Last month, inflation hit a 30-year high of 5.4%, a rate being attributed to higher energy costs and protracted supply chain disruptions like shipping bottlenecks. Meanwhile, average real wages, adjusted for inflation, have fallen below where they were in 2008, and a recent report by the Office for Budget Responsibility (OBR) suggested they will still be lower in 2026 than they were in 2008.
This is despite falling unemployment and a faster-than-expected economic recovery from the pandemic. Next year’s average earnings are set to fall 0.5% below CPI inflation, meaning a pay cut in real terms for most people.
In spite of this, the Bank of England (BoE) is set to continue with its small but incremental interest rate hikes in a misguided attempt to control inflation. KPMG is predicting three rate rises this year, which would culminate in a significantly tighter monetary policy stance. This is intended to address the ‘issue’ of tight labour markets, with members of the monetary policy committee claiming to be worried that companies and workers will respond to jumps in costs by raising prices and increasing wage demands.
Other than sticking to an arbitrary 2% inflation target, though, it isn’t clear why supressing moderate increases in wages in line with rising prices would be desirable, or that it would even be effective at addressing the underlying causes of the current inflation.
In November, the annual rate of food price growth more than doubled from the previous month to 2.5%, and increasing prices for food and energy are hitting poorer households hardest. The Institute for Fiscal Studies (IFS) has estimated that families will need additional funding to the welfare system of £3 billion in response to inflationary pressures, and that the current government plans to increase benefits by 3.1% would be inadequate.
What this all means is that, to keep up with rising costs, people need more income and more welfare support—not less.
It’s true, and good, that workers in some sectors, like logistics, have won substantial pay rises over the past year due in part to tighter labour markets. But in other sectors, particularly in the public sector, there have been wage cuts in real terms where tighter labour markets have meant rationing and stretched, overworked staff.
NHS workers, for instance, have lost thousands in real pay over the past decade; for some teachers, the increased cost of living has meant as much as a 17% pay cut, while the pandemic has seen them take on a significantly increased workloads. This raises questions about the authenticity of the BoE’s consternation over wage increases leading to price increases.
It’s common for historical examples of hyperinflation like the Weimar Republic or the Winter of Discontent or, in modern terms, Zimbabwe or Venezuela, to be used as a justification for tighter monetary policy today. If we let higher wage demands persist for too long, we run the risk of triggering hyperinflation and becoming another Venezuela—or so the story goes.
But the reasons these countries have experienced such violent episodes of runaway inflation are more complex than just low interest rates, higher wage demands, or spending on welfare. The UK and other advanced economies are not subject to the same global financial conditions, like exchange rate risks, facing emerging markets or developing countries.
As such, citing hyperinflation as a risk that necessitates interest rate hikes and wage restraint is disingenuous, and ultimately serves only to entrench existing inequalities between wage earners and asset holders. Inflation in the hundreds or thousands of percent annually is obviously not desirable, but moderate inflation akin to the kind currently being experienced in the US and UK, if accompanied by proportionate wage increases, could be beneficial in terms of reducing wealth inequality, so long as steps are taken to offset the real inflationary problem—which is in asset and housing markets.
The Housing Problem
For the past three decades, asset prices have been rising exponentially while wages have stagnated. The average house price has increased from around £50,000 in 1990 to over £260,000 in 2021; the average annual salary, during the same period, has risen only from around £10,000 to £30,000. As a consequence, the number of 20-34 year olds living with parents has increased from 2.5 million to 3.3 million since 2004.
The main reason house prices have increased so much relative to wages is because the growth of mortgage lending has significantly outpaced the supply of new homes, meaning there’s more money chasing the same number of homes. Private landlords, using buy-to-let mortgages, have exacerbated this problem by reducing the supply of housing stock available for sale and forcing those priced out of home-ownership into the rental market. There’s been a 50% increase in the number of homes rented out over the past 10 years, with the value of houses owned by landlords rising 124% to £1.62 trillion.
A higher ratio of house prices and mortgage debt to incomes means a financial system more vulnerable to economic shocks impacting people’s income—like a fall in salaries relative to prices, or rising in interest rates. That means the case for wage increases at a higher rate than house prices is even stronger.
The Government’s Solution
Rather than introduce progressive taxation to fund increased demands on the welfare system or measures that enable workers and their trade unions to effectively negotiate with employers for higher wages in line with inflation, the government is instead proposing handing over huge sums of tax money to the highly profitable energy companies. The Conservatives are planning to pay energy suppliers the difference when wholesale gas prices exceeded the price threshold, so they don’t pass the increase on to consumers.
But if high energy prices persist, this won’t be sustainable long-term. It would, in effect, be a public subsidy to corporate profits, when most of the big suppliers have the capability to absorb the cost of the price cap themselves. Energy companies like BP, Shell, and the Big Six have spent £190 billion on dividends and share buybacks since 2010, which is considerably more than the £118 billion they paid in taxes.
In France, by comparison, ministers have said they will force EDF, the 80% state-owned energy company, to take an €8.4 billion (£7 billion) financial hit to protect households by limiting energy bill increases to just 4% this year. If similar action isn’t taken in the UK, energy bills could rise by over £600 a year (nearly 70%), at the same time as Chancellor Rishi Sunak’s National Insurance Contribution tax rises take effect.
Alternatively, if the government and BoE are genuinely concerned about businesses putting up prices, they could back wage increases and introduce price controls, rather than squeezing workers and giving corporations welfare to protect their margins. Research using US data has shown that up to 60% of inflation can be attributed to corporate profits, and with corporate profits reaching record levels in the UK, well above the pre-pandemic trend, there seems ample scope to justify price controls.
Supressing wages won’t address any of the supply-side issues causing inflation, and we desperately need wage growth across to board to address the destitution being wrought by the cost of living crisis. The uneven distribution of profits across sectors, with some large businesses in particular doing very well at the expense of SMEs and the public sector, has led to highly uneven wage growth.
Ultimately, that means we need state intervention to redistribute—through taxation, welfare subsidies, and public spending—the excess profits of large corporations to workers in sectors like healthcare and education—whose pay has consistently failed to reflect the immense pressure of the last two years, and beyond.