From the blogs: Inflation and the gig economy

Inflation is accelerating again, but some think the ‘gig economy’ will hold it back

Reports of his death, said Mark Twain famously, had been exaggerated. It could now be a similar story for global inflation, which has been dormant for so long that many hoped it was gone for good. But in 2017 the beast seems finally to be stirring. UK inflation has risen to a two-and-a-half year high of 1.8% per year, caused by rising food and fuel prices. Meanwhile German inflation is spiking, reaching a 4 year high of 1.9% in January. In the US the December inflation figures exceeded the Federal Reserve’s 2% target for the first time in over two years, while China is also seeing a return of inflationary pressure: consumer prices rose by 2.5% while producer prices surged by nearly 7% in January.

The causes of inflation in these different countries are not the same. In the UK, it is largely the result of the Brexit-induced devaluation of sterling. In Germany and China, it is mostly about a rise in energy and raw material costs. These should be temporary, largely one-off, factors. However, there is also a common thread: they are all evidence of an increase in global growth, particularly in manufacturing, while economies are gradually approaching full output. In such an environment, inflation is to be expected. But how far it increases and how long it lasts depends on many factors, particularly the response of central banks and wages.

Source: Carmen Reinhart, Project Syndicate.

Carmen Reinhart, a professor of international economics at Harvard University, highlights that if IMF forecasts prove correct then 2017 will be the first year since 2010 in which no major economy experiences deflation (see chart). She thinks there are two potential factors which may mean that inflation persists this time. First, that central banks, conscious of deflationary pressures since the 2008 crash, are unlikely to tighten monetary policy soon. As she puts it:

“If 2017 really does mark a broad reversal of a decade of deflation, it is reasonable to expect that most major central banks will be not be inclined to overreact if