Low inflation, deflation and pay – The Magpie

In the second instalment of their column, The Magpie explores how to argue for a pay rise when in the face of deflation or low inflation.


For several years employers cut real wages by holding increases in average wages below the increase prices. Bosses, workers and our unions now face unfamiliar territory – low inflation (prices rising slowly) and the possibility of deflation (falling prices).

Two major factors in the falling rate of inflation are the slowdown in the giant Chinese economy and the falling oil price which feeds through to many other prices.


How low is inflation really?

Inflation (the percentage annual increase in prices) measured by the Consumer Prices Index (CPI) was 0% in the year to March 2015, while it ran at 0.9% measured by the Retail Prices Index (RPI).

It’s worth understanding the differences between CPI and RPI, as people tend to pick the figure that suits their agenda. For example, the government uses the (lower) CPI for increasing benefits, but the (higher) RPI for student loan charges.

Any measure of inflation is imperfect. Indices are based on a sample of prices, not the whole picture. The change in the cost of living varies widely between individuals depending on what you buy. For example, someone living in rented accommodation in London is likely to experience higher inflation than someone who has paid off a mortgage. The falling oil price has benefitted drivers but rarely those using public transport.

There are two main differences in the CPI and RPI calculations which explain why CPI inflation is nearly always lower than RPI. Firstly, CPI excludes housing costs. Secondly, they use different mathematical methods for averaging prices.

Given that Britons spend 40% of their income on housing costs, which have risen faster than overall inflation, it’s obvious that excluding housing costs makes CPI a worse measure of the cost of living.

The debate about the maths has been a lot more complicated. At the time when the Office of National Statistics abandoned RPI as a “national statistic” it was widely accepted that the averaging method used by CPI gave a better reflection of reality, even though it produced a lower number. Further research has thoroughly debunked this argument, as explained in this excellent paper on the UNISON web site.

So there really is no excuse for workers to accept the use of CPI rather than RPI when discussing pay.

What could happen to pay?

In recent years, many unions have got used to seeing RPI as a target in pay negotiations, rather than a floor. Workers need to dust off old arguments for pay rises when inflation is low or negative.

The most obvious argument is catch-up. Many workers have seen their real wages fall sharply in recent years. This is true even if you look narrowly at wages. Once you include cuts in pensions and other benefits the transfer of wealth from workers is even more dramatic. Low inflation is an opportunity to make up lost ground.

An equally important argument is productivity. The experience of the overwhelming majority of workers who stay in the same job is that their productivity goes up each year. Unpaid overtime is massive; it’s hard to take breaks; work is more intense; targets are raised; time for each task is cut. If your wages just go up in line with inflation, that means you can buy the same stuff this year as you could last. But you are producing more. Your share of what you produce is shrinking, while that seized by your boss keeps growing. Just to maintain your share of what you produce, you need an increase of inflation PLUS your productivity increase. This is a powerful argument connecting the pressure people feel on their job to the widespread anger about the rich getting richer at the expense of the 99%.

The (misleading) Tory claims that real wages are now rising ignore the ongoing shift of wealth from poor to rich.

One argument we will undoubtedly hear against the productivity argument is that during the recession, overall productivity in the UK has not increased. There’s a lot of debate about the reasons for this. One possible explanation is that the proportion of jobs with very high productivity (typically lots of capital investment per worker e.g. in manufacturing) keeps declining, and more people are in low-productivity service sector jobs. One thing’s for sure though – it isn’t because people aren’t under pressure to work ever harder and longer – people doing the same job are producing more.

Implications of deflation

There is a fair amount of panic in the establishment about the possibility of deflation (currently seen as possible in the UK, but not that likely). When prices are falling, individuals tend to delay purchases in the hope of lower prices, and companies delay investment for the same reason. Both drag the economy backwards. For example, Japan experienced decades of deflation and economic stagnation from the 1980s which it struggled to escape despite desperate measures such as giving money to citizens and urging them to spend rather than save.

Deflation is bad news for people with debts, who see the real value of their debts increase, instead of inflation eating them away over the years.

In recent years employers have been able to boost profits by allowing inflation to eat into real wages, thus avoiding large direct confrontations. If the UK does enter deflation more employers could demand wage cuts and adopt aggressive tactics such as dismissal and re-engagement or lockouts to try to impose them.

Educating workers about inflation, deflation and the arguments around pay are an important task for activists and unions as debates about pay claims and campaigns take place on unfamiliar ground.

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