What is wage-push inflation? Economic theory explained amid train strikes over pay and record UK inflation

The extent of the UK cost of living crisis became clearer on Wednesday (22 June), after the Office for National Statistics Consumer Prices Index (CPI) showed inflation hit 9.1% in May.

This new 40-year-high means the cost of the average shopping basket has risen by more than 9% over the past year.

Meanwhile, wages have remained relatively stagnant for most Brits - a situation that has led to rail strikes this week and the prospect of further industrial action from public sector staff, including NHS workers and teachers.

However, the government has used the ‘wage-push inflation’ economic theory to argue against supporting pay increases.

So what does this economic theory mean - and do all economists agree with it.

Here’s what you need to know.

Why are wages in the news?

Wages are in the news because record inflation has meant many workers have taken a real-terms pay cut in recent months.

According to the Office for National Statistics, average pay growth without bonuses sat at 4.2% in April - under half the current rate of inflation.

It basically means paypackets are not keeping pace with price rises, therefore denting consumer purchasing power.

Rail workers are seeking a pay increase that would mitigate inflationary pressure - a demand that has so far been rejected by rail bosses and has led to strike action on the UK’s railways.

Meanwhile, public sector workers are also reported to be considering strike action as the government has called for wage restraint.

What is wage-push inflation?

Also known as a wage-price spiral, this economic theory believes that increasing workers’ pay acts as a principal driver of inflation.

In essence, the thinking goes that if you pay people more money to do work, you drive up costs for the business that employs them, and therefore the price of the final product.

Given inflation is a measure of how much more expensive goods and services become over a period of time, the theory states that higher wages will stand to increase inflation.

It also states that once workers find their spending power has been eroded by this heightened inflation, they will seek out greater wage increases and the process will start again, thus driving inflation up even further.

The economic theory emerged in the 1960s and 1970s at a time when inflation was viewed by academics as a major threat to the economy.

This thinking came about because more workers worked for fewer companies, the biggest of which were sometimes state-owned.

Therefore, any widespread calls for pay increases were thought to be likely to lead to inflationary pressure.

However, the wage-push inflation theory has never been proven in the real world, with general economic consensus finding that prices drove wages rather than the other way around.

Instead, economists think inflation is largely pushed by supply disruptions (such as the ones we have seen due to Brexit, Covid and the Russia-Ukraine war) and cheap money lending denting the supply of goods and services.

Is the government using the wage-push inflation theory?

Some of the language the government has used in the face of the cost of living crisis suggests it is using the wage-push inflation economic theory.

It has repeatedly called for restraint on wage demands.

Boris Johnson told MPs earlier in June: “When a wage-price spiral begins, there is only one cure and that is to slam the brakes on rising prices with higher interest rates.”

This claim led dozens of economists to write a letter to the PM which read: “Suppressing wages is the exact opposite of what is needed in response to this current wave of inflation, and risks fuelling dramatic increases in poverty and hardship, and ultimately a recession.

“Inflation today comes from huge external factors, including the aftershocks of lockdowns, war in Ukraine, and extreme weather events across the globe.

“It is not the product of domestic wage demands.”

Only a day after the open letter was published, Treasury Chief Secretary Simon Clarke said pay demands which seek to match the rate of inflation risked creating a “run away” 1970s-style wage-price spiral.

And on Tuesday (21 June) Downing Street insisted that “chasing inflation” with pay rises for public sector workers was not “feasible” as it would further fuel inflation.

A Number 10 spokesperson told reporters: “We think it would not be sensible and not be in these public sector workers’ best interests to chase inflation, cause inflation to spike further and in effect mean the money they take home is worth less.”

They insisted the government wanted to see public sector workers get pay increases and these would be determined by pay review bodies over the coming months.

The use of the wage-push inflation theory has come at a time when Boris Johnson and his Chancellor Rishi Sunak have stressed the “importance of fiscal discipline” following major public spending drives during the Covid pandemic.