Far from causing inflation, wages make up a declining proportion of the cost of the products we buy, explains economist Michael Roberts
UK inflation hit a 40-year high in June, reaching 9.4% compared to a year earlier.
The rate is expected to hit double digits later this summer. If you include mortgage costs, the retail price index is already up 13.7%.
Inflation – the change in the prices of goods and services – is driven by accelerating food and energy prices. Road fuel prices are up 33%, the largest ever one-year jump.
The so-called “energy price cap” which supposedly fixes a limit on home gas and electricity prices, increased by 12% in October 2021 and by 54% in April 2022. The April increase is equivalent to £700 for “typical” levels of dual fuel consumption paid by direct debit.
There is every possibility that this cap will be raised by another 30 to 50% in October.
At the same time, world food prices are at an all-time high.
Why is this happening when, for years, inflation rose by no more than 3 to 4% a year?
Costs, wages and profits
Three parts make up the price of any good or service.
One: the cost of raw materials or components in, say, a car or a packet of tea bags, or the price of electricity or oil, plus depreciation – a machine’s life may be 10 years so you need to calculate the annual cost for replacing it.
Two: the wages paid to people making tea bags or delivering fuel etc.
Three: profits – the mark-ups on costs made by companies.
In the past two years there has been a very sharp rise in the cost of raw materials and components due to Covid - lockdowns leading to supply bottle-necks and to workers lost through either being sacked or moving on - compounded by the war in Ukraine which has led to the loss of food exports from both Russia and Ukraine and sanctions on Russia leading to rocketing energy prices.
Behind these immediate causes is a longer-lasting reason for rising inflation – the slowing and very low rate of growth in labour productivity. If the value created by workers is not growing enough, then any demands by companies to keep profits rising, or by workers to increase wages, will tend to cause a rise in prices as demand outstrips supply.
This particularly applies to Britain, where productivity growth is one of the lowest of the top economies.
Some economists tell us rising wages cause inflation.
This is nonsense. Prices have been rising sharply with little or no rise in wages. Over the long term, wages as a share of what makes up the price of a product have been falling.
What is missing from the claim that wages are driving up prices is what is happening to profits.
A report by Unite found that company profits were responsible for 60% of the rise in prices over the past two years, with raw material costs taking up most of the rest. Labour costs took up only 8%.
Profit margins for the UK’s biggest listed companies were 73% higher than pre-pandemic levels. UK-wide company profits jumped 11.7% in the six months to March 2022. In the same period, labour income rose only 2.6%; and fell by 0.8% after accounting for inflation.
It is the big corporations that have continued to raise their prices to increase their profits at the expense of wages.
Far from a wage-price spiral, we have a profit-price spiral.
This has led to average wages in the UK falling at their fastest rate for more than two decades. Annual growth in regular pay fell by 4.5% in April after adjusting for inflation – the biggest fall since comparable records began in 2001.
If this continues, it will leave the average worker almost £13,000 a year worse off by the middle of the 2020s. By 2026, average household earnings would be £30,800, compared with £43,700 if wages had risen at the same pace as in the two decades before the banking crisis, according to the Institute for Fiscal Studies.
No wonder workers are trying to recoup their loss of income from profit-driven inflation.
But that will not be enough to avoid future crises, because energy and utility companies continue to be run for profit, not as a public service. The public should own these monopolies so that prices can be controlled; and investments made to improve services, not to go into huge dividends for shareholders.
Above all, public investment is badly needed to boost productivity growth so that average incomes can rise without price inflation devaluing the ‘pound in our pockets’.
Michael Roberts is an economist who blogs on economic issues at thenextrecession.wordpress.com.
He provides regular analysis on his Facebook site: facebook.com/100064268366203
