In the early 1970s, when rising inflation and unemployment tore through the economy, someone coined the aphorism “one man’s wage increase is another man’s job” (unfortunately, most of the talk was about men in those days).

It took off, in part because it appealed to common sense. If the price of something (workers) went up, employers would want would want less of them (workers).

Employers have used it to oppose every wage increase or improvement in working conditions in history, and still are.

Sometimes they are supported by widely respected economists, such as Ian Harper, who as head of the Fair Pay Commission in 2009 delivered Australia’s last freeze in minimum wages amid forecasts that unemployment was about to climb.

Now he and other economists are calling for another freeze, for the sake of jobs, in the downturn caused by the coronavirus.

Wages are more than prices

But the price of labour is different to other prices. While it represents the cost of buying a service, it also represents an income, one that bundled together with other incomes pays for the service.

When wages grow, spending grows (so-called “aggregate demand”), and so does the economy, as measured by gross domestic product.

Nevertheless, the standard neoclassical growth model used by the treasury and Reserve Bank doesn’t recognise this. Instead, it assumes that over the medium term economic growth is entirely determined by supply rather than demand, and that supply is a function of the three Ps: productivity, population and workforce participation.

Read more: Vital Signs: Amid talk of recessions, our progress on wages and unemployment is almost non-existent

Demand is said to merely cause short term fluctuations around the medium term growth path, and it is thought to be the job of monetary and fiscal policy to iron out the fluctuations to avoid unnecessary inflation or unemployment.

There are a number of other peculiar things about the model. It assumes that there are constant returns to scale, that technological progress favours neither labour nor capital, and there is perfect competition.

These assumptions effectively mean the distribution of income between wages and profits is constant and can be ignored.

The model that continually gets it wrong

Fluctuations in wages growth are presumed to be cyclical, amenable to correction by by monetary policy (interest rates), with fiscal policy (tax and government spending) held in reserve.

The model hasn’t performed well.

Over the past decade the treasury and Reserve Bank have persistently overestimated wage growth.

Wage growth has almost halved during the time it was overestimated, and it seems likely this is related to a similar decline in the growth of GDP.