Real disposable incomes have been falling in Britain since late 2021, and politicians are scrambling for ways to stop the biggest squeeze on living standards in decades. In his Budget this month, Chancellor Jeremy Hunt announced an extension of the energy subsidies that have kept heating and electricity bills below wholesale market energy rates since last autumn, as well as an extension of free childcare hours for parents. But those measures will only limit the pressures on households rather than improve them.
The features of the crisis are familiar: an energy shock has been precipitated by a disastrous land war. Waves of strikes are disrupting basic services. Household finances are severely strained by rampant inflation. Growth forecasts look bleak.
These symptoms of economic malaise would also have applied just as aptly to the 1970s, as Wolfgang Münchau highlighted in the New Statesman in March. The crisis in Ukraine and the sanctions imposed against Russia have led, just as the Yom Kippur War did in 1973, to a breakneck revision of energy flows and oil and gas markets, resulting in spiralling bills. Trade union activity has increased across Europe and the US as inflation has whittled down real-terms pay. The UK lost 2.5 million working days to strikes in 2022 – the highest since 1989.
But there are important differences between today’s crisis and the 1970s. As well as inflationary pressures from external energy shocks, governments face supply chain disruptions caused by a host of other factors: two years of Covid-19 restrictions, changing consumption habits, climate breakdown and labour constraints across the West, after millions have dropped out of the jobs market in the wake of the pandemic because of long-term sickness or early retirement. But comparisons are also flawed because of one crucial difference: the current downturn is worse.
There is no consensus between economists about the causes of inflation, or its remedies. Last year, before the price increases began in earnest, the Nobel Prize laureate and former chief economist of the World Bank, Joseph Stiglitz, told Spotlight that inflation had not been a “significant problem” for 40 years. It was not linked to over-spending by governments or unions demanding higher pay. “The inflation we had in the 1970s… was supply-side not demand-side inflation”, he said. “[It was] when the price of oil soared. It wasn’t profligacy that led to that inflation, it was a supply shock.”
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In 2023, industrial disputes remain comparatively rare. Thirteen million Britons were members of a trade union in the late 1970s. Today, membership is below half that. Days lost to strike action in 1979 totalled almost 30 million – more than ten times the level in 2022. While many blamed the price rises of the1970s on the pay demands of workers outstripping productivity improvements, few would identify wage increases as the starting point of today’s crisis; real-terms pay has been stagnant since 2008. Instead, economists of the free-market right have identified new culprits: the expansion of the money supply through cheap credit, ultra-low and even negative real interest rates, and money creation (known as quantitative easing, or QE, a policy the Bank of England introduced in 2009 as a response to the global financial crisis). Kristian Niemietz, head of policy at the free-market think tank the Institute of Economic Affairs, told Spotlight that “inflation is the result of loose monetary policy… We’ve got too much money chasing too few goods. It’s a hangover from a long time of quantitative easing.” Some £895bn has been created through QE – when the Bank buys government bonds to increase their prices, reduce interest rates and replenish Treasury coffers – which is not far below the UK government’s entire outgoings in a normal year.
James Meadway, a former adviser to the one-time shadow chancellor John McDonnell, has co-authored a book, The Cost of Living Crisis (and how to get out of it). As an economist of the left, he is sceptical of the view that QE has doled out too much money, but is still critical of it. “A great deal of that money made its way into the property market,” he says. The result was inflated asset prices, which benefited property owners rather than supporting incomes or investment in useful capital projects. “It didn’t necessarily turn into people having more money in their pockets,” Meadway adds.
And people’s pockets are increasingly empty. In the 1970s, despite the narrative of decline, real household disposable income grew in line with the postwar trend. That simply isn’t the case in 2023. In the mid-1970s, annualised inflation consistently hovered around the mid-teens, and hit 24 per cent in 1975. Interest rates were raised to a whopping 15 per cent (today they stand at 4 per cent). But the widespread collective bargaining arrangements that were in place, and the increased leverage enjoyed by a unionised workforce, meant that wages often rose as fast as prices. This further pushed up demand and resulted in that infamous wage-price spiral. Today, the Treasury and the Chancellor use the threat of a similar spiral to warn public-sector workers away from making “excessive” pay demands, but the situation is far from analogous.
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Despite the Bank of England’s worries about a tight labour market, with plenty of vacancies but not enough workers to fill them, prices are spiralling with only meagre increases in take-home pay. The result is worse living standards and more in-work poverty. While the consumer price index measure of annual inflation stood at around 10 per cent in January 2023, wages grew by only 7 per cent over the same period. The vast majority of growth in the latter figure was driven by increases in private-sector pay, with nurses, teachers, firefighters and other public-sector workers suffering dismal real-terms cuts, and are still negotiating with the government for an increase.
Productivity growth for the 1970s – or the output of the economy for every hour worked – also rose in line with the postwar trend. The difference with today is that, along with real measures of prosperity such as household disposable income, productivity has been stagnant since the 2008 financial crash. Real incomes are falling rapidly.
Perhaps the biggest difference between the 1970s and 2023, however, is that 50 years ago solutions were emerging from both the left and right of the political spectrum.
Traditional postwar Keynesianism was dumbfounded: rising unemployment should have provoked government stimulus spending, but simultaneously high inflation risked adding fuel to the inflationary fire. Higher levels of joblessness were supposed to signal a deflationary environment as workers accepted lower pay and demand for goods was depressed. Instead, goods were becoming more expensive.
