Why wages should keep up

with inflation: the economic

case for getting a pay rise
July 12, 2022
The recent sharp rises in inflation have effectively put an end to three decades
of relative price stability in the UK. The prices of most goods and services have
gone up and could go even higher.

The reasons for this include increased economic activity after the ending of
COVID restrictions, global supply chain issues and the war in Ukraine. And
one immediate effect of such steep inflationary pressure is that people’s wages
are suddenly not worth as much as they used to be.

In the UK, there have been strikes in 2022 by rail workers and criminal
barristers, and warnings of industrial action in sectors such as nursing,
education and transport – all seeking pay rises in response to the increasing
cost of living.

But while inflation has indeed led to a substantial squeeze on living standards
and depressed real wages, there have also been arguments made that increases
in wages could lead to further inflation. The so-called “wage-inflation spiral”
suggests that wage increases lead to higher price inflation which in turn makes
workers demand higher wages.

The basic idea is that the consistent ratcheting up of workers’ pay to match
inflation and cost of living increases leads to firms raising prices to protect
their profit margins.

Some then, including the governor of the Bank of England, and the former
chairman of Goldman Sachs, have called on both employers and employees to
exercise “wage restraint”.

These interventions are easily (and often) criticised on the grounds that a
person earning close to £500,000 a year (as the governor does) is not best
placed to tell millions of people who earn much much less that they should
settle for what they’ve got. But even if we ignore this moral dimension, there
are still major flaws in the argument for not increasing wages.

Firstly, the notion that wage increases lead directly to an increase in inflation
does not always hold. The current high inflation rate is largely caused by
factors which are not connected to pay levels, so will not be solved by
restraining wages. Secondly, a restriction on real wages is likely to bring
forward the prospect of a recession.

The UK (along with the US and many European countries) is already showing
a decline in economic growth. Allowing wages to fall in real terms is only likely
to make this situation worse by squeezing household incomes. This squeeze
will inevitably lead to a decrease in consumption and spending, putting
further pressure on the economy. It is also likely to push many more people
into poverty. The negative effects of wage restraint cannot be ignored.

Wage watch
It is also worth looking ahead. The most recent forecast by the Bank of
England suggests that by the middle of 2025 there are risks of “deflation” – a
reduction in general price levels across the economy. And while some may
welcome the idea of price falls, deflation brings its own serious risks, including
higher unemployment and lower economic growth.

What is needed now is urgent action to ensure that wages rise in line with
inflation, so consumption and spending is maintained to avoid or at least
dampen the expected recession. This will require workers to bargain for pay
rises, and employers to provide them.

And yes, it will also probably mean more strikes in the public sector – but the
government needs to come to terms with the economic value of raising public
sector pay. Public sector workers – after years of pay freezes – deserve a pay
rise. Their colleagues in the private sector also need and merit an uplift in
their wages.

Finally, progress in pay and the move to a sustainable recovery will require a
state determined to raise productivity. Increases in wages will themselves
create the conditions for higher productivity by boosting the motivation and
morale of workers. Higher wages can support the economy and help to avert
the threat of stagnation – and ward off even higher inflation, and an even
greater cost of living crisis.

Pakistan: how an economic

crisis has sent prices rocketing
July 4, 2022

Pakistan’s current economic struggles exemplify the little fires everywhere set
alight across the global economy by a war during a pandemic. Like others in
countries dependent on imported commodities — for example Ghana and Sri
Lanka — Pakistanis are seeing food and fuel prices soar. Foreign exchange
reserves – used to pay for imports such as food and fuel – have shrunk.

Pakistan is using up its foreign exchange reserves more quickly than

previously anticipated because prices of foreign goods are going up. If the
situation doesn’t change, the country faces bankruptcy.

