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  • Dr Gerard Lyons

Crisis, what crisis? Is there a cost of living crisis?

Updated: Sep 25


Crisis what crisis?


Gerard Lyons

Midday, 25th September, 2021

A short essay on the present economic situation in the UK.


Not the Seventies


‘Crisis what crisis?’. Perhaps these are among the most famous words attributed to a Prime Minister, although never actually said. The press attributed them to Jim Callaghan during the winter of discontent in 1978-79, and while they were never actually uttered by him that really didn’t matter. They caught the mood of the moment.


I remember that winter well, being in the sixth form at school. One abiding memory was watching a rubbish tip appear outside the school gates and then continue to grow and grow as bins were not collected, and people deposited their waste wherever they could. As bad as that cold winter was, with ubiquitous strikes in 1978-79, it was nothing compared with the three-day week of 1973-74.


Then the country was gripped by an energy crisis that had already triggered power outs over the winters of 1972 and 1973. By December 1973 Ted Heath introduced a three-day week, limiting the number of days factories could open. In turn 1974 witnessed two elections, in February and October, as the energy crisis triggered a political crisis.


One memory I have from the 1972-73 winter was when, for a number of weeks, our coal fired school building had to shut and there wasn’t room to accommodate us fully in the new modern building across the road so we, as first years, attended school for only one day a week. It was less blissful than one might imagine; central London then appeared more akin to drab eastern Europe.


If what the economy is experiencing today in 2021 is not like 1978-79 it is certainly not like the early ‘70s either. Yet, there are many who forecast that events now, and how they may unfold over this winter, justify comparisons with the seventies. If one is looking for comparisons perhaps it is rising inflationary pressures, albeit even these are not on the scale by any measures of what we saw in the 1970s. There is also a pervasive element of unions causing disruption as we emerge from the pandemic, just one example reported in the media is in the slow processing of HGV licenses, but even this is not on the scale of the 70s.


Today’s economy is in a very different position but the aftermath of a pandemic is triggering havoc across the globe and how short-lived or prolonged the outcome is will be heavily influenced by the policy response today. Thus, although the current situation could get worse, it is premature to make such historical comparisons.


A cost-of-living crisis


Today’s supply shortages should be short-lived. The bigger worry is a cost-of-living squeeze over this winter. Whether this evolves into a crisis remains to be seen.


The last major one of those was about a decade ago when, in the wake of the 2008 global financial crisis, sterling fell, triggering a temporary period of higher inflation that exceeded wage growth and squeezed living standards. This time, though, it is not just higher inflation, but the aftermath of the pandemic that is hitting the economy hard.


The economy is already facing the challenge of higher taxes over the next year - including higher corporate taxes, a freeze on income tax thresholds and the recent rise in national insurance. Now, exacerbating the impact from these, is a fresh triple whammy of: supply chain problems that look set to push prices up and trigger rationing with firms and people waiting longer for items; energy costs that are already rising; and higher inflation as the Bank of England fails to take action.


Let’s consider each of these issues in turn, and the likely policy responses.


Supply shortages


First, is the supply shortage and distribution challenge because of the shortage of HGV drivers. Importantly, this is a worldwide problem facing a number of countries, including the US and a number on the Continent, particularly Poland and Germany, but also across Italy and Scandinavia.

Consequently, while Brexit may have somewhat exacerbated this issue and fed uncertainty, the impact of this is overstated and the current state of play is not simply a ‘Brexit effect’.


To blame it on Brexit, as some are, thus risks misdiagnosing the problem and reaching wrong conclusions about how to deal with it.


Moreover, many of these shortfalls among drivers were being talked about here and elsewhere over the last few years, not just recently.


It should be a temporary problem if addressed efficiently. It is the result of a host of factors including disruption from the pandemic liming the number of drivers that could be trained and more drivers leaving the industry over the last year. Some of these may have left because of Brexit but this is overwhelmed by other factors given it has happened in other countries. It may possibly be because of the fear linked to the increased risk of exposure to the virus. It may be demographic as well, as older workers left without being replaced quickly enough. Above all, though, it is wage related. Wages are low. Transport costs are squeezed by keeping costs down, particularly wages.


The immediate economic implications of this shortage are: higher prices and the need for rationing, or a combination of the two. Because the shortage of drivers has spread to the distribution of petrol there may be some disruption in the wider economy, including deliveries and in rural areas.


Costs will rise, and as with other higher costs, firms will seek to recoup their margins. In short, rising costs will lead to more broad-based price pressures.


It also will lead to rationing, in the sense that people will have to wait longer to get hold of something or shops may even limit how many items people can buy. This issue could be compounded if there is further panic buying as, for instance, has happened at petrol stations. Although, as we saw in the early stages of the lockdown, this impact can soon pass, either because supplies are rationed, or people just stop panic buying.


Policy to address supply blocks


What’s the policy response? Attracting more workers to fill the shortage is needed.


- Higher wages would be an immediate help but whether they become a lasting necessity is harder to say. At least it is one answer to attract drivers or workers now who have the skills back into the industry.


- Speeding up the process for people to train as HGV drivers is a necessity. A medical test, followed by a theory test and five days to train can be followed by a wait, it seems, of up to eight weeks. This wait, surely can be reduced, with the relevant government department fast tracking the process. This surely would be the obvious issue to sort and the question should be asked whey it has not been addressed already?


