June 28, 2023

When Britain’s brightest economists gathered last week, they set themselves a straightforward task: to decide what to do about the UK’s high rate of inflation. Eventually, after much brain-racking, they came up with a solution: to crash the economy.

It seems almost inevitable that the Bank of England’s recent decision to raise interest rates for the 13th consecutive time since the end of 2021 will push the UK economy into recession by the end of the year. Simply put, raising interest rates means that homeowners have to devote a bigger chunk of their disposable incomes (as much as 20%, according to estimates) to paying back their mortgages, potentially pushing 1.2 million households into insolvency. Renters, too, are likely to see their payments increase as buy-to-let landlords pass on higher mortgage repayments. Meanwhile, businesses will fail, workers will be laid off, and, with less money being channelled into the economy, the latter will ground to a halt.

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What’s worse, this catastrophic scenario isn’t the result of the Bank’s economists not realising the consequences of their actions; among Britain’s policymaking elite, it’s the desired outcome. As J.P. Morgan’s Karen Ward, who is also an external adviser to Chancellor Jeremy Hunt, said: “The difficulty for the Bank of England is they have to create a recession. They have to create uncertainty and frailty.” Asked if he agreed with the idea of the central bank doing whatever was needed to bring down inflation, even if that could cause a recession, Hunt himself responded in the affirmative.

In this, however, he was merely channelling Andrew Bailey, the governor of the Bank of England, who said: “We’re not desiring a recession. But we will do what is necessary to bring inflation down to target” — even if that means causing a recession. Rishi Sunak has also expressed unwavering support for the Bank’s work, though no-one is more explicit than the Financial Times’ Martin Wolf, who went so far as to call for an engineered recession: “The question is not whether there will be a recession; it is rather whether there needs to be one, if the spiral is to be halted. The plausible view is that the answer to the latter part of this question is ‘yes’.”

If the idea of wealthy politicians, journalists and bankers (Bailey earns $575,000 a year) casually talking about the need to plunge millions of people into poverty makes your blood boil, good for you: you’re still human. But there is, of course, a logic to their madness. Their argument is that the British economy is facing a wage-price spiral, where workers demand higher wages to compensate for higher prices, to which companies respond by raising prices even more in an attempt to defend their profit margins, causing workers to push for even higher wages — and so on, in an inflationary feedback loop.

In this context, Bailey and his peers argue, the only way to break the inflationary spiral and put an end to the “unsustainable” wage demands of workers is to raise unemployment through an engineered recession, thus recreating a reserve army of labour and weakening the latter’s bargaining power. If such a policy sounds crazy, or wicked, it’s because it is. For starters, even if we were actually witnessing a textbook wage-price spiral, you would have to be particularly callous to blame ordinary workers for trying to protect their living standards and feed their families in the face of a cost-of-living crisis which they did nothing to create. Even the former deputy governor of the Bank of England, Sir Charlie Bean, has acknowledged this, criticising the Bank’s interest rate hike.

At the very least, this situation would call for a consensual approach to the problem, via wage and price guidelines that would distribute the burden of reducing inflation equitably among labour and capital, rather than a one-sided approach aimed at placing it on workers alone via higher unemployment. But even this ignores the fact that the UK’s wage-price spiral might not exist at all. Over the last two years, real wages — that is, wages adjusted for inflation — have been falling at among the fastest rates for more than two decades, while corporate profits, in several sectors, have been soaring. Workers, then, are already losing out in their tug of war with capital over who should shoulder the burden of inflation.

More importantly, there is no evidence that inflation in the UK is driven primarily by “irresponsible” wage demands or even overall excess demand in the economy (as was partially the case when the Government supported people’s incomes during the pandemic), which would at least provide some theoretical justification for the argument that the economy needs cooling down. If anything, we would appear to be witnessing a price-wage spiral, where workers are simply trying (and failing) to keep up with companies pushing up prices, rather than vice versa.

Since the start of the year, however, many of the supply-side costs which had been driving up prices throughout 2021 and 2022 — such as the increased cost of energy, fertilisers, metals and other commodities, as a result of supply-chain bottlenecks and the war in Ukraine — have been rapidly falling. It’s also hard to argue that Brexit is responsible when food price inflation has been higher in the euro area. So, why are prices continuing to rise?

According to a number of economists, it all comes down to greed. The idea is that, in late 2022 and early this year, large companies, especially those enjoying considerable market power, have raised prices by a greater margin than necessary to accommodate for higher input prices, thus leading to considerable profit margins. As Albert Edwards, investment strategist at Société Générale, has observed: “Companies have used the ‘cover’ of supply constraints from the pandemic and the war in Ukraine to raise output prices well beyond what is justified to maintain margins” — and consumers have largely accepted these hikes as inevitable after hearing so many stories about energy prices, the war in Ukraine, supply-chain disruption, Brexit and so on.

Until recently, “greedflation”, or profit-led inflation, was dismissed as a fringe theory, but thanks to the work of economists such as professor Isabella Weber of the University of Massachusetts, its importance — at least in the US and eurozone — is no longer ignored. In March, experts at the European Central Bank concluded that profit margins had become the main driver of inflation, accounting for two-thirds of real-terms price increases in 2022. Just this week, a similar conclusion was reached by the International Monetary Fund, while several studies have pointed to a similar dynamic at play in the United States.

What about the UK? Unfortunately, neither the Bank of England, with its 4,500 staff, nor the Government, has felt the need to commission an in-depth investigation into the phenomenon, so we don’t really have much solid data to go on. However, analysis published in March by Unite, the UK’s largest private sector trade union, found that the average profit margins of the top 350 companies listed on the London Stock Exchange increased from 5.7% in the first half of 2019 to 10.7% in the first half of 2022. And a more recent study found that the jump in UK-wide company profits was responsible for almost 60% of inflation in the past half year, as opposed to just 8.3% due to labour costs.

Despite this, the Bank of England has systematically dismissed the issue of corporate profiteering. Only last month, Andrew Bailey said that the increase in corporate profits was not the result of greed but “a story about rebuilding margins that were squeezed, particularly in the early part of last year”. Even if this were true, it is telling that the Bank considers it fine for corporations to “rebuild their margins” after a two-year squeeze, but if workers demand higher wages to compensate for their own living standards squeeze, they have to be crushed.

That said, there is evidence that, in some sectors at least, there is a degree of price-gouging going on in the UK as well. Food inflation, for example, remains at a historic high despite the falling wholesale costs faced by farmers and food manufacturers. MPs, academics and trade unionists have largely blamed supermarkets, accusing them of increasing food prices beyond the pace of inflation and their own rising costs. Tesco, the UK’s biggest supermarket, made £2.6 billion in adjusted operating profit in the 2022-23 financial year — £1 billion more than it made in 2018 and the highest it has made in any year other than 2021-22.

But the pressure may also be coming from further down the supply chain: from food manufacturers and producers. Margins among the big food manufacturers, for instance, are in the 16-22% range. And Paul Donovan, the chief economist at UBS Wealth Management, believes that thousands of companies have jacked up bills for many months, improving profit margins at their customers’ expense.

No doubt realising this, the Bank of England and Government have started to timidly acknowledge that big businesses may be playing a role in the inflationary surge — but it’s too little, too late. Indeed, following pushback from the industry, the Government quickly drew back from suggestions that supermarkets should impose “voluntary caps” on the prices of essential goods. What’s left is a recessionary policy that will do little to appease inflation, but will serve to punish workers for daring to protect their incomes. And this comes as no surprise: not for the first time, in the silent class war being waged by big business against workers and consumers, Britain’s technocratic elites have made it amply clear on whose side they stand.