In April, a litre of petrol cost about 150 rupees (£0.60), but by July 1 the price
had risen to nearly 250 rupees. And the price of cooking oil increased by 40%
just between May and June. At present the country has only enough foreign
currency to pay for five weeks of imports. Pakistan is heavily dependent on
imported fuel and cooking oil, but also on machinery and food grains from
overseas.

All of this has made day-to-day activities more challenging. Power outages are
not uncommon in the country, even when the economy is strong – they
become frequent and long when the economy is under duress. This happens
because energy companies struggle to operate when the costs of power
generation are higher than the revenue they collect. Over the past few weeks,
residents of major cities have had to go without electricity in their homes for
as much as 10 hours a day – in rural areas for even more. The discomfort of
the public is compounded by an intense heatwave in many parts of south Asia
that has caused temperatures in some places to hit 51℃.

Relying on imports

Foreign exchange reserves with the Pakistan central bank currently stand at
US$10.3 billion, (£8.4 billion). This is a sharp drop from US$16.6 billion in
January 2022. Though recently bolstered by Chinese bank lending, reserve
levels have been volatile since late April 2022, when a political crisis resulted
in the ousting of the prime minister, Imran Khan.

In Pakistan imports are far higher than exports. To preserve foreign currency,
an early measure taken by the newly appointed government in May 2022 was
to ban many types of imported goods deemed non-essential luxury items. The
list included chocolate, nappies, pet food and tampons, but has been
amended. Initially there were concerns that pets and livestock would be
malnourished because of this ban, and that chocolate would be confiscated at
international airports. And that menstruating women would not have access to
sanitary pads. Because of public pressure, the list has been amended and
clarified. Chocolate is no longer being seized, pet food taken off the list, and
sanitary pads are being manufactured domestically.
A more recent intervention, intended as a placid nudge but widely derided, is a
cabinet minister’s suggestion that individuals should drink fewer cups of tea.
The drink is ubiquitous in Pakistan, which is the largest global importer of tea
by a considerable margin. It is considered one of life’s simple pleasures in a
country troubled by power outages and expensive basic food items.

Consternation over the petty politics of “austeri-tea” can deflect from larger,
more compelling issues. These are recurrent and arise from the position of
Pakistan, and other fragile, externally indebted economies in a global system
of currency hierarchies.

Poor countries cannot borrow in their own currency, but need to use one of
the major currencies being traded on the international exchanges. The US
dollar is the most used currency, while other dominant currencies include the
British pound and the euro. These “hard” currencies are those which indebted
countries must regularly purchase to pay for imports and to repay and service
the loans they owe to private bondholders, international financial institutions
and lenders.

Before he was ousted, Khan tried to retain public support as prime minister by
resisting demands from the International Monetary Fund (IMF) to increases
taxes and remove subsidies. So, by not taking steps such as making fuel more
expensive, the Khan government delayed inflows of external finance. This
weakened Pakistan’s reserves and made it difficult to maintain the value of the
rupee. As the chasm between the dollar and rupee grew, the popularity of the
government fell.
Global sanctions on Russia and Iran complicate Pakistan’s economic situation.
Khan was frustrated at not being able to use a supply of relatively cheap
Russian oil because of international pressure over Ukraine. Given the need for
drastic measures, Pakistan’s government may now follow in the footsteps of
Sri Lanka and turn to Russia for cheap fuel.

International tensions

Pakistan has also refrained from importing oil from neighbouring Iran.
Smuggled Iranian oil remains attractive to those living near the border. Fuel
and energy cooperation between Pakistan and Iran is an especially prickly
issue given opposition from the US and Saudi Arabia, another nation that has
often financially assisted Pakistan.

To avert bankruptcy – and to continue buying food and fuel – Pakistan is now
awaiting assistance from the International Monetary Fund (IMF). This
Washington DC-based institution has rescued crisis-ridden economies on
many occasions. In exchange, recipient governments must commit to policy
reforms that are often unpopular with the public.

