Adverse supply shocks often pose a dilemma for the Keynesian approach to aggregate demand management: Implementing expansionary monetary and fiscal policies tends to exacerbate inflation, whereas the laissez-faire policy stance is conducive to acute and prolonged unemployment before the economy restores its natural rate level of output. One way to avoid the predicament is to reverse adverse supply shocks with favorable supply-side adjustments, such as pushing down nominal wages. Indeed, as an alternative means to cope with demand shocks as well as supply shocks, appropriate labor market policies (including wage policy) are gaining importance in macroeconomic management. In the euro area, particularly, the familiar policy instruments, such as the exchange rate and money supply, have ceased to be available at the national level, and fiscal policy is also often constrained by the straitjacket that the budget deficit cannot exceed 3% of gross domestic product (GDP) under such circumstances, the more or less centralized wage bargaining processes that remain in place in some existing and prospective member countries are faced with the challenge (as well as an opportunity) of achieving wage moderation and flexibility in macroeconomic management.
Unfortunately, wages tend to be sticky downward and it becomes difficult to attempt to reduce them due to the existence of strong labor unions or the laws prohibiting such measures. (1) Furthermore the idea of instituting an agreement by unions and corporations to link wage growth with productivity growth, though attractive, often faces great political and economic challenges when it is put in practice. (2) Accordingly, in general there is a dearth of research on the effectiveness and dynamics of wage policy in an environment where other aggregate demand policies exist.
Singapore is an ideal case for the study of the effectiveness and dynamics of wage and exchange-rate polices, not only because it has actively deployed its wage policy in combination with exchange-rate policy for more than two decades but also because it has maintained a remarkable record of sustained economic growth with low inflation in a small, open economy. (3) Singapore imports more than 70% of its consumption goods, and imported raw material and intermediary goods are also important for Singapore's exports. Hence, policy makers in Singapore face the challenges of "imported" foreign inflation as well as the wage-push inflation that results from rapid economic growth and labor shortage. The exchange rate and wage movements naturally become the two interrelated key factors in maintaining macroeconomic stability. Specifically, the wage policy manipulated by a tripartite collective bargaining institution known as the National Wages Council (NWC) has actually acted as an important complement to the country's exchange-rate policy controlled by the Monetary Authority of Singapore (MAS) (Otani and Sassanpour, 1988; Wu, 1999).
The NWC is made up of representatives from the government, labor unions, and employer federations. Its main function is to select the rate of wage increase that is not only agreeable to all three parties but also compatible with macroeconomic targets. Although the NWC's wage recommendations only sketch a guideline for negotiations between employers and employees, both public and private sectors usually accept and implement them rather smoothly. The resulting collective bargaining agreements often extend to nonunion workers as well. Instead of bargaining unilaterally for union workers' wage benefits at the expense of nonunion workers' job security, unions act as an integral part of the NWC and often speak for workers as a whole in weighing real wage growth against unemployment. Particularly, unions actively promote sound economic policies to their members and support restraints when needed. In this way, the wage council helps reduce the frictions that information asymmetry and costly bargaining cause in supply-side adjustments. …