Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.
The last week has seen the rail system brought to a standstill and strikes being threatened by teaching unions and airline staff.
Voters are focused on the cost-of-living crisis. It figured as one of the prominent issues in last week’s by-elections. This should be not be a surprise. One lesson throughout the decade of high inflation in the 1970s was that it was hard for the Government of the day to escape the blame.
However, as bad as things may seem now, the economy is very different from that of the 1970s. Yet there are policy lessons to heed from then.
The 1970s was a grim decade, with continuous industrial unrest and rampant inflation. Rising oil prices was the initial trigger for inflation, but a wage-price spiral saw it soar. In 1975, inflation reached 25 per cent and the miners settled for a 35 per cent wage rise.
One lesson was that the higher inflation goes, the tougher the policy medicine needed to reduce it. It was only after Margaret Thatcher came to power in 1979 that inflation was tamed.
Another lesson is the critical role that wages can play in an inflation cycle. This aspect is of particular relevance for the Government now, as wage demands rise.
Retail price inflation, which determines rail fares and interest payments on student loans, has reached 11.7 per cent. The Bank of England’s two per cent inflation target is based on consumer prices. In May, consumer prices rose by an annual rate of 9.1 per cent. The Bank forecasts 11 per cent by the autumn, as fuel prices rise again. Worryingly, there is evidence of more broad based inflation pressures.
It is important to appreciate the scale of the monetary policy mistake that has contributed to the present situation. Consumer price inflation hit a low of 0.2 per cent in August 2020 but, by May last year, it had already breached the two per cent inflation target.
Despite the fact that inflation then was already on a clearly rising trend, the Bank of England kept policy rates at a rock-bottom level of 0.1 per cent, continued to print money via quantitative easing and also had a bias to ease, examining how commercial banks would cope if policy rates were cut to below zero.
Global influences have also been significant, because of the pandemic and then war in Ukraine. As the conflict persists, high food and fuel prices could be with us for some time.
Some have blamed Brexit. That is wrong. My last column for this site examined current developments in our tight labour market and debunked some fears. The actual inflation data should do likewise. Last week saw producer prices rise by an annual rate of 22.1 per cent in the UK. This will feed into higher costs and inflation. It’s even worse in Germany, where producer prices are up 33.6 per cent. Meanwhile, the EU’s harmonised measure of inflation is also high, at 8.7 per cent.
Interestingly, wages have not been a factor so far in our inflation cycle. However, this does not mean we can afford to be complacent. Earnings are rising by 4.2 per cent. This varies between a rise of 1.6 per cent across the public sector and 8.2 per cent in the private sector. Thus it is hardly a surprise that people are seeking large wage hikes.
But are strikes justified? Certainly not where they cause so much widespread disruption. Yet it is hardly a surprise that workers are flexing their muscles. While people will naturally seek higher wages, the outcome will depend on market conditions and the ability of firms or the Government to pay.
Almost half of people in employment work in low wage, low productive service industries like food services, retail and accommodation. An additional challenge is that many people in high-skilled professional roles may feel that they are not being well paid, either – teachers and doctors among them. So many people may have empathy with the rail strikers, even if they may not necessarily agree with the strikes themselves.
As inflation takes hold, the worry is that we see a self-feeding spiral. Firms pass on higher costs. Prices rise. Workers seek higher pay. And in turn costs rise further, forcing prices higher.
Throughout the 1970s, preventing a wage-price spiral became central to policy. Two very different approaches were tried. Both failed. During the mid-1970’s, Labour’s then Prime Minister, Harold Wilson, tried to get people to understand the inflation challenge. An official 16 page pamphlet was posted to every household. In it, Wilson’s message was clear: “One man’s pay rise is not only another man’s price rise: it might also cost him his own job – or his neighbour’s job”.
As inflation persisted, Wilson’s successor, Jim Callaghan, introduced a wage and price freeze. This eventually collapsed during the 1978-79 winter of discontent, as public sector unions went on strike.
Today’s rail strikes should be settled by agreement between the unions and the different privately-run rail franchises. The Government does not need to get involved directly, but pressure for it to help broker a deal will intensify if the strikes persist. The dispute may influence wage demands elsewhere and encourage more widespread industrial action.
As inflation persists, disputes over public sector pay may become a focus through this year. The Government’s approach will also be influenced heavily by how tight it wants to keep the fiscal purse strings. Rising inflation should allow the government scope to pay modest public sector pay increases. But for larger rises, public sector reform is needed and seems unlikely.
The Government also needs to reiterate that it has also unveiled a succession of financial packages. In particular, it is directing around £1,200 to eight million vulnerable households this year while, next month, people in work will see an increase in national insurance allowances – saving £360 a year for a person on average earnings. The combined effect of all these measures should lessen the case for aggressive wage hikes – but will not remove the pressure for people wanting some wage increase.
Recently, some unions have blamed higher inflation on greedy firms pushing up profits, and thus argued that workers need to grab a bigger slice of the cake. It is more accurate to say the economy and profits rebounded after the pandemic, and many firms have passed on higher costs. Furthermore, excess profits in the energy sector has led to a windfall tax.
Office for National Statistics data shows that the share of the economy’s income that goes to wages is now 60 per cent, and that the share of wages has risen for each of the five years since 2016.
Across the private sector the picture varies. The national minimum wage is £9.50 per hour. The Living Wage Foundation proposes a living wage based on the cost of living. Last year, it was £9.90 per hour and £11.05 in London. This year’s higher figure will be unveiled in September. It is important that this remains voluntary, as many small firms already face excessive costs because of regulations and tax. But those firms who can afford it should pay it where productivity merits it.
The current difficult situation reinforces the need for decisive policy action. The economy faces rising inflation and economic slowdown. The Bank of England needs to tighten monetary policy. But with consumer confidence plummeting and a recession likely, it is imperative that the Chancellor cut taxes. And there is a need for the Prime Minister to outline a market friendly, pro-growth economic vision, that helps both workers and firms. For it is only with stronger future sustained growth that the economy will be able to deliver higher productivity and wages.