Over the next few weeks, the IMF is likely to step in and commit to a bailout of
approximately US$1.85 billion. If, and when, this happens, the exchange rate
between the Pakistan rupee and US dollar will stabilise. Given that the dollar
has risen more than 15% against the rupee since January 2022, policy makers
will welcome a stronger Pakistani currency to calm surging prices.

But the heavy costs of a deal with the IMF have already driven a cost-of-living
crisis as fuel subsidies have been sharply withdrawn and made food and
transport unaffordable for many. Tax increases have also added to day-to-day
pressures.

Currency issues and cost-of-living crises in Pakistan are inextricably linked. A

more expensive dollar makes fuel more expensive, and these price increases
are quickly reflected in daily essentials. Given that Pakistanis spend more than
40% of their income on food, inflation makes large segments of the population
marginalised and vulnerable.

Unless exports drastically increase in coming years, Pakistan’s economy will

remain precarious and high prices will remain a threat. Given this situation,
financial assistance is the only way to overcome the crisis. Unfortunately this
tends to come with financial or political strings attached.

Pakistan’s economy is on the brink

04-May-2022

Pakistan is in political and economic chaos. Its most populous province,

Punjab, was without a government for almost a month because the governor,
who was appointed by former prime minister Imran Khan, had refused to
administer an oath to the newly elected chief minister of the province. The
president, Arif Alvi, a member of Khan’s party, is backing the Punjab
governor’s actions.

Meanwhile, Pakistan’s foreign exchange reserves have fallen sharply in the

past two months. The new government hopes to stop the bleeding with an
enhanced IMF package and more short-term loans from China and Saudi
Arabia. Supplies of electricity to households and industry have been cut as the
cash-strapped country can no longer afford to buy coal or natural gas from
overseas to fuel its power plants.

Newly elected prime minister Shehbaz Sharif was in Saudi Arabia last week to
seek more financial assistance from the oil-rich kingdom, in addition to the
existing bilateral credit of $4.2bn. Pakistan owes China $4.3bn in short-term
loans in addition to the expensive loans to finance the power plants built
under the China-Pakistan Economic Corridor programme.

Pakistan’s finance minister Miftah Ismail met the IMF in Washington last
month and requested an increase in the size and duration of its current $6bn
fund programme, initiated in 2019.

International commercial debt markets are practically shut for Pakistan. Its
five-year sovereign bonds are trading near 13 per cent, which is among the
highest in the emerging markets.

Pakistan’s official liquid foreign exchange reserves (excluding gold reserves of

about $4bn) have dropped to just $6.6bn, or by $6bn, since the end of
February. The level of reserves provides cover for just one month of imports.

According to Ismail, the fiscal deficit could hit Rs5.6tn ($30bn), or about 8.8
per cent of gross domestic product, versus a target of about Rs4tn, by the end
of June. Pakistan’s volatile political situation makes it difficult for the new
government to take any tough steps.

The federal budget deficit in the first nine months of the current fiscal year
jumped to a staggering Rs3.2tn, 53 per cent higher than compared with the
same period of the previous year. A significant reason for this was Khan’s
populist measures, including his decision to not pass the impact of rising oil
prices to the consumer. It is costing about $1.1bn a quarter to subsidise
petroleum products. However, this is not the only reason for the parlous state
of the public finances.

Pakistan’s rent-seeking political economy, dominated by the military

establishment and special interests, provides Rs1.3tn in tax subsidies to the
big businesses and the industries, according to Pakistan’s Federal Bureau of
Revenue, its tax collection authority.

However, Pakistan collects very little in taxes from the urban property market,
which has been booming for some time, for example. Large houses or plots of
land can cost anywhere between $500,000 and $2mn, but the owners pay
little tax. According to Shahrukh Wani, an economist at Oxford university, all
of Punjab, home to a population of more than 100mn, collects less in urban
property taxes than the city of Chennai in India, with a population of about
10mn people.

