It would be an understatement to say that 2022 was an eventful year for the United Kingdom. From short-lived prime minister Liz Truss to Kwasi Kwarteng’s disastrous mini-budget to the interminable in-fighting over Brexit, the Conservative Party – also known as the Tories – appears more incapable than ever of governing the country. One of the latest woes to befall them is the ongoing strikes within the public sector, with unions in education, public transportation, and healthcare calling for wage rises to combat the current inflation rate of about 10%.
The UK government’s response to such demands has primarily been to argue that pay rises would only “stoke” inflation. Such claims are not only largely unwarranted – they dismiss the underlying causes of inflation in the British context – but they are used to divert attention from the Tories’ own failings.
The Debate Over Inflation
Inflation can be thought of in two equivalent ways: it is a rise in the price of goods and services or a decline in consumers’ purchasing power (since the same amount of money in numerical terms can no longer buy as many goods and services as before).
Just as there are “winners” and “losers” from low levels of inflation, there are “winners” and “losers” from the theories provided to explain inflation.
While this can clearly be detrimental for consumers, especially if unaccompanied by an increase in wages, inflation has tended to be more of a concern for investors. This is because creditors’ real returns are reduced by inflation, meaning higher inflation tends to diminish their profit margins, yet lower the real burden for debtors or borrowers. This typically only applies, however, if borrowers are benefiting from inflation in the form of pay rises. Just as there are “winners” and “losers” from low levels of inflation, there are “winners” and “losers” from the theories provided to explain inflation.
Two of the most common ones are what is known as “excessive demand” relative to supply – or “demand-pull inflation” – and “excessive monetary injections”, meaning the money supply has surged relative to demand, pushing up prices. These two theories have allowed some economists to argue that the financial support schemes provided during the Covid-19 pandemic in the UK and elsewhere have been one of the major drivers of inflation.
While it is certainly likely that consumers attempted to “make up” for lost purchases with this additional income post-pandemic, leading to a spike in demand relative to the period of low spending that preceded it, this alone cannot explain why inflation in the UK remained at 10% in February 2023, almost 3 years after the start of the pandemic.
When nominal wages in the UK – albeit growing – are falling in real terms, it is difficult to conceive of “excessive demand” as being the primary driver of inflation.
However, if it were to be true, it would “justify” the implementation of austerity measures. If “excessive” consumer spending is the primary cause of inflation, then increasing interest rates – the primary responsibility of the Bank of England – will raise the cost of borrowing, relieving some of the pressure on demand while contributing to higher unemployment.
More importantly, putting downward pressure on wages – or at the very least failing to index them to inflation – should in theory also reduce demand at the macro level by eroding workers’ purchasing power and thus spending. The logic behind this is that “excessive demand” is the fault of wage increases that are untied to productivity changes, which “forces” companies to push up prices in order to retain their profit margins. However, when nominal wages in the UK – albeit growing – are falling in real terms, it is difficult to conceive of “excessive demand” as being the primary driver of inflation.
Nonetheless, this thinking has allowed the Tories to justify their refusal to increase salaries for public sector workers out of fear of what is known as a “wage-price spiral”, wherein inflation accelerates out of control due to conflicts between workers and employers over their part in the income distribution.
Inflation in the UK is not caused primarily by “excessive demand”, but by supply-side factors that the Tories – at the very least – have exacerbated.
Not only does a “wage-price spiral” require bargaining power that – at least until recently – workers in the UK have not had since the 1980s, but it is highly unlikely to occur for the same reason that increasing interest rates is unlikely to seriously dampen the ongoing rise in prices.
Inflation in the UK is not caused primarily by “excessive demand”, but by supply-side factors that the Tories – at the very least – have exacerbated. Some of these causes are global in nature: the Covid-19 pandemic has disrupted supply chains, leading to shortages in both goods and workers, and geopolitical conflicts such as the War in Ukraine have caused food and energy prices to soar. But others are entirely of the Tories’ own making.
The Tories’ Failings
Perhaps the most prominent accelerator of inflation in the United Kingdom is Brexit or the UK’s departure from the European Union. By encouraging European migrants to return to the EU, Brexit has given rise to a labor shortage, limiting British businesses’ productive capacities, particularly in the agricultural sector, and thus cutting domestic supply.
