major source of "signal loss" is income tax. It works by brackets, as you certainly know. Simplifying again because I am lazy:

$0-$100 = 0%;
$100-$500 = 10%;
$500-$1000 = 20%;
$1000-$5000 = 30%;
$5000-$10000 = 50%;

Take a guy who earns $100. Pays no taxes. Can buy 100 products at $1 each. Now, put in some inflation... He earns $500. He pays $50 in taxes and can buy 90 products at $5 each. By the time he earns $10,000, he can only buy 50 products on account of income tax.

So this is another area where you are bleeding purchasing power, and why income tax, which was originally presented as a tax for the ultra-rich is now a fact of life for most people (except the ultra-rich, of course).

Money as debt

Next stop: Money itself. Money is created as debt in our society. At the risk of over-simplifying things again, let's say Bank A has $1000 in assets. In the fractional reserve system (our current system), Bank A can lend out many times over that amount. Let's say $9,000, for a total of $10,000 (much more in reality). And of course, it lends that money at interest. When bank A has made $10,000 available through 10% interest loans, the total amount of money has increased by $10,000, but when the loans are paid back, $11,000 must be paid to the bank, so the net result of the operation is that $1,000 get taken out of the market.

This system explains why almost all companies and governments have huge debts, and why most of the world's large companies belong to financial institutions of some kind, and why most of the world's wealth rest in very very few hands.

To fully answer your question and provide details and references and names, one would have to write a book or 5. There is a lot more than can be said on the subject, and of course, all the examples given here are extremely simplified, but I think they illustrate the key issues pretty well.

Bottom-line is that our system is designed that way. Our economic system is rigged and the delta bleeds out on automatic.

  • Of course, in a sane economy, those banks lend money @10% to companies which an 11+% ROI. That is to say, they create $1100+ of economic value on that $10,000 loan. Therefore the FED can print an extra $1100 without triggering inflation, more than the $1000 needed for the repayment. You only get a breakdown if there is hardly any economic production (e.g. USA in the 21st century, or the Great Depression) – MSalters Apr 29 '11 at 9:25
  • @MSalters: Ok, but can you tell me why a bank would deserve $1000 out of $1100 extra production created by a company, in exchange for money which they did not have in the first place? Also, take out taxes on the $1100 and what you have is a system where the companies & people who produce stuff can barely maintain their standards of living, if at all. The company, in spite of producing increasing value, is having a hard time, and little (if any) trickles down to the employees. It is no idle comment that most wealth on this planet belongs to financial institutions. – Sylver May 1 '11 at 17:44
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    in case you missed it, banks don't get that money for free either. They'll pay a (lower) interest on savings accounts. Furthermore, interest always includes a risk premium; not every loan will be paid back. But bank profits are irrelevant to the flaws in "money as debt" scaremongering. The only thing they prove is that the monetary system is in deep problems whenever the physical economy is. Big surprise. Finally, the "most wealth" comment plain wrong. You're missing oil. The biggest companies and the richest individuals make their money with oil, just check the Dow Jones. – MSalters May 2 '11 at 10:46
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    @MSalters: 1. They pay a much lower interest...on a much much smaller amount. Deposits. A mere fraction of the money they lend. Not totally free, but pretty close. 2. Oil. Ad who owns controlling shares in major oil companies? The subject deserves a more in depth discussion and I would be happy to do so, but comments are not really suited for that. – Sylver May 3 '11 at 9:07
  • Also note that when banks fail, the government comes in to save them. – gerrit Jun 22 '15 at 10:24
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Purchasing commodities (whose prices are increasing rapidly), improving corporate profitability, buying imports (the US dollar is weaker than it was, so the price of everything imported has gone up), paying down corporate debt, etc.