It is time for Pakistan’s rich to start paying their proper share of taxes. The
IMF should not allow itself to be seen as bailing out the wealthy, which it
seems to be doing by ignoring Pakistan’s repeated slippages in meeting the
programme targets.

The rich should also pay higher taxes on property and pay more for electricity
and luxury cars than the low income or middle-class citizens who are already
reeling from double-digit inflation (currently 13.4 per cent), which is the
third-highest among major global economies. Steve Hanke, a professor of
applied economics at Johns Hopkins University, has calculated Pakistan’s
realised inflation rate to be a whopping 30 per cent per year, more than double
the official rate.

Further delay in carrying out meaningful economic reforms could lead to more
economic hardship and social unrest.

How This Economic Moment Rewrites

the Rules
Aug. 6, 2022

To understand the strange, conflicting signals being sent by the U.S. economy right now,
it helps to look at Williston, N.D., in about 2010.

North Dakota was in the midst of an oil boom. Scores of rigs were drilling hundreds of
wells, filling up train cars with crude because there hadn’t been time to build a pipeline.
Pretty much anyone who wanted a job could find one, even the teenagers who dropped
out of high school to work in the oil fields. Wages soared. Fast-food restaurants offered
signing bonuses. State coffers filled up with tax revenue.

Yet as good as the economy was, it also felt unstable. Restaurants couldn’t hire enough
workers. Housing was in short supply, and costly. Local infrastructure couldn’t
withstand the sudden surge in demand. Prices for practically everything soared.
“It was chaotic,” said David Flynn, an economist at the University of North Dakota who
lived through the boom and has studied it. “The economy was doing well, revenues for
the local areas were up across the board, but you were still short of workers and
businesses were having trouble.”
“That sounds a lot like the stories you’ve been hearing at the national level for the past
couple years,” he added.
Economists and politicians have spent weeks arguing about whether the United States is
in a recession. If it is, the recession is unlike any previous one. Employers added more
than half a million jobs in July, and the unemployment rate is at a half-century low.

Typically, in recessions, the problem is that businesses don’t want to hire and
consumers don’t want to spend. Right now, businesses want to hire, but can’t find the
workers to fill open jobs. Consumers want to spend, but can’t find cars to buy or flights
to book.

Recessions, in other words, are about too much supply and too little demand. What the
U.S. economy is facing is the opposite. Just like North Dakota in 2010.
The underlying causes are different, of course. Williston was hit by a surge in demand as
companies and workers flooded into what had been a small city in the Northern Plains.
The United States was hit by a pandemic, which caused a shift in demand and disrupted
supply chains around the world. And the comparison goes only so far: Williston’s
population roughly doubled from 2010 to 2020. No one expects that to happen to the
country as a whole.
Still, whether local or national, the most obvious consequence is the same: inflation.
When demand outstrips supply — whether for steel-toe boots in an oil boomtown or for
restaurant seats in the aftermath of a pandemic — prices rise. Mr. Flynn recalled going
out to eat during the boom and discovering that hamburgers cost $20, a feeling of
sticker shock familiar to practically any American these days.

There is also a subtler consequence: uncertainty. No one knows how long the boom will
last, or what the economy will look like on the other side of it, which makes it hard for
workers, businesses and governments to adapt. In Williston, companies and
governments were reluctant to invest in the apartment buildings, elementary schools
and sewage-treatment plants that the community suddenly needed — but might not
need by the time they were complete.
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“Think of it as a situation of every day, seemingly, was a new shock, so you couldn’t even
adjust before a new one was hitting,” Mr. Flynn said. “It’s that constant adjustment.
Completely unpredictable.”

Businesses have now spent two and a half years in a state of constant adjustment. In
early 2020, practically overnight, Americans traded restaurant meals for home-baked
bread, and gym memberships for socially distanced bike rides. Those shifts caused huge
disruptions, in part because businesses were reluctant to make long-term investments to
address short-term spikes in demand.
“That was always going to cause its own problems on prices and shortages,” said Adam
Ozimek, chief economist for the Economic Innovation Group, a Washington research
organization. “Businesses were never going to be like, ‘I’m going to build 10 new bicycle
factories right now because we’re in a long-term bicycling boom.’”
Some other shifts caused by the pandemic are likely to prove longer lasting. But it is
hard for businesses to know which.

