Alexander Tziamalis and Yuan Wang point to sources behind ballooning inflation.
The bad news: inflation is back in the public spotlight these days and rightly so. Inflation has kept on rising and is now forecast to exceed 11 % by the end of 2022 – the highest inflation in over 40 years. It reduces the real income of the majority of the population while it also has the potential to reduce trade, growth and investment in the economy.
Worse news: due to a number of negative structural forces working in the UK economy, even though the inflation rate could fall from its predicted high of 11%, it will not easily return to the benign rate around 2% we’ve grown accustomed to since the 2008 Financial Crisis.
Until recently, the Bank of England conveniently attributed rising prices to temporary factors and claimed that inflation will soon stop rising in the UK without much intervention. Its head-in-the -sand view has since been revised to account for the fact that prices have risen more widely and violently than they predicted. The costs of food, clothes, transportation and a multitude of services and products have all risen.
Inflation was on course to hit 8% even before the war in Ukraine started.
Yet the bank’s ostrich attitude remains to a lesser extent. Its governor has even called for workers to avoid asking for hefty pay rises – effectively trying to render households responsible for the organisation’s failure to control prices. And the bank now focuses on the war in Ukraine and high energy prices as pretty much the sole cause of rising prices in the UK. Yet, inflation was on course to hit 8% even before the war in Ukraine started and there’s mounting evidence that prices are rising for more reasons than high energy prices and logistic bottlenecks.
The Bank of England and the Conservative party choose not to stress some of the deeper causes of inflation, namely: the diminishing value of the pound, Brexit, and 12 years of quantitative easing which has boosted demand and asset values.
Sterling’s slide is a pivotal contributor to inflation because it swells the price the UK pays for the hundreds of billions of pounds-worth of consumer products and raw materials it imports
The pound has already been weakening against its rivals for several years due to economic factors such as poor productivity. This falling trajectory is also likely to continue due to political factors such as the looming second Scottish independence referendum, aggressive interest rate rises in the US which make the dollar more appealing, the emerging separatist sentiment in Northern Ireland and the chronic under-investment and consequent productivity gap in the UK compared to other G7 countries.
Brexit is a major structural factor in UK inflation yet both major parties choose for different reasons not to talk much about it. But its detrimental effects cannot be silenced forever. It has destroyed trade with the European Union (EU) – a move that mostly harmed the UK rather than the continent (see box: The opportunities’ knocks). And Brexit has hindered production in the UK by alienating a percentage of EU nationals working in the country.
Brexit is a major structural factor in UK inflation yet both major parties choose for different reasons not to talk much about it.
At least 500,000 EU workers are currently missing from the UK workforce. Shortages of fruit pickers, lorry drivers and NHS nurses have been in the news recently and have pushed wages higher and made UK production more expensive. These additional production costs eventually translate into higher prices on the shelves. And many professionals from the EU are finding the UK a less appealing destination than it used to be – the UK suffers from a skills gap in comparison to other G7 countries and used to rely on high quality EU labour migration to fill it in. Brexit generated visa costs for these skilled workers, reduced opportunities for research funding and perhaps also a subconscious feeling among EU nationals that they are not welcome – these factors have the effect of reducing the numbers as well as the quality of skilled workers from the EU.
And added to the much-talked-about trade sanctions against Russia which will be with us for years to come, there’s a slow burning de-coupling between the rich consumer of the West and the cheap producers of the East (see box: Russian ricochet).
A key factor that has kept product prices low has been cheap exports from the East – particularly China. The UK and the West more generally have grown accustomed – possibly even reliant – to the £2 t-shirt, affordable prices for machinery, electric and electronic devices, raw materials, household products and more. A few years back, the Trump administration in the US led an effort to impose trade sanctions against China and even Biden’s new administration seems even more determined to end US reliance on Chinese products.
This partial reversal of economic globalisation is an important structural factor that will increase product prices and keep inflation higher than it would have been for years to come
Economic nationalism in the US and other Western countries seems to unite opposing political sides in their efforts to protect local jobs, keep strategic industries within the home country and reduce national trade deficits. According to the head of the Bank for International Settlements (BIS – often described as the central bank of the central banks), this partial reversal of economic globalisation is an important structural factor that will increase product prices and keep inflation higher than it would have been for years to come.
Finally, an important factor which has stoked inflation, not just in the UK, but also in other Western countries, is the record low interest rates, courtesy of successive rounds of quantitative easing that central banks around the world have been implementing since the 2008 Financial Crisis. Indeed, in centuries of capitalism we’ve never had such low interest rates and that creates a backdrop of high demand in a time when our production capabilities and supply of cheap energy and imports are disrupted.
The numbers here are staggering: In a UK Gross Domestic Product of about £2.3 trillion, quantitative easing has reached about £900 billion. For more than a decade now we essentially supported government expenses by having the Bank of England issue more money and then buy the debt that its parent government issued. If your gut feeling tells you that this can’t be economically sound in the long term, you’re probably right.
Another key thing to note is that quantitative easing has pushed all asset classes (real estate, stock market shares, precious metals, cryptocurrencies and even non-fungible tokens) into bubble territory and has also boosted inequality in our societies. Households as well as businesses have taken cheap debt to finance properties and investments, or just to stay afloat. Faced with this environment, central banks in major economies will need to tread very carefully when it comes to rising interest rates to combat inflation. As central banks tiptoe around the nightmare of triggering a brutal recession, that can only mean mild base-rate interest hikes and consequently higher inflation for longer.
Clearly there are a number of structural factors that can pin inflation consistently high for years to come. But what can we do about it now?
The most vulnerable people should be protected. Two million people in the UK currently cannot afford to eat every day and this statistic will only get worse. Linked to the moral, economic and political necessity of helping the vulnerable, is the issue of mounting inequality in our societies. Record high, staggering, wealth is concentrated in the hands of a small group of people. It’s detrimental for the economy when 1% of the population owns over 50% of the global wealth. Trillions in tax havens can be put to better use by funding green sources of energy, used to offer better education for everyone, build desperately-needed infrastructure and protect the most vulnerable. The world needs the UK to champion a fairer society, rather than work against it.
Shortages of people and skills in the labour market can and should be addressed before the production capacity of the UK is scarred by more businesses going bankrupt, relocating or outsourcing production. Quality labour is perhaps the most critical factor of production and long-term prosperity. Through Brexit, the UK public voted to take control of migration, not shut it down when it’s desperately needed.