Getting the big calls wrong

We’re in Trouble with a capital “T”. The Bank of England has issued a report in which they predict UK Output is due to fall and inflation is predicted to rise to a level not seen since the eighties.

Like most developed world economies, we’re facing short-term pressures such as rising energy prices, supply shortages and slowing growth, but the juggernaut called “recession” hurtling down our side street can’t be blamed on these factors. Our BIG problems come from poor productivity, low investment, and the impact of Brexit, which is contributing mightily to our short-term problems being exacerbated.

The problem with the inflation we’re facing is it is not the classical demand led inflation where rising wages cause an increase in effective demand meeting an inelastic supply of goods and so raising prices. It’s cost-push inflation.

Cost Push Inflation

Cost-push inflation normally occurs when overall prices increase due to increases in the cost of wages and raw materials. Higher costs of production can decrease the aggregate supply (the amount of total production) in the economy. Since the demand for goods hasn’t changed, the price increases from production are passed onto consumers creating cost-push inflation. In the current scenario though, wages AREN’T increasing, they are being suppressed and this version of cost-push is entirely dependent on rising material, energy, and transport costs. In fact, real wages are falling – we are experiencing the sharpest fall in real income for two decades.

If, as forecast by the TUC, inflation rises to 13% and nominal wage growth continues to struggle to reach 5.5%, we could see the worst real wage falls for 100 years. And here is the real problem for consumers. Wages will buy less, which means hardship and contracting demand. This will probably mean inflation will be slightly blunted after the winter when Christmas excess is out of the system, but we will still have a situation where wages are lagging behind rising prices dramatically. I believe this is “priced in” by the government.

If we take the period from 1977 to 2009, the only times UK average disposable income fell was in the immediate aftermath of a recession: in 1980 to 1982, 1991 to 1993 (small blip 94-95, although it was still higher than 1993) and the global financial crisis of 2007 to 2009. Since then, however, apart from briefly recovering due to Gordon Brown’s initiatives in 2008 it has fallen from 2010 to 2013 and again 2013 to 2015 and is now set to fall again, but more dramatically so.

It’s no mistake this is after the biggest heist of public funds we have ever seen, which allied to unwarranted, crisis-justified energy price increases has seen a massive bite out of consumer’s budgets. The worrying thing is though, the Bank of England says only about a third of inflationary factors are accounted for by energy price increases – so if none of it is attributable to wage increases, what is it causing it? The answer is it is inflation is becoming embedded in other areas of the economy such as goods and services.

The UK inflation is worse than just about anyone else. Certainly, it is one of the highest in the OECD. This is because for the last fifteen years we have seen a drop-off in UK economic performance and our growth has fallen behind the post war trend. This is mostly because productivity has fallen off a cliff, mainly due to weak levels of investment in both the private and public sector. And we have fallen short in housing, transport, and the development of new technologies in manufacturing, all of which adds up to a weak economy in dangerous times.

Mostly, this was avoidable and would have been avoided had we had a competent government for the last twelve years. But we haven’t.

Austerity

There is now a mismatch between government spending on welfare, pensions and health care and revenues from taxation which have not been rising in concert with steadily increasing government expenditure. The response from government has been short sighted. Instead of incentivising investment and productivity increases, they have been cutting back on Government expenditure, which in turn has suppressed demand and cause lack of confidence in the private sector to invest in greater productivity. It’s a vicious circle and probably the biggest failing of Austerity, which has effectively destroyed any chance of growth and massively weakened the UK economy. Then, as if that wasn’t enough, we had Brexit lumped on top of all this.

Brexit

Brexit has increased the cost of trade to our biggest customer, the EU. Our poor trade performance in the post Brexit period has been illustrated perfectly by the ever-widening UK Current Account balance of payments. But that’s not the end of it. Since the Brexit vote the pound has fallen in value (at one stage it fell below the level we achieved after the financial crisis and has been hovering there ever since), so it costs us more to buy stuff from other countries. Remember the cost of materials is THE major causative factor in our current inflation cycle – there’s your reason – Brexit is the cause.

It doesn’t end there either. Despite unemployment falling (although hours worked has on average fallen), there is a rise in firms struggling to recruit workers. This is due to a three factors: lack of qualified workers (education and apprentice cuts) being one – Austerity can take the blame for that one, and a reduction in the participation rate due to an increase in long term sickness – Covid maybe, but unlikely given the growth of long term sickness only really started in September 2021, but more seriously, we used to have access to the European worker pool, but since Brexit we haven’t. This means a whole range of jobs throughout all areas of the economy aren’t being filled.

At any time, we could have done without the drag on the economy of Brexit, but after a sustained period of Austerity, falling demand caused by wages slipping behind prices, the pound falling, raw materials consequently rising dramatically and a structural fall in productivity allied to curtailed access to a dynamically fluid labour pool, it is a recipe for disaster. If you wrote the book on how not to manage an economy, the last twelve years take up the first three chapters.

Ruinous Conservatives

The Conservatives have been ruinous and for every possible reason. These smug, public-school types have absolutely no idea how to run an economy and have taken the wrong options almost every time. It is almost staggering how wrong they have been. Far from “getting the big calls right” they have messed up over a sustained period and almost unerringly got everything: big, small, and middling; utterly, and disastrously wrong.