“I think businesses are correct that the current state of the economy can’t really hold —
something has to give,” Mr. Ozimek said.

To most people, of course, this doesn’t feel like a boom. Measures of consumer
confidence are at record lows, and Americans overwhelmingly say they are dissatisfied
with the economy. That perception is grounded in reality: High inflation is eroding —
and in some cases erasing — the benefits of a strong job market for many workers.
Hourly earnings, adjusted for inflation, are falling at their fastest pace in decades.

“I know people will hear today’s extraordinary jobs report and say they don’t see it, they
don’t feel it in their own lives,” President Biden said Friday. “I know how hard it is. I
know it’s hard to feel good about job creation when you already have a job and you’re
dealing with rising prices — food and gas and so much more. I get it.”

Tara Sinclair, an economist at George Washington University, said the United States
wasn’t experiencing a true boom. That would imply a virtuous circle, in which prosperity
begets investment, which begets more prosperity and makes the economy more
productive in the long term — a rising tide that lifts all boats.

Instead, the lingering disruptions of the pandemic, uncertainty over what the post-Covid
economy will look like and fears of a recession have made businesses reluctant to make
bets on the future. Business investment fell in the most recent quarter. Employers are
hiring, but they are leaning heavily on one-time bonuses rather than permanent pay
increases.
“It’s not an economic boom in the sense of wanting to invest long term,” Ms. Sinclair
said. “It’s a boomtown situation where everyone’s just waiting for it to get cut off.”
Indeed, the Federal Reserve is trying to cut it off. Jerome H. Powell, the Fed chair, has
described the labor market, with twice as many open jobs as unemployed workers, as
“unsustainably hot,” and is trying to cool it through aggressive interest rate increases.
He and his colleagues have argued repeatedly that a more normal economy — less like a
boomtown, with lower inflation — will be better for workers in the long term.

“We all want to get back to the kind of labor market we had before the pandemic, where
differences between racial and gender differences and that kind of thing were at historic
minimums, where participation was high, where inflation was low,” Mr. Powell said last
month. “We want to get back to that. But that’s not happening. That’s not going to
happen without restoring price stability.”

Mr. Biden and his advisers, too, have argued that a cooling economy is inevitable and
even necessary as the country resets from its reopening-fueled surge. In an opinion
article in The Wall Street Journal in May, Mr. Biden warned that monthly job growth
was likely to slow, to around 150,000 a month from more than 500,000, in “a sign that
we are successfully moving into the next phase of the recovery.”

So far, that transition has been elusive. Forecasters had expected hiring to slow in July,
to a gain of about 250,000 jobs. Instead, the figure was above 500,000, the highest in
five months, the Labor Department reported on Friday. But the labor force — the
number of people who are either working or actively looking for work — shrank and
remains stubbornly below its prepandemic level, a sign that the supply constraints that
have contributed to high inflation won’t abate quickly.

Ms. Sinclair said it shouldn’t be surprising that it was taking time to readjust after the
coronavirus disrupted nearly every aspect of life and work. As of July, the U.S. economy,
in the aggregate, had recovered all the jobs lost during the early weeks of the pandemic.
But beneath the surface, the situation looks drastically different from what it was in
February 2020. There are nearly half a million more warehouse workers today, and
nearly 90,000 fewer child care workers. Millions of people are still working remotely.
Others have changed careers, started businesses or stopped working.
“We have to remember that we are still sorting that out,” Ms. Sinclair said. “It was a big
economic shock, and the fact that we came out of it as quickly as we did is still incredibly
impressive. These residual pains are us just still adjusting to it.”