Wage Indexation in Labor Contracts and the Measurement of Escalation Elasticities

Abstract

It is not widely acknowledged that the process of wage determination in long term labor contracts may be critical to the determination and persistence of inflation and unemployment in North America. This paper uses Canadian contract data to analyse one important feature of long term contracts with cost of living indexation: the responsiveness of contracted vage rates to changes in prices within the contract period. Surprisingly, there is wide variation in this responsiveness across industries and across contracts. In about 15 percent of contracts average wage earners are over-indexed to inflation, receiving cost of living wage adjustments that increase their wages faster than the rate of inflation. On the other hand, in another 30 percent of contracts average wage earners receive cost of living increases that respond to each percentage increase in prices with a .7 percent or smaller increase in wages. Much of this variation is attributable to systematic industry effects, suggesting that industry characteristics may have a major role in determining the degree or indexation.