- Also is the option that the government has already opted for, namely granting temporary visas to attract foreign workers to address the immediate challenge,. The government has opted for 5,000 visas, which given the scale of the shortfall of drivers, suggests this route is not being seen as the permanent solution - after all there is a shortage of drivers across western Europe. Rather it is aimed at getting the UK out of the present shortage by filling posts immediately.


The general commentary suggests that this number can be filled quickly, but let's see. Of course it is not clear whether any more than this would be attracted in the face of uncertainty about the pandemic and also attracting such workers would likely still to have to go hand in hand with higher wages. In the past hauliers have, it seems, used foreign workers as a way to suppress wages and keep costs down. That is not sustainable.


The UK’s immigration policy should focus on attracting to the UK the workers we need – if that includes HGV drivers fine – but this should not be a substitute for the need to train and invest in workers at home, or to pay them sensible wages.


More slack and spare capacity


A longer lasting lesson links into an issue already evident since the pandemic began, namely the need to build more slack and redundancy into supply chains. Prior to the pandemic, ‘just in time’ was the main driver in supply chains, helping keeping costs down, but a consequence of this was little spare capacity in the event of a shock.


Now, the need to increase resilience by having more spare capacity is evident, but this will add to costs. It also feeds into the current energy issue in the UK.


Gas prices


The second immediate challenge to the cost of living is the upward pressure on gas prices. Gas prices are soaring. This is a global problem, too. But the full extent to which prices rise – and how it plays out in countries - depends on a number of national factors, such as the energy mix and other interventions such as the impact of the price cap in the UK.

With petrol prices we are more accustomed to price moves, reflecting global influences. While the energy we use at home can be similarly impacted by global demand and supply, we are far less accustomed to fluctuations or large swings in such prices.


Interventions such as price caps distort the market – although it is important to appreciate that a factor behind its introduction was the inability of suppliers to reduce prices to customers when wholesale prices fell. Unlike on forecourts, there was not sufficient competition among the suppliers. Ensuring competition and that the market mechanism works properly is the best way to protect customers. When it doesn’t, and then policy resorts to price interventions, it can often trigger unintended consequences, as we are seeing now. Indeed, the cap perhaps gives the misleading impression of price rises being limited as opposed to just delayed, in turn not preventing fuel poverty as energy costs squeeze peoples’ spending power especially those on fixed incomes and also leads, as we have seen, to suppliers going bust.


The fallout has been compounded by smaller suppliers selling gas contracts below the price cap to then be caught out as prices rise. These firms had either not bought sufficient gas in advance when prices were lower to meet their commitments or did not hedge their exposure. When they make money they keep the profits, but when as now they lose money it appears they push for the government (and thus the tax payer) to bail them out. Customers need to be protected, not the suppliers, which is the approach the government is taking. After this episode an issue to consider is whether keeping or getting rid of the price cap would allow the market to operate more efficiently, helping customers. It does not protect people from the global reality, as seen with it set to rise 11% now and by another 17% next spring.


Also, this episode has highlighted the problem with the UK energy mix – France, for instance, has a higher nuclear mix – the UK has a high proportion of wind, and while this is very welcome in many respects, the base load of wind can be low meaning, as we have seen recently when apparently it has been less windy, it may be not as reliable. It also feeds into the need to build more capacity into the energy supply chain, too, as this leaves us less exposed to shocks.


We need more stocking of spare capacity to cope with shocks. It has been said that storage suppliers were not stocking this spare capacity now, presumably because of cost or poor planning. Energy infrastructure, and base load and spare reserves used to be seen as an important necessity of our strategic planning as a critical NATO member. Now, it seems, our reserves are low for the economy, never mind strategic defence.


The immediate impact of higher energy costs, though, will be to squeeze disposable incomes, and limit the ability of people to spend, thus having a wider negative impact across the economy.


The third whammy

This challenge, though, is compounded by the third shock: rising inflation pressures. Whereas the US Federal Reserve has communicated with the markets with a way in which the Fed is now seen as ahead of the curve, in the City the feeling is that the Bank of England is reacting to events. Communication as well as actions are key. Balancing worries about growth and about rising inflation pressures are not always straightforward but the Bank has been taking risks as inflation builds.

At its latest policy meeting, the Bank of England voted unanimously to keep interest rates unchanged at 0.1% and voted 7-2 to continue to provide liquidity via asset purchases, or Quantitative Easing. Inflation pressures are building and the Bank has not taken action to address this. I have advocated action involving not tightening via higher rates but tapering via via halting and possibly reversing asset purchases. It is not just inflation risks that are building, but financial stability ones too.


If they are not careful central banks are feeding financial instability. Close to zero policy rates mean markets are not price properly for risk while large-scale quantitative easing means the biggest buyers of government debt are the central banks who are non-commercial buyers. This is distorting bond yields.


In conclusion


So, comparisons with the wider economic problems of the 1970s may be wide of the mark. The economy - now heavily focused on services - is very different. But we do face a rising cost of living challenge and this needs to be taken seriously. On top of that, taxes are set to rise next spring too, further curbing discretionary spending.


What is the message? Take action as noted above to address each of the specific challenges on driving shortages, energy and inflation. Market solutions will help deliver the answers. Moreover, in coming months there is an even greater need to provide the public with some context regarding what is happening, to help them understand and plan ahead themselves, and trying to ensure that they retain confidence about the outlook that lies ahead. Perhaps this may be a trigger to revisit some of those planned tax rises too. The government needs to take actions to address the immediate challenges but they need to bring the people with them to understand the longer-term solution.


END