Picture credit: Sean Gladwell/Getty

Big pay rises won’t beat inflation

The poor are best helped through tax and benefits, not boosting the minimum wage

Tim Congdon

This article is taken from the August-September 2023 issue of The Critic. To get the full magazine why not subscribe? Right now we’re offering five issues for just £10.

Wartime emergencies excepted, Britain’s inflation rate first became an acute problem in the 1960s. The initial policy reaction accorded with the wider enthusiasm at that time for state planning and interference. The government negotiated limits to the maximum increases in wages and prices with the peak organisations of labour and industry, the Trades Union Congress and the Confederation of British Industry. 

However, experience showed that these “prices and incomes policies” — administered by lawyers, civil servants and the like — could be evaded. Businessmen and workers found ways round them, and they were ineffective if demand and output were too buoyant. 

One of the key clarifications of the Thatcher period was that an appropriately responsible monetary policy was the correct answer to inflation. On coming to power in 1997, New Labour accepted this when it gave the Bank of England operational independence in monetary policy-making. The Bank’s main job was to meet an official inflation target, with the target from 2003 set at a 2 per cent a year increase in consumer prices. 

Until the recent debacle of double-digit inflation, consumer prices increased on average by almost exactly the target 2 per cent figure. There may have been ups and downs, wobbles and jiggles, but on average the target was met. On the face of it, monetary restraint — not direct government meddling in prices and wages — was the way to beat inflation. The lesson was clear and became accepted across the political spectrum. 

Prices and incomes policies were indeed a mistake. However, they did have a few merits. They gave governments a benchmark for limiting pay settlements in the public sector, which — unlike the private sector — was more or less immune to monetary discipline. They also reminded everyone that a key part of inflation control was to manage expectations downwards. In the Britain of the 1960s and 1970s, politicians were prepared to lecture the public on how “Britain had to pay its way in the world”, which meant that our prices and costs had to be low relative to our competitors. 

Roll forward to the twenty-first century. In October 2021 Rishi Sunak, as Chancellor of the Exchequer, announced a 6.6 per cent increase in the national minimum wage to £9.50 an hour, to take effect in April 2022; in November last year, now as Prime Minister, he proclaimed that April 2023’s increase would be of 9.7 per cent to £10.42 an hour. Political hoopla accompanied both occasions, with one point of the announcements being to impress potential voters on low incomes with Sunak’s generosity. The official intention was to shift pay increases upwards and, inevitably, to make business costs higher.

No doubt the Low Pay Commission — which recommends levels of the national minimum wage to the government — hopes that any increases give a genuine uplift exclusively for the less well-off. But in practice people with skills and experience resent loss of status compared with those lower down the pecking order. Like it or not, pay rises for those on much higher hourly rates have to adjust upwards to maintain relativities. 

In this context it cannot be overlooked that labour costs are the dominant element in total costs, with wages and salaries accounting for over half of national income. The leap in the national minimum wage in the last two years of nearly 17 per cent has put upward pressure on costs in an economy where consumer prices in the same period are supposed to have gone up by only 4 per cent. 

Sure enough, in the long run, the increases in nominal gross domestic product and the quantity of money will be related, while the Bank of England’s ability to influence money growth enables it to keep inflation at target. All the same, the fashionable emphasis on the supposed virtues of large rises in the national minimum wage is plainly inconsistent with the requirements of anti-inflationary monetary policy. Pay policy and the inflation target are at loggerheads. 

The quantity of money, broadly defined on the M4x definition, went up by 18½ per cent in the two years to the first quarter of 2022. That surge — due mainly to the Bank of England’s misjudged asset purchases — is the main cause of the current inflation episode. But the economy’s adjustment to monetary shocks is being made more difficult by officially legislated increases in wage costs. 

The lower-paid need help. But that is best done through the tax and benefit system

The national minimum wage did not exist under the Conservative governments of 1979 to 1997. Yet in that period consumption rose by 62 per cent, or at a compound annual rate of almost 2¾ per cent. By contrast, in the 13 years of the present government — ostensibly Conservative but actually anti-business — consumption has gone up by 17½ per cent, or at a compound annual rate of only 1¼ per cent. 

The lower-paid need help. But that is best done through the tax and benefit system, not by loading costs on small, labour-intensive businesses. In the coming recession too many of these businesses will go bust. They will not thank Rishi Sunak and the Conservatives for undermining their commercial viability. 

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