A friendly user in r/AskEconomics wanted to know why wages aren't indexed to inflation.

That user got the rather unfortunate answer which I quote in the title, along with some just okay answers.

I correct the badeconomics and answer the question in this post here. Guest appearances are made by Uncle Milton, David Card, and the Fed.

For your convenience, I quote my post below, but if you dive into the thread there's some juicy discussion on the nature of greed as well. Also, if you do check it out, take a look around r/AskEconomics! Good contributors are always welcome.

Also, quick disclaimer about my post below: there's apparently a big macro literature about the desirability or non-desirability of indexing wages to inflation. I don't know anything about it other than it exists, and would be pleased to receive comment on that literature from someone less ignorant of the subject.

Copying my post from r/AE:

Ignoring the [original question's greed-based] normative framing, the question: "why aren't labor contracts negotiated in real terms?" is actually a pretty darn good question.

I think zzzzz94 gave a not-particularly-good answer to your question while HeFlipYa gave a terrible answer to your question -- at least in so far as they wrote off the issue as sort of silly and uninteresting at worst and, at any rate, addressed by the usual sorts of wage renegotiation we see occur at firms.. But if they're right, it's awfully strange to consider, then, that Milton Friedman bothered to write a piece in 1974 advocating for more wage contracts to be indexed to inflation. Not to mention strange to consider that there was an entire follow on literature, featuring empirical contributions from David Card among many other noted labor economists....

I'll start by discussing why you might care about having your wages indexed to inflation.

First, let's recall what HeFlipYa had to say about this:

That aside, wages are simply prices for labor. In a free market, there is no legal or logical reason to index wages to inflation, as prices, including labor, are negotiated (monopsony/monopoly aside).

I can think of a lot of reasons why I would want to negotiate a contract that indexes my wage to inflation!

First, there would be an insurance motive for doing so. In general, workers are risk averse. If I only renegotiate my wage annually or every 2 years or something, the real value of my wage will change over time by an uncertain amount. Assuming that inflation is our only concern, risk aversion should make me willing to pay my employer a little bit to get an inflation indexed wage that buffers me against inflation-related risk. Note: this is similar to the reason why employees don't generally go for compensation primarily as a function of company profits -- it's a risk thing.

Second, with a wage indexed to inflation, that may reduce the number of times I need to renegotiate my wage. Instead of annual (or whatever) renegotiations related to inflation, we would only need to renegotiate when my productivity or outside options or whatever change. This could save on some quantity of negotiation costs.

In this vein, when zzzzz94 says that in the long run wages will rise with inflation, z is correct (people periodically negotiate their wages up to adjust). However, that empirical observation doesn't explain why people don't simply contract on the inflation adjustment pattern to begin with and dispense with the informal periodic negotiations.

More than all of the above, it's possible that even if you don't personally care whether or not your contract is inflation indexed, maybe you should care about its implications for the macro economy. If your theory of the business cycle involves inflation expectations getting up to some funny business or nominal, but not real, rigidities-- then you probably care about inflation indexing wages! But, I don't know if your theory should include those things, as I am not a macroeconomist and am not particularly competent to judge the relevance of the 70s-90s macro literature discussing this topic. (Also, there's a curious political economy point to consider here: governments have incentives to cook the inflation statistics right before elections if it means they can use them to force lots of companies to give out raises.)

Putting aside, then, the motives for why you might want your wage contract to be inflation indexed, we're still left with the question of why people don't have inflation indexed wage contracts more often. My best answer to this question is: "I don't know". But my low-certainty, speculative answers include:

1. The question isn't entirely factually grounded: some people do have wages that are indexed to inflation. Government workers especially, probably some union contracts, etc.
2. Indexing to inflation is a sort of complicated concept that may be too much bother to implement, given that it goes against conventions. Indexing schemes may be costly to explain, costly to implement, and they make your job offer look superficially worse (recall that the inflation indexed wages should have a lower starting wage level if they're to match an identical offer in real terms the insurance value should lower them a bit further anyway). If workers don't care about having inflation indexed wages -- and in the current low inflation environment, they probably don't -- then it may well not be worth it to offer.
3. It may be to the employee's benefit to have inflation as an excuse to renegotiate wages more or less annually. They may prefer being able to force the employer to incur renegotiation costs annually no matter what, since it lowers the cost of asking for raises to reflect increases in their own productivity or for whatever other reason.
4. It may be to the employer's benefit to have the option to use inflation as a way to lower real wages without lowering nominal wages (which is generally thought to be costlier), especially as a way to buffer against negative shocks to a firm's profitability.
5. Inflation indexes are produced at a lag, meaning it's hard to use them for really high frequency inflation adjustments anyway. If wages get renegotiated relatively often anyway, the rate at which they are inflation adjusted through negotiation may not be that different from how often they would be adjusted using inflation indexes. (Though I guess you could use real time stuff like the billion price project or whatever to address this issue)

Another question to ask is: is there any literature on this topic?

As mentioned above, there's a lot of literature looking at wage indexation. Not surprisingly, a lot kicks off in the 70s when inflation was really high. The thing is, a lot of it looks from a macro perspective, asking about the implications for the macroeconomy of indexing wages to inflation. That doesn't help us too much here, does it? That said, interesting things come out of this literature.... Card finds, for example, that inflation shocks have persistent effects on real wages, at least within the set of union jobs he examined. (I find that result highly surprising!) This macro oriented lit review discusses a string of papers around page 6-7 that turn out to have already formalized my intuitive arguments I outline for why you might want inflation indexed wage contracts (guess I've been scooped by about 40 years as far as publishing those insights go).

Unfortunately, there isn't a lot of literature I could find directly answering the question "why aren't more wage contracts inflation indexed?". Most of the literature explores the consequences of indexation were it to occur (or, occasionally, when they do observe it occurring). That said, a common thread in the theory literature I could find tended to echo some of my points I made in my 2nd speculative answer to your question. The proportion of wage contracts that are indexed against inflation should at least in theory be increasing in the amount of uncertainty we have over inflation in the future. It sort of looks to me like the Fed is doing a pretty good job at keeping inflation low and stable these days. The U Michigan inflation expectations survey seems to point toward pretty stable and pretty low inflation expectations, as does the expected inflation rates implied by the spread between inflation-indexed and non-inflation-indexed treasury bonds.

So, in conclusion, it seems to me that the reason why we don't see more inflation indexed wage contracts is not because "in a free market, there is no legal or logical reason to index wages to inflation" or because periodic contract renegotiation is a necessarily preferable means for dealing with inflation.

It seems to me that it's because the Fed is doing a good enough job controlling and stabilizing inflation that it's just not worse the hassle these days.