Are you unhappy with the rising cost of living? If so, it’s not surprising. Ditto if you’re not happy with the state of the economy. The plain fact is that the economy’s in the doldrums.

Although almost everyone who wants a job has got one and unemployment remains low compared with recent decades, nothing else in the economy is looking healthy. Growth has been weak, especially once you take account of the growing population.

People’s preoccupation with the cost of living is easily explained: wages haven’t been keeping up with rising prices. “Real” wages have fallen by 5 per cent since March 2021.

Investment by businesses in new plant and equipment is weak.

Productivity improvement – where greater efficiency allows the economy’s output of goods and services to grow faster than its inputs of labour and capital – isn’t happening. This matters because it is productivity improvement that makes the economy grow and raises our material standard of living.

So what can we do to get the economy growing again, with wages rising in real terms?

The conventional answer is to do whatever’s needed to improve productivity. This will allow wages to grow faster than prices without adding to inflation. Cost of living worries recede and our standard of living gets better.

Trouble is, control over production rests mainly with the private sector – business. For instance, productivity improves when businesses invest in more or better machines for their employees to work with.

This doesn’t sit easily with the notion that the government should be “managing” the economy, slowing it down when pressure on inflation is mounting and giving it a kick along when its growth is weak.

From this comes the now unfashionable “neoliberal” notion that if the economy isn’t growing fast enough, there must be something the government’s doing that’s slowing it down. Whatever that is, stop doing it.

See the problem? How does the government know which button to press that will prompt the nation’s million businesses – big and small – to find ways to improve their productivity? Or do we just have to wait for those businesses to get the urge to make themselves more efficient?

Part of the problem is that, although businesses are driven by the desire to make a profit and increase it over time, improving productivity is just one way to improve profits. At present, business profits are doing OK without them doing the hard yakka of finding ways to lift productivity.

That’s what’s wrong with the conventional explanation of what’s wrong with the economy and how it can be made to grow faster.

But I have an unconventional solution to the problem. It’s time to turn the problem on its head. Rather than waiting for businesses to decide to improve their productivity and then give their workers a rise in their real wage, the government should simply order them to give workers a big pay rise.

Businesses wouldn’t like this, of course, because it would reduce their profits. To stop that happening, businesses would have to increase the productivity of their workers – say, by buying bigger and better machines for them to work with.

This, in turn, would ensure the wage rise wasn’t inflationary.

In other words, by increasing wages, governments can pressure businesses to improve their productivity, with that improvement leading to growth in the economy and a higher standard of living.

If the idea of governments imposing wage rises on employers strikes you as unthinkable then I’m sorry, because that just shows how little you know – or remember.

Heard of the centralised wage fixing system? It was a system by which an independent government agency used to impose wage rises on the nation’s employers every three months. The agency was called the Industrial Relations Commission, and this was the way we ran the economy until just a decade or two ago. In those earlier decades, the sky didn’t fall. And our rate of productivity improvement was much better than it is now.

What we have now is decentralised wage fixing, where, for the most part, wage rates are left to be bargained between bosses and workers. These days, some workers have unions, but many don’t. The proportion of workers who are members of unions has collapsed to 13 per cent.

The key problem with the economy now – the reason people worry about the cost of living, and the economy is contracting rather than growing – is that wages aren’t even keeping up with prices, let alone rising a bit faster.

My guess is that the reason wages aren’t keeping up is that, in the decentralised system, employers have got the upper hand in wage bargaining and are – unsurprisingly – using this to keep wages low. Wages are a cost, and they want to keep costs down.

The trouble with this is that the economy is circular. Where do households get the money they spend on buying the goods and services businesses produce? Overwhelmingly, from wages.

See the problem? What makes sense from the perspective of the individual business – keep wage costs low – is bad for businesses as a whole because wages are what power consumer spending.

This is what economists call a collective action problem. Businesses as a whole would benefit if employers raised the wages they pay, but no business wants to be the first to pay its workers more than its competitors are paying.

Of course, if my competitors were paying more, I wouldn’t be too worried about paying more. So what would solve the problem would be if some magical fairy came along and raised all employers’ wage rates at the same time.

But, since we don’t have a magical fairy to hand, why don’t we get the government to do it?

Ross Gittins is economics editor.

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