Imported inflation means the UK is less well off and we all have to pay a price – John McLaren

People protest in Glasgow's George Square against the rising cost of living earlier this year (Picture: Jeff J Mitchell/Getty Images)

As a result of higher international energy and food costs over the past year, the UK as a whole is less well off.

This imported inflation, largely a result of Covid and the war in Ukraine, has led to our standard of living taking a hit. After decades of benefitting from globalisation helping to reduce import costs, we are now faced with the reverse. There is no getting round this, just as there was no getting round the negative impact of the oil price hikes in the early 1970s and 1980s.

The UK can try to garner a bit back through higher taxes on companies that benefit but, when Shell hasn’t paid any tax on its UK oil and gas production since 2017, that’s unlikely to come to very much. We need to accept the fact that the purchasing power of the country has fallen, and address the question of how to adjust for this loss.

A decision was taken, wisely, to allow inflation to rise in light of these higher costs. The alternative was for the Bank of England to have been ultra-hardline in keeping to its two per cent target and imposing very high interest rates – much higher than now.

The result would, again, have been a big cut in living standards, just by soaring mortgage and other borrowing costs rather than falling real wages. The natural response of employees in such circumstances is to seek compensation, especially as it comes after a sustained period of low-to-no real wage growth.

The Royal College of Nursing is seeking a pay settlement of retail price inflation plus five per cent, which is over 17 per cent based on September’s data. A similar rise might reasonably be sought by other, equally deserving, public sector employees – including teachers and social care staff – as well as in sectors where the government is seen to have a role – transport workers, minimum wage earners etc. If agreed to, we would probably be looking at national wages going up by double figures.

Such pay deals then come up against the problem of a near fixed budget, which means that, on the public sector side, an ‘inflation plus’ settlement leads to either large cuts to non-wage public service budgets and/or jobs or else a big hike in taxes. In terms of who takes the hit for the UK’s loss of spending power from higher imported prices, the bottom line is a choice between: falling real wages; rising taxes; or a falling standard of public services. Each way the public, and households, pay a price.

This is a point well understood by the Bank of England. A recent speech by Monetary Policy Committee member Ben Broadband put it thus: “It’s understandable, faced with this extraordinary squeeze, that people and firms in the UK economy have sought to protect their real incomes – whether pay or profits – through compensating rises in wages and domestic prices. Unfortunately, and at least collectively, those efforts will not make us better off. It’s not as if one group or sector is worse off only because another, within the (non-North Sea) UK, is better off. The rise in import costs has depressed the purchasing power of the country as a whole. So all that can be done is to shift the losses from one place to another.”

The trouble is that both the Bank and the UK Government have not been very good at getting this point over, or making clear the unpalatable alternatives to wage restraint. The same could be said of the Scottish Government. John Swinney saying to health workers that seven per cent is the very best he can do may be accurate but when he suggests that this is due to UK Government obduracy rather than international economic circumstances acting against us, he is being less than frank.

The real point of debate then is who takes the hit. This distributional question is very much in the hands of the government. It could decide to pay higher wages, especially to lower paid workers, and claw this back by raising taxes on higher earners.

The only problem is that there is a lot of money involved here and the three biggest tax sources, by far, are: Income Tax; National Insurance; and VAT. In order to raise enough tax to pay for inflation-matching public wage rises and keep borrowing in check, most households, including those in the basic rate of income tax bracket, would need to pay more taxes. Some easing at the edges is possible but basically everyone’s standard of living will have to drop as a result of higher import prices for basic products, over which the UK has little control.

Going back to ‘fair pay’ for the likes of nurses and care sector workers, there remains a valid question as to what that level of pay should be, but it is a different question from how should their wages be adjusted to take into account the current spike in inflation. How to properly compensate workers in jobs whose importance became much more evident during Covid is a question that has been largely overlooked since the pandemic receded.

As with much in our post-Covid world, we carry on regardless, rather than recalibrating and adjusting to a more resilient model, which would incorporate measures to better retain and up-skill health, and other, staff. Things have been tough of late and inflation is having a significant negative impact but there are no easy answers just distributional choices to be made.

John McLaren is a political economist who has worked in the Treasury, the Scottish Office and for a variety of economic think tanks