Furthermore, as the UK is a net importer – with the EU being the country’s largest trading partner representing about 45% of all imports to the UK – Brexit adds to the “red tape” of trade between the two economic powers. Such trade barriers include additional customs checks and paperwork, which delay the arrival of shipments to the UK, tending to artificially restrict supply and thus increase the price of goods.
With the EU being the country’s largest trading partner representing about 45% of all imports to the UK, Brexit adds to the “red tape” of trade between the two economic powers.
At the time of writing in March 2023, for example, there is a shortage of fruits and vegetables available in British supermarkets which – despite being blamed on poor weather conditions in Southern Europe and Northern Africa – do not appear to be affecting any EU country quite as significantly, if at all.
The UK’s inflation is also partially imported. Kwasi Kwarteng’s mini-budget introduced in September of last year before being quickly abandoned caused the Pound sterling to drop to historic lows. Despite recovering in the past few months, the value of the pound remains lower than in prior years, causing the cost of imports to be higher than they would be otherwise.
This is particularly true of energy: as the Tories have cut subsidies for domestic sources of energy over the years – many of them renewable – British consumers have become increasingly subject to the whims of global energy suppliers. Other contributors to inflation – or, at the very least, falling productive capacities – stem from a lack of long-term investment.
An ideology that emphasizes short-term profits over long-term productivity has meant that British companies consistently invest less in future economic gains.
Britain has seen its productivity growth slow since the 2008 financial crisis. While the Tories cannot be blamed uniquely, many of their Thatcherite ideas do appear to be at the heart of this slowdown. For one, an ideology that emphasizes short-term profits over long-term productivity has meant that British companies consistently invest less in future economic gains. More practically, this means that firms have invested less in research and development, as well as new forms of capital than their American and European counterparts.
Furthermore, a lack of public investment in education and workers’ training programs among other austerity measures has meant a rise in skills mismatch. Perhaps most importantly, however, a failure to sufficiently fund the public institutions that allow an economy to run smoothly – the NHS, trains and other forms of public transportation, the postal service, the civil service, and the education system – has, unsurprisingly, prevented the economy from running smoothly. As a result, the UK is predicted by some to be poorer than Poland by 2030 if such trends continue.
Why the UK Government Needs to Take the Public Sector Seriously
Claiming that the government cannot “afford” pay rises for public sector workers or that such would only “stoke” inflation, i.e. lead to a “wage-price spiral”, purposefully disregards the primarily supply-side causes of inflation in the UK. Worse still, it “justifies” the postponement of overdue pay rises for public sector workers. As Ben Zaranko from the Institute for Fiscal Studies rightly points out, it is unlikely a “wage-price spiral” could even take place following a rise in public sector pay as there are no real “prices” in the public sector.
Such claims by the UK government also fail to consider diminished funding for the public sector following a decade of austerity measures and pay freezes.
Furthermore, wage-setting in the public sector, which relies on the input of independent pay review bodies, does not reflect that of the private sector in which employers and employees “fight” over their respective share of a company’s profits. This implies that, even if there were to be “prices” in the public sector, it is unlikely pay rises would “stoke” inflation through a “wage-price spiral” like that in the private sector, especially since public sector workers only make up about 17% of the total workforce anyways.
Such claims by the UK government also fail to consider not only diminished funding for the public sector following a decade of austerity measures and pay freezes, but inequalities in pay between the private and public sector. Between July and September 2022, pay in the public sector grew by only 2.2% compared to the private sector’s growth rate of 6.6%, with both of these rates falling behind inflation at about 10%. Although there appears to be no real pay gap for the time being when accounting for differences in workers’ education and experience, private sector pay could overtake public sector pay if these trends continue.
How will the UK government be able to provide necessary public services if qualified public sector workers all have an incentive to go to the private sector?
This could pose difficulties for the recruitment and retention of public sector workers. Indeed, how will the UK government be able to provide necessary public services if qualified public sector workers all have an incentive to go to the private sector – or, in the case of British doctors, abroad? Admittedly, with the current budget deficit, the timing is not ideal, but refusing to raise public sector wages will clearly be riskier on the long-term.
As the Tories should realize by the UK’s next general election, an economy cannot be run without functioning trains and public transport, an educated populace, and healthy employees. In short, Britain can no longer continue to ignore its public sector workers.