On the right, fresh ideas were circulating in free-market think tanks such as the Mont Pelerin Society, the Centre for Policy Studies and the Institute of Economic Affairs, then incubating in sections of the Conservative Party. The theories of Austrian economists like Friedrich Hayek held sway, and the right was uniting behind the ideas of “monetarism” developed by Milton Friedman. Their “classical liberal” economic analyses gained such traction in Tory circles that, upon taking office, Margaret Thatcher was said to have interrupted a cabinet meeting by slamming down a copy of Hayek’s The Constitution of Liberty and bellowing “This is what we believe!”
The diagnosis was simple: an overweening state and bloated public sector were crowding out the supposedly more efficient private sector and disincentivising the profit-seeking motives that drive growth. The solution was a programme of deregulation, privatisation, marketisation, lower taxes and a squeeze on spending, not dissimilar from the solutions favoured by Liz Truss. Interest rates would be hiked abruptly to tame inflation, even if it came at the cost of rising unemployment and damaged exports.
Meanwhile, on the left, Tony Benn and radical members of the Labour Party drew up the Alternative Economic Strategy (AES). Their route out of economic stagnation was a protectionist form of state socialism: public investment in infrastructure and national industries; exit from the European Community’s free trade area; the imposition of tariffs, import and capital controls to promote British manufacturing and shore up the pound; increasing wages to boost demand; upping taxes on the wealthy; price controls on basic goods to stymie inflation; and boosting production through the nationalisation of key industries and economic planning.
Faced with sky-high inflation and a currency crisis in 1976, the government of Jim Callaghan accepted loans with strict conditions from the International Monetary Fund, effectively rejecting the AES’s socialist road and taking the monetarist route. Thatcher’s election in 1979 solidified the onset of what became known as the neoliberal era.
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Today’s politicians are less set on concrete solutions to the economic crisis. The Conservative Party is split between a technocratic faction represented by Rishi Sunak, which is low on ideological zeal and has few policy ideas beyond commitment to fiscal rectitude, and the Trussite wing’s slash-and-burn approach to regulation and insatiable desire to reduce taxes and initiate a supply-side, free trade revolution – represented best by Truss’s “enterprise zones” policy.
“Inflation is always and everywhere a monetary phenomenon,” says Tom Clougherty, research director at the Centre for Policy Studies, quoting Friedman. While acknowledging the impact of supply shocks, Clougherty maintains that today’s price increases are down to loose monetary policy (set by the Bank of England) and loose fiscal policy (set by the government). His solution centres around letting the market do its work. He argues that artificial bottlenecks like restrictive planning laws are distorting the economy and limiting the provision of the most expensive goods such as housing, the biggest outgoing for many.
“There are too many different veto players in the system, too many people with the opportunity to block something or delay it,” he tells Spotlight. The government should deregulate and allow developers to respond quickly to demand. Another example of burdensome regulation Clougherty cites is the over-stretched childcare sector.
He claims rules on the ratio of staff to children are pushing up prices. In March’s Budget, the Chancellor increased the number of children that could be looked after by one nursery staff member. But there were no signs that public-sector pay would be improved. “The government is basically right to show the kind of restraint that they’re showing,” says Clougherty.
This is not the consensus among economists however. “That narrow view of inflation is politically convenient for the right,” says David Barmes, head of research at the Positive Money think tank. He thinks it’s a post-facto justification for shrinking the state. “They either blame inflation on too much public spending or too much money creation… and their solution is always a combination of tightening fiscal policy and/or tightening monetary policy – not giving into workers demands, essentially.”
Barmes and Meadway are critical of the Bank of England’s decisions to raise interest rates. It’s a blunt tool, they say, that will deliberately stimulate a recession and lower living standards to tame price pressures. Instead, they recommend new wealth taxes, windfall taxes on the profits of energy and shipping companies, a programme of short-term price controls on basic goods, as well as public and private investment to strengthen supply chains. But that kind of radical action isn’t gaining huge traction on the centre left.
Few of Benn’s proposals in the AES would be welcomed by the more cautious leadership of today’s Labour Party. But just as the crisis of the 1970s birthed the neoliberal model of British capitalism, the weaknesses of our post-Covid economy, the expansion of government largesse brought about by lockdowns and the cost-of-living crisis are resetting the relationship between market and state.
In the US, President Joe Biden’s Inflation Reduction Act and multi-trillion-dollar infrastructure investment programmes are evidence of an economic model more comfortable with interventionism, state aid, industrial subsidy, limited protectionism and the championing of national industries. There’s continuity with the Donald Trump administration, alongside the mission to “de-couple” the US economy from China’s. Biden’s government openly talks of strengthening supply chains by re-shoring manufacturing jobs, and the approach ties in the green transition.
In Europe, too, the EU is dropping its long-held aversion to common debt issuance and investing in projects, particularly in green energy sectors, to build a more resilient economy. So far, Labour has announced it will found a publicly owned Great British Energy company, set an industrial strategy recommending corporatist “partnership” between business and unions, commit £28bn annual investment in energy infrastructure, and boost UK manufacturing with a promise to “buy, make and sell more in Britain”. Labour’s shadow chancellor, Rachel Reeves, has championed Biden’s approach, and promised a “national wealth fund” to invest in industry in the north and “left behind” regions.
On both sides of the Atlantic, the cost-of-living crisis has repoliticised the economy in a way that didn’t seem possible when Bill Clinton declared the “era of big government” over in the mid-1990s. When Tony Blair rhapsodised about “open, liberal economies”. Now, there is popular recognition about the drawbacks of free trade agreements and limited, laissez-faire government.
“The fib,” Stiglitz told Spotlight last year, “that the neoliberals told us – that everything was going fine, that there was trickle-down economics, that everybody was doing well – that was… so obviously wrong.” A new economic era may not yet have fully emerged, but the old one has palpably failed, and the cost-of-living crisis is only the latest symptom of its collapse.
This article appeared in the Spotlight special policy supplement on the cost of living crisis. To read the full report click here.
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