People in the UK are feeling a huge amount of concern about rising inflation in recent months, and it has been made worse by the fact that wage inflation has not been keeping up. Those in high-paid jobs have enjoyed higher bonuses and pay rises — it has just been reported that CEO pay has recovered to pre-pandemic levels for instance. But for many workers, higher price inflation is now eroding the real value of what they earn.


More than a fifth of workers are struggling to afford the things they need to live. Food, housing and fuel especially. For many, the cost-of-living crisis spells real hardship. Its resolution calls for a rethinking of policies towards inflation and indeed the economy more generally.


Economics textbooks teach us that lower unemployment is the cause of higher wage inflation. The textbooks also refer to the possibility of wage-price spirals, where higher prices fuel higher wages. This way of thinking gained support from the experience of the 1970s, when higher prices and higher wages coexisted, leading to a period of stagflation.


But the present shows us how price inflation and wage inflation can be decoupled. As a challenge to economic theory, workers are facing cuts in their pay with seemingly no prospect of wages catching up with headline inflation. This is despite the fact that unemployment is low. Lower real living standards now represent the price of being in paid work and the cost of an economy that is jobs-rich.


Why the Low Wage Inflation?


Wages decreased in the years immediately after the 2007-2008 financial crisis and have remained low.  And although they were able to increase again on the back of very low inflation from 2012 onwards, they only returned to pre-2008 levels very recently.

The fact that this is as far as they have managed to increase in a period of low unemployment is surprising. It is not entirely clear how to explain this, but several factors are potentially important.


  • Decline of union power

First, there is the decline of union power together with the rise in firm power. Unlike the 1970s, British workers are not able to collectively demand and secure pay rises via union organization. They face bargaining at an individual level, and the best way to get higher pay is often to leave and find a new job.


  • The actual level of unemployment is higher

There are other measures of unemployment. While recorded unemployment has fallen, the actual level of unemployment is higher: workers on incapacity benefits — in relatively large numbers in particular areas such as Wales and Scotland — would be in work if suitable jobs were available, but are not counted in the official unemployment statistics.


While wage inflation may not be rising by as much as price inflation now, in the coming months, some argue it will begin to rise and perhaps even overtake price inflation. This argument has been put by the Bank of England Governor Andrew Bailey, leading him to call for wage restraint.

But while the possibility of above-inflation wage rises cannot be ruled out, it seems unlikely to think that workers — in all sectors and regions — will be able to protect their real wages. The prospect of wage inflation catching up with headline inflation may be stifled by unemployment rising.


It’s time for a change


New policies are needed to ensure that wages catch up with headline inflation, especially if workers are not to suffer economic harm. It is a welcome step that the government is offering direct financial support to the least well-off in society to help with soaring energy bills. While the government announced some time ago that it plans to increase corporation tax from 19% to 25% for most firms from 2023, it has only just decided to impose a windfall tax on oil and gas companies to help pay for this support, having previously resisted pressure to do so.


In any case, support payments do not help raise wage inflation to levels that match headline inflation. This would be easier to achieve if workers had greater bargaining power which could lead to radical reforms. It entails reimagining corporate governance structures and giving workers more of a say in firms. It also entails strengthening union power and widening forms of public and worker ownership.


Only until the imbalance of power is addressed will we secure an economy that is sustainable and run in the interests of everyone, not just the few.