It’s back to the Seventies, and this time we haven’t a Thatcher to handbag inflation
‘Inflation is threatening to destroy our society. It is threatening to destroy not just the relative prosperity to which most of us have become accustomed, but the savings and plans of each person and family and the working capital of each business and other organisation. The distress and unemployment that will follow unless the trend is stopped will be catastrophic.”
In 1974, Sir Keith Joseph made three great speeches to launch the Centre for Policy Studies, the think tank I now run — and, more importantly, to invent what became known as Thatcherism.
What is hard for us to understand, now that Thatcher has passed into myth, is the extent to which that cause was above all a crusade against inflation. In the 1970s and into the 1980s, inflation was the dominant evil of British life. It wrecked the economy. It triggered the Winter of Discontent. And, as the historian Dominic Sandbrook points out, “The costs fell most heavily on people who could ill afford it — the poorest, the elderly, those living alone.”
That is why Joseph devoted the speech entirely to inflation. It is why Thatcher accepted unemployment in the millions as the price of curbing it. It is why the central mission of the modern Bank of England is to keep it under control.
And now it is back.
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As happened with the Yom Kippur War in 1973, a military conflict has spread to the energy markets — and sent rising inflation supersonic. I mentioned last week that gas prices had risen tenfold in 12 months because of the one-two punches of Covid and Ukraine. But all kinds of other prices are spiking, too. Grain, fertiliser, shoes, clothing, metals. Inflation is predicted this year to rise from the present 5.5 per cent to at least 8 per cent. As a result, the CEBR consultancy predicts that UK growth will be halved this year and vanish completely in 2023.
Money people spend on energy is money they don’t have for other things. Increased costs to firms, whether in raw materials or energy bills, eventually have to be reflected in the prices they charge. Consumer-facing businesses are already seeing orders falter as customers grow nervous.
Worse, inflation does not just reflect rising prices, but causes them. All sorts of spending automatically rises and falls with inflation — pensions, rent agreements, benefits, mobile phone contracts, repayments on government debt. Such costs will keep feeding into the economy, and public finances, long after the initial price shock. For example, many defined benefit pension schemes find themselves with cavernous deficits as payments increase while share prices crash.
The prime minister has admitted it will be a “bumpy period” for the cost of living. Which is a little like saying the Hindenburg ran into some minor turbulence. “The economic and fiscal outlook is deteriorating by the day,” one Treasury source warns.
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In many ways Britain is far better placed to cope with an inflationary surge than in the 1970s. Inflation is still in the single digits. We no longer have all-powerful trade unions who can march into Downing Street to demand eye-popping pay rises. Our economy depends much less on physical goods and much more on ideas.
But in one big way we are more vulnerable. The textbook cure for inflation is to wring it out of the economy (note the pain implied in that verb) with higher interest rates. But our prosperity floats on a sea of cheap money. Raising rates will be extraordinarily tough, especially for anyone in debt, such as mortgage-holders and governments.
So what can Rishi Sunak do when he stands up next week to deliver his spring statement?
The natural response of any chancellor, faced with this many voters facing this amount of pain, would be to throw money at the problem. The trouble is that government spending is one of the main ways to fuel inflation. That’s what happened in the 1970s. And it’s what has happened in the US, where both Joe Biden and Donald Trump spent trillions of dollars by writing cheques to ordinary Americans as a Covid stimulus package. Chasing inflation by further stoking demand risks turning a dose of economic food poisoning — painful but temporary — into a chronic infection.
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The most immediate problem in Britain is not a new spending splurge but the fact that the chancellor is still ready to pile an extra £12 billion on to national insurance next month — a double whammy on voters’ pockets.
Those around Sunak defend this by pointing out that the money is needed to pay for the NHS backlog, and voters will deliver a harsh punishment for a collapsing health service. They also point out that the top 15 per cent of earners will pay half of the increase, so cancelling it would be a tax cut for the rich. (Actually it would be a tax not-rise.)
But the chancellor is under pressure to ease the pain in other areas. As Tim Shipman reports today, that might include a cut to fuel duty, perhaps accompanied by measures such as removing the £153 green levy on energy bills or extending the scope of his £9 billion rebate scheme.
Our preference at the Centre for Policy Studies would be to scrap the NI rise completely. But if the chancellor isn’t going to do that, there is a solution sitting under his nose. The 2019 Conservative manifesto, inspired by one of our reports, included an aspiration to let people keep £12,500 of their income before paying national insurance, matching the threshold for income tax.
This idea was swiftly dumped when the pandemic came along, not least because the Treasury didn’t like it. But as a new paper of ours will show, you could completely protect the average worker from the NI rise — and actually cut taxes for those on lower incomes — by raising the starting point for paying NI by roughly £1,250, at the price of sacrificing about a third of the extra revenue.
It wouldn’t be a panacea: the wealthy would still pay far more, as would employers. But at least it would mean that the government was no longer actively compounding the inflationary horror for those on low and middle incomes.
Whatever he decides to do, Sunak, and by extension Boris Johnson, faces an awful choice between compassion and prudence. But ultimately there is only one path to choose. As Joseph warned his fellow Conservatives in 1974: “If we recognise the nightmares which galloping inflation brings, we can abate it.” If we do not, “all other social and economic objectives will be lost”. Those words are still true today.
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