Arguments about wages and inflation are spiralling out of control

By Carl Parker, ASCL Conditions of Employment Specialist: Pay

It's difficult not to agree with the former Deputy Governor of the Bank of England, Sir John Gieve, who recently told the BBC’s Today programme in December 2022 that “…public sector pay increases don’t directly affect prices…”

There is also a strong case to be made that public sector wages are not in a position to “spillover” into private sector wages and drive them higher. Public sector pay is lagging too far behind the private sector and pay increases in the private sector are too far ahead of the public sector for this to be an issue. 

We will cover the absence of a “spillover” effect in part two of this blog. Meanwhile, back to Sir John Gieve, who said in the same interview that he does not believe public sector pay increases have a “major effect” on private sector pay.

Do wage increases lead to a wage price spiral?
But what about the argument that wage increases across the public and private sectors will lead to a wage price spiral? This is the argument that wages go up because of inflation, leading to prices going up because of increasing costs associated with wages, with this leading to demands for higher wages to address rising inflation. And so on in a never-ending spiral. 

The wage price spiral is also associated with demand-led inflation – too much money circulating in the economy increasing the demand for goods leading to price increases so that the supply of goods matches the demand.

For ASCL members, these arguments should be viewed through the lens of public sector pay, especially the pay of teachers and leaders. 

As public services aren’t charged for, there are no direct effects on inflation from public sector pay increases. And the likelihood of public sector pay increases spilling over into private sector pay increases is negligible or non-existent.

This means that a wage price spiral caused directly by public sector pay increases just can’t happen. So, the only argument left in terms of public sector pay and inflation is that it will fuel inflation because of too much money being generated in the economy.

Monetary policy
Monetary policy is set by the Bank of England’s Monetary Policy Committee (MPC) and we have seen a number of interest rate increases over recent months. The MPC has set a clear path to restrict the money supply and everyone is feeling the pinch – both public and private. This is the established way that money supply is controlled and it is the remit of the MPC to achieve the 2% inflation target.

We should remember that the public sector is less than 20% of the UK economy. In other words, any attempt to restrict the money supply via public sector wage restraint in addition to interest rate increases is limited to less than one fifth of the economy.

This causes two significant problems: 
  • It widens furthermore the public sector pay gap as the private sector will not subject itself to the same level of pay restraint. 
  • It hits public sector workers twice – lower pay and higher mortgage payments.

The net effect of this is yet more dissatisfaction amongst public sector workers and increasing recruitment and retention issues. All for a monetary policy effect that can only reach 20% of the economy.

Surely, it is wrong for public sector workers to become an arm of monetary policy?

Are we on the verge of a wage price spiral?
Away from just looking at the public sector, we should also explore whether or not the UK is on the verge of a wage price spiral.  We know that inflation is largely driven by supply side factors such as rising energy costs and the higher cost of imported goods. This chart from the Bank of England shows the underlying causes of inflation:


The Bank of England expects inflation to fall sharply once the external shocks to the economy caused by the war in Ukraine and the pandemic have dissipated:

We expect inflation to fall sharply from the middle of next year. 

The price of energy is not expected to rise so rapidly. The Government has introduced a scheme that caps energy bills for households and businesses for six months

We don’t expect the price of imported goods to rise so fast as some of the production difficulties that businesses have faced are starting to ease

We also know that real wages across the whole economy are lagging behind inflation, as this chart from the Office for National Statistics (ONS) shows:

The chart shows real wages heading downwards and inflation (CPIH) heading upwards. A wage price spiral occurs when the wages start to rise at more than inflation. In other words, we are nowhere near wage increases driving up inflation and entering into an out-of-control spiral.

As with lawyers, ask two economists the same question and you get at least two different answers, but it can be safely said that the argument that the UK is on the verge of a wage price spiral is far from convincing. There is much evidence that the argument just doesn’t hold water.

There is even less evidence that public sector pay restraint is necessary to control inflation. It doesn’t directly lead to higher prices, it doesn’t spill over into private sector wages, and it has limited impact on demand led inflation (at a time when inflation is largely fuelled by supply side issues).

It really is time to stop using inflation as the reason why teachers and leaders can’t be paid what they deserve.

Carl Parker is ASCL Conditions of Employment Specialist: Pay

Posted: 03/02/2023 08:34:52