  • 3
    I'd also add that salary goes up because of productivity gains not because of rising prices. – mpenrow Apr 19 '11 at 13:04
  • Also some amount of delta can go to individuals making them more richer. For example if the raw material required is from a farmer, he may become more richer. – Dheer Apr 19 '11 at 13:11
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    +1 for "purchasing commodities". Especially with a falling dollar. Seen the price of gasoline lately? That's somewhat political-instability but there's more where that came from. Especially with a) a falling dollar b) competition from China for these resources. Then there's "agflation" - food prices increase - including as a result of corn-ethanol subsidies. whee! :D – user296 Apr 19 '11 at 14:24
  • @fennec - I'm guessing that gas isn't anywhere near $8/gal, which is the current UK price for unleaded petrol. *8') – Mark Booth Apr 19 '11 at 19:02
  • @mpenrow, salary goes up because of increasing demand for that type of labour relative to supply. Salaries can rise while productivity remains constant. Consider for example a case where many skilled workers are leaving the country. – poolie Apr 19 '11 at 23:53
5

One of the byproducts of free trade is that there is now a global labor market. So companies routinely review their operations and think strategically about where the company is going. Standard options are:

  • Status quo.
  • Automate
  • Externalize/outsource

Because the disincentives that once existed in the past are gone (the need for humans to do work, tariffs, regulation, poor infrastructure in the developing world), the available supply of labor is greater and demand lower -- thus wages are falling in real terms.

Think in the simplest terms in an office environment.

In 1980 to make photocopies, you needed a Xerox machine that required a technician on site every couple of weeks to make adjustments, change toner, etc. There was probably a local rep you called to schedule break/fix serivce. Now technology has replaced that copy machine with a cheap multi-function device that requires no maintenance and any technical support is delivered by a person sitting in a Indian call center.

So to answer your question, the incremental money from rising prices goes to a number a places. Alot of it goes to oil producers and other commodity producers. Much of it consists of indirect costs that fulfill other mandated services -- when you buy something, buried in that cost are things like health insurance, prescription drugs and school taxes.

2

Salaries normally shouldn't fluctuate with inflation and deflation... Inflation prevents consumers from spending (prices get too high), ultimately taking money out of circulation. This causes the market to go in to deflation (or at least deflate back to normal). That's when people begin to spend again, and start the cycle all over again.

Now... Imagine if salaries increased with inflation... Inflation would never end. Everyone could keep affording the high prices. A Starbucks coffee would eventually cost $150, but the "middle-class" would all be millionaires. Your "small-change" would consist of a wad of useless bills, and the government would have to continually print out more money just to keep up.

NOTE: This is not a direct answer to "where goes delta?", but would more be directed to the part "Prices go up and salary doesn't".

  • 5
    "Inflation would never end." Indeed, when inflation is in full swing, and people expect cost-of-living increases in line with inflation, that feeds inflation, and it's very hard to stop. This is why it's generally prudent for central banks to avoid inflation to begin with. – user296 Apr 19 '11 at 14:11
  • There is always inflation as long as the money supply can expand. Colonial Spain suffered from inflation because they extracted lots of gold and silver from South America. Nowadays, we just print money. – duffbeer703 Apr 19 '11 at 17:57
2

I expected a word or two on the price elasticity of demand here :)

Andrey, Your question needs slight revision in its current form. Rising prices actually do not mean increased profitability for a company. The quantity they sell also pays a huge part and actually is correlated to the price at which they sell the goods (and other factors such as the price at which their competitor sells the goods etc., but we will ignore it for simplicity).

The net profit of sales for any firm is equal to

(Qty x Sale Price) - COGS - SG&A - taxes - other expenses

where,
COGS means cost of goods sold
SG&A means sales, general and admin costs (e.g., cleaning the inventory storage area daily so that the goods stay fresh etc.)
other expenses include any miscellaneous other costs that the firm incurs to make the sale.

Now, if everything in that equation remains same (COGS, SG&A, taxes, and other expenditures), rising prices will only translate into a higher profit if the quantity does not fall by the same margin.

Prices may also rise simply as a response to risking COGS, SG&A or other expenditures --the latter may be observed in inflationary environments. In such a case, the supplying firm can end up losing its profit margin if the quantity falls by more than the price rise.

protected by Chris W. Rea Jan 12 '17 at 3:08

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