Thursday , May 19 2022

Power, not prices

Summary:
We’re heading for a cost of living crisis because of big price rises for essential items such as gas and food. Everybody knows this. Which is unfortunate, because it’s not quite true. Of course, I don’t deny that prices are rising. They are. What’s doubtful is that they are the sole cause of falling real incomes. Simple statistics tell us this. Since quarterly data began in 1955 fluctuations in annual inflation (measured by the consumption deflator) have explained only 4.2% of the variation in annual growth in real households’ incomes; for longer-term changes such as three or five-year ones the explanatory power is even lower. This tells us that rising prices alone have been only a tiny cause of changes in real incomes. What’s more, our period of highest inflation actually saw real

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We’re heading for a cost of living crisis because of big price rises for essential items such as gas and food. Everybody knows this. Which is unfortunate, because it’s not quite true.

Of course, I don’t deny that prices are rising. They are. What’s doubtful is that they are the sole cause of falling real incomes.

Simple statistics tell us this. Since quarterly data began in 1955 fluctuations in annual inflation (measured by the consumption deflator) have explained only 4.2% of the variation in annual growth in real households’ incomes; for longer-term changes such as three or five-year ones the explanatory power is even lower. This tells us that rising prices alone have been only a tiny cause of changes in real incomes.

What’s more, our period of highest inflation actually saw real household incomes do well. Consumer prices more than tripled during the 1970s, in part because the oil price rose by a factor of ten. But real households’ disposable incomes then grew by an average of 3.4 per cent a year – more than twice as much as they grew in the ten years before the pandemic, a period of low inflation.

Inflation on its own, therefore, is not a sufficient explanation of falling real incomes. Sometimes, as in 2016, real household incomes fall when inflation is low. And sometimes they rise when inflation is high, as in the 70s.

So, what does explain variations in real incomes?

Power, that’s what. There are two big differences between now and the 70s. Wageshare

One is that back then many workers had the bargaining power to extract pay rises to maintain their real incomes in the face of rising prices. In the mid-70s the wage share in GDP rose sharply. It was capitalists and shareholders who suffered a crisis, not working households.

The other was that government borrowing rose markedly, which helped support incomes. Because that increased debt was devalued by inflation (in those naïve days before index-linked gilts) this meant there was in effect a transfer of real resources from gilt investors to other households.

Today, things are different. Except in a few industries, workers don’t have the power to protect real wages that they had for a while in the 70s. ONS data show that average weekly wages rose 4.2% in the year to November and that median monthly pay rose 5.3% in the year to December. Both measures fall short of CPI inflation.

What’s more, fiscal policy is being tightened. The OBR foresees cyclically-adjusted net borrowing falling by 4.4 percentage points of GDP in 2022-23. Higher NICs, the cut in Universal Credit and public sector pay restraint are all taking real incomes from households.

Real household incomes are not, then, falling solely because of inflation. They’re falling because people lack the market or political power to protect themselves from external shocks in the way they did in the 70s. Back in the 70s, working people were portrayed as greedy knaves; today they are seen as pawns, victims lacking agency (to borrowing Julian Le Grand’s terminology (pdf)). There’s a reason for this change.

A fall in some people’s real incomes at a time when GDP is growing – as is likely this year – is a transfer of real resources, from those without power to those with it. Inflation is a means (often unintended) whereby this transfer occurs. It is not the sole cause of it.

The “classical dichotomy” – the idea that real variables affect only things and monetary variables (such as prices) only monetary ones – is sometimes wrong. But not always; it usefully reminds us to think about real factors, not just monetary ones.

Those who attribute the cost of living crisis to inflation are therefore wrong. But their error is an old one. It’s what Georg Lukacs called reification, the process whereby:

A relation between people takes on the character of a thing and thus acquires a ‘phantom objectivity’, an autonomy that seems so strictly rational and all-embracing as to conceal every trace of its fundamental nature: the relation between people.

It’s what Marx called commodity fetishism – the way in which relations between people assume “the fantastic form of a relation between things.”

Even well-meaning talk of inflation, therefore, is ideological: it effaces a brute fact about capitalism, that some people have more power than others.  

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