Is Britain heading into a wage-price spiral?

Are wages about to spiral out of control? Boris Johnson certainly thinks there’s a risk. Last week he warned that the economy was ‘steering into the wind’ and that the UK could be entering a 1970s-style malaise.

With inflation shooting up to 9 per cent – and expected to go higher still – rail workers are embarking on the first of three days of industrial action today, demanding a minimum pay rise of 7 per cent. Network Rail has offered just 2 per cent, with the potential for an extra 1 per cent on top if they can meet productivity targets later this year. Barristers too have voted for a walkout, and teachers and doctors are threatening to join the strikes. Speak to people in Westminster and there is a prevailing sense that there is only one way to stop runaway inflation: keeping wages down.

The wage-price theory is simple enough: higher costs mean workers demand higher pay, higher pay then pushes prices further upwards, and a vicious circle ensues. The theory is predicated on a couple of factors, one being a tight labour market, which allows workers greater leverage in negotiating more pay. With unemployment currently at 3.7 per cent and job vacancies at a record high of 1.3 million, that condition has certainly been met. Another is that wage growth exceeds productivity growth – otherwise, businesses would be able to absorb the rising cost of labour without having to pass on price rises to their consumers. Again, that condition has been met: growth is so stagnant that there are now even fears of a recession. The final condition is that workers and employers expect inflation to stay high. If it were transitory, businesses might feel able to weather the storm without having to push up prices, potentially making them uncompetitive.

The Bank of England certainly thinks inflation is transitory. According to the Bank, inflation should be back to 2 per cent by June 2024, predicated on the assumption that energy prices fall back down to normal levels soon. It’s a huge gamble (the Bank has called it wrong before) and relies on western allies such as Saudi Arabia agreeing to play ball when it comes to pumping more oil (hence why Biden is visiting the Gulf state next month).

One criticism of the spiral theory, put forward by economists such as Grace Blakeley, is that because UK inflation is largely imported – caused by that spike in energy prices and post-Covid disruptions to shipping – the spiral won’t get going in the first place. But you have to think about it from the position of businesses: their costs are going up, for whatever reason, and if workers add to those costs by demanding higher pay then their only option is to raise the price they set for their goods. It doesn’t really matter why, for example, raw materials are getting more expensive, the problem is that costs are going up full stop.

Such arguments also fail to account for a major culprit that has stoked inflation at home: money printing. As Mervyn King, the former governor of the Bank of England, has said, ‘The problem was that central banks… put a lot of money into the system.’ Post-2008 quantitative easing went to balancing government books; pandemic printing has been funnelled into the wider economy through furlough, loans, support packages and the rest.

And then there's the sheer amount of printing that took place: the UK printed nearly £500 billion during the pandemic, nearly twice what it had printed between 2008 and 2020. Meanwhile, consumers weren’t spending nearly as much during the lockdowns (as many as 85 per cent of UK adults reduced their spending when the country shut down). In the US, demand was boosted even further with a series of stimulus cheques sent out to every American. The result, when we finally did reopen, was an overheated global economy.

This is perhaps why the UK government hasn’t got involved in the rail workers pay dispute. They know that Network Rail is unable to meet the wage demands – subsidies tripled to £12 billion during the pandemic to make up for the huge fall in revenue – and the government doesn't want those demands to be met anyway. The result is pain, both in people’s pockets and in disruption to services. The gamble is that it will save more pain in the longer term.