Story: Prices and inflation

Page 5. Price of labour and capital

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Price of labour

Changes in the price of labour – of wages and salaries – have been measured since 1993 by the labour cost index (LCI).

Between 1993 and 2008 the LCI rose by 37.5%, compared to a rise in the producers price index (PPI) for outputs – which measures the price of goods and services – of 41.5%. The change in the consumer price index (CPI) in this period was 39.5%. This shows that the relative cost of labour for businesses fell slightly over the period, and that the buying power of wages and salaries failed to keep pace with the prices of goods and services purchased by households.

Purchasing power

However the changes in LCI, PPI and CPI between 1993 and 2008 do not necessarily imply that New Zealanders were worse off over that time. The adjusted LCI is not a good guide to changes in the purchasing power of wages and salaries over time. This is because the LCI is an index and adjusts the price of labour for quality changes in workers’ qualifications and experience, and to changes in the quality of work required.

A new worker entering an existing job position is generally treated as a ‘quality’ change by the LCI – any associated wage change does not register. But obtaining a wage rise as they move between companies, or between positions within companies, is one of the main ways people increase their pay, and excluding these movements leads to a downward bias in the adjusted LCI.

A better guide to how the purchasing power of wages changes is to compare the CPI with average hourly earnings (AHE). Unlike the LCI, AHE makes no adjustment for the quality of labour.

Between 1988 and 2008 the increase in AHE was 93.6%, compared to an increase in the CPI of 65.1% – the purchasing power of hourly earnings increased by 17.2%, or about 0.8% per year.

Price of capital

Interest rates are the price people pay for ‘capital’ – money to invest. If a firm has to borrow funds to purchase buildings or equipment, the price of those funds is the interest rate at which the firm borrows. If it secures funding through inviting investors to subscribe to bonds or shares, it usually has to pay its investors at least what they could obtain by depositing their money in a bank account – investment in business is generally more risky.

Interest rates vary with:

  • different loan or investment periods
  • the amount borrowed or invested
  • the assessed creditworthiness of the borrower.

They also vary in different business cycles, and are significantly affected by monetary policy. Nevertheless, over a long period various interest rates tend to track each other quite closely.

In New Zealand the margin between the six-month deposit rate (the interest that the bank pays to those who take out a savings bond for a six-month term) and the variable first mortgage rate for housing loans has averaged about 2.5 %. This is the margin between borrowing rates and lending rates which banks retain, and earn much of their income from. The margin between the rates narrowed after the 1990s as banks earned more of their income from fees and other service charges.

How to cite this page:

Adolf Stroombergen, 'Prices and inflation - Price of labour and capital', Te Ara - the Encyclopedia of New Zealand, http://www.TeAra.govt.nz/en/prices-and-inflation/page-5 (accessed 23 April 2019)

Story by Adolf Stroombergen, published 11 Mar 2010