In all industrial countries, the seventies were a time of slowdown

In all industrial countries, the seventies were a time of slowdown in real economic growth. In some countries, people resisted the decline in real income growth and tried to maintain their accustomed growth in living standards by demanding higher wages and salaries. In other countries, where there was a higher degree of ‘social consensus’, it was recognized that such a wage-price spiral would be damaging to the society as a whole, and people accepted the lower real income growth without demanding a pushing up of wages and prices. In testing this hypothesis, researchers examined the experience of eighteen industrial countries in the seventies. It was seen that the differences in the inflation performances of these countries were well-explained by the indicator representing the degrees of social consciousness.

Two rationales are advanced for the role of social consensus. The first is based on conflict over the distribution of a known loss in aggregate real income, while the second is based on imperfect information regarding the size of the loss. The two rationales are not mutually exclusive, but the first represents a greater departure from economic orthodoxy than the second. Let us first suppose that there is a big increase in the price of imported oil and that the size of the resulting loss of aggregate real income is known to all. In countries having a high degree of consensus, each group of individuals may be willing to scale down its claim on output in the same proportion as the aggregate reduction. On the other hand, in countries lacking such consensus, there may be an unwillingness to scale down demands. In the latter case, inflationary pressures will emerge even though the process is ultimately likely to be counterproductive or irrational from the point of view of the society as a whole.

According to the second rationale, workers demand no more than what is warranted by productivity, and if they know that productivity has fallen or oil prices have increased, they are willing to accept a lower wage. However, workers will not generally have enough information to know the value of their contribution to production, and they will not necessarily believe statements by the firm that productivity growth has declined. They will not be certain whether such statements are true or whether these statements represent attempts by the firm to cheat them. Statements by the firms will have greater credibility where the firms have established a reputation for fairness than where there is a high degree of mistrust between workers and employers. The greater the degree of trust, the less will be the workers’ resistance to reduction in the level or growth rate of real wage.

Both rationales suggest that real wages may be relatively inflexible, at least in downward direction, when there is a lack of social consensus.

3. The authors believe which of the following regarding the two rationales advanced for the role of social consensus?

I. Both the rationales challenge traditional economics.
II. Both the rationales explain the role of social consensus in inflation performance.
III. The rationales can co-exist.

A. I only
B. II only
C. II and III only
D. I and II only
E. I, II, and III