Bank of England, Aug 2009. Bank of England, Aug 2009. Source: lhongchou's photography - Flickr / cropped from original / shared under license CC BY-NC-ND 2.0

Dominic Alexander argues that state policy is economics as apologetics for capitalist interests whose central aim is to attack working class living standards

So the state is evidently prepared to engineer a recession in order to deal with inflation. The Chancellor, Jeremy Hunt, agreed that he was comfortable with the Bank of England raising interest rates yet again, as the only way to tackle inflation and restore ‘stability’ to the economy. Moreover, he claimed he had to make the ‘very difficult decisions to balance the books so that the markets, the world, can see that Britain is a country that pays its way.’

Consciously or not, Hunt was echoing what Huw Pill, the chief economist of the Bank of England said almost a month ago that we all just have to accept that price rises will hit our living standards, and accept that we are worse off. The message is therefore that wage ‘restraint’ and austerity are the only answers. Lurking in these comments also is the false notion that the nation’s finances, its ‘books’, work the same as a household: ‘Annual income 20 pounds, annual expenditure £19, 19s and six pence, result happiness. Annual income 20 pounds, annual expenditure 20 pounds ought and six, result misery,’ as Dickens’ Mr Micawber had it. But a national economy is not a zero-sum game in the same way, nor does it scale down to each individual household in the mathematically even way that Hunt and Pill’s reasoning presupposes.

Worse than those hidden assumptions is the ideological fixation on wage suppression as the solution for persistent inflation. This is founded upon the further assumption that it is ‘excess’ demand which is the main factor driving the problem. For business, the cost of labour usually appears to be the largest current expense, and therefore is always the cost to be cut, although appearances are never the underlying reality in capitalism. Since inflation has been persistent, with core inflation even rising in April to 6.8% from 6.2% in March, then if your operating assumption is that ‘demand’ must still be too high, despite previous rises in interest rates, then the conclusion inevitably follows that interest rates must rise again in order further to supress demand.

Wages are not driving inflation

And yet, the evidence is that excess demand is not the problem. For many millions of workers, pay has been slipping inexorably and dangerously behind the rising costs of essentials like food, for which inflation is over 19% to March 2023. It is true that the cost-of-living crisis is not evenly spread. Phillip Inman, writing in the Guardian attributes the rise in core inflation as being ‘being driven by business services – which includes workers in finance, accounting, legal, marketing and advertising. This category experienced wage inflation of 8.8% in the three months to the end of March, according to the latest ONS figures’.

In other words, there is a stark class differential at work; better-paid middle-class employees are getting substantial rises, while NHS workers and many others are being pushed into reliance on food banks. Nonetheless, wage rises of 8.8% are still significantly below inflation, so better-paid employees are also facing a fall in their standard of living. Since most such people will have mortgages, the rises in interest rates will be hurting them too. It doesn’t add up to a convincing picture of excess demand underpinning continued inflation.

Food inflation is one of the most socially damaging aspects of persistent inflation, but apparently, again according to Phillip Inman, Andrew Bailey, the governor of the Bank of England has ‘failed to commission any in-depth research from his 4,500 staff about the reasons for the particularly sharp inflation in food,’ and nor has Hunt done any better. Evidently, the wellbeing of the millions of the lower-paid in this country are of negligible concern to such people. Even so, if they want to control inflation for the supposed good of the economy as a whole, they need to understand the causes properly, rather than bashing away randomly with the indiscriminate club of interest rates.

Where there are in-depth analyses of inflation, it becomes clear that demand is not the problem that needs to be tackled. Philip R. Lane, a member of the Executive Board of the European Central Bank, in March this year attributed ongoing inflation to the ‘reverting component’; that is the passing on of costs from one sector to another. His list of such instances puts the emphasis on supply-side problems: ‘the passthrough of energy and food cost shocks to other sectors; the impact of bottlenecks; and pandemic re-opening effects by which there are temporary mismatches between demand and supply in contact-intensive sectors.’

Although there were expectations that these effects would have subsided by now, he warned that ‘the adjustment process to these shocks is still ongoing and is not likely to come to a sudden stop.’ Lane notes that in fact in Europe, ‘the real value of compensation per employee declined around 5 percentage points below the 2021Q1 level’ in the following year. Despite this fact, Lane concludes that the ECB will have to make further interest-rate rises to deal with inflation. Observation: the cause of inflation is supply-side not demand-side. Conclusion: to deal with inflation it is necessary to further impoverish people. With logic like this, it’s no wonder people find economics to be a difficult science.

Ideology trumps evidence

Michael Roberts points out a similar mismatch between evidence and conclusions in a paper by two economic heavyweights, Ben Bernanke, former Federal Reserve chief and Olivier Blanchard, former chief economist at the IMF. Their headline argument is ‘that the inflationary spike in the US since the end of the Covid pandemic slump was down to a sharp rise in “aggregate demand” and not due primarily to supply blockages and weak productivity recovery in key sectors’. Yet, at each stage of their detailed analysis, the evidence shows that ‘excessive wage demands played no role in raising inflation – on the contrary.’

The ideological insistence that wage rises are behind inflation clearly has to do, not with the rigorous analysis of evidence, but the present class context: ‘What B[ernanke] &B[lanchard] want to push though is that now in 2023, attempts by workers to compensate for huge price rises hitting their real incomes by using their bargaining power in “tight labor markets” will cause inflation to stay high’, even though their evidence contradicts their political conclusion. This is economics as vulgar apologetics for capitalist interests, and as a stick with which to beat back an increasingly militant, organised working class. In the context of rising class struggle, the orthodox answer to tackling inflation is no more than a weapon in the class war.

The further problem is that if excess demand is not the cause of inflation, then suppressing demand further through raising interest rates will not cure the disease, but will make the situation worse by forcing economies into recession. Since the same situation with the same answer is arising in the UK, Europe and the US, such a recession is unlikely to be limited or mild. Given the already dangerous levels of social harm being caused by the cost-of-living crisis, a rise in unemployment through recession doesn’t bear thinking about. However, that is the goal of classic Keynesian demand management: raising interest rates pushes unemployment upwards, thereby reducing inflation, and rebalancing the economy. This approach fell apart in the 1970s, and it seems clear it will not solve the currently entrenched crises of capitalism.

Economic planning needed

The case of food inflation suggests some directions in which to look for a different solution. The spike in energy costs was clearly the original cause of food-price rises, but since energy costs have come down, then why has food-price inflation been so bad recently? Part of the blame is being put on the climate emergency, with shortages of salad foods blamed on droughts in Morocco, the price of potatoes on the impact of last year’s heat wave in Britain, and the current cost of sugar on poor weather in Europe, and extreme heat waves in India and elsewhere in Asia. Additionally, sugar is being diverted to ethanol production by producers such as Brazil, which has to do with high energy costs. However, processing, packing and logistical costs are also part of the problem.

Moreover, as it did back in 2010, financial speculation is having a big impact on prices, and since it’s expected that there will actually be a world surplus of sugar by the end of the year, it is not absolute shortage which is the problem. The problem with food prices is one of distribution and market effects as much as climate chaos. With the shortage of salad crops in Britain, one answer would have been for British suppliers to increase production, but this didn’t happen because they didn’t wish to incur the associated energy costs. All these problems call out for direct state intervention into production in order to secure affordable food supplies, something which will become more urgent the worse the climate emergency becomes.

There is also an argument that corporate efforts to restore profit margins, otherwise known as ‘greedflation’, are not really to blame for the persistence of inflation since it is normal behaviour for firms to raise ‘markups in the present to smooth price increases they expect in the future’. In other words, nothing should ever disturb predictable profit-making; like many forms of privatisation, the private sector gains the profits, while the public is required to shoulder all the risks and the economic pain.

The injustice of the government’s orthodox approach to inflation management ought to be abundantly clear. The inflation crisis has revealed the blatantly dysfunctional nature of the economy, while orthodox economic policy carries on prioritising profitability above the basic well-being of the population. Even worse, given that interest rates look likely to rise in the US as well as the UK and Europe, there is surely a grave risk that the banking crisis of March this year will reignite, and bring about something like a 2008-scale crisis once again.

The answer to all this is not to stick to conventional economic policy, founded upon the assumption that capitalist markets will return to an equilibrium without excessive pain; this was partly true in the supposed golden age of post-war capitalism, but it is certainly not true now. The system is in a deeper crisis than can be resolved through the tinkering policy of ‘demand management’. What is needed is large-scale and precise state intervention into the productive structures of the economy; not just top-down quantitative easing in the vein of policy from the 2008 crash to the pandemic, but interventionist planning to relieve supply problems, to invest in areas like green energy, and the resilience of food supplies. We need detailed planning to ensure that the economy can actually meet the needs of people, rather than just the interests of capital.

Before you go

Counterfire is growing faster than ever before

We need to raise £20,000 as we are having to expand operations. We are moving to a bigger, better central office, upping our print run and distribution, buying a new printer, new computers and employing more staff.

Please give generously.

Dominic Alexander

Dominic Alexander is a member of Counterfire, for which he is the book review editor. He is a longstanding activist in north London. He is a historian whose work includes the book Saints and Animals in the Middle Ages (2008), a social history of medieval wonder tales, and articles on London’s first revolutionary, William Longbeard, and the revolt of 1196, in Viator 48:3 (2017), and Science and Society 84:3 (July 2020). He is also the author of the Counterfire books, The Limits of Keynesianism (2018) and Trotsky in the Bronze Age (2020).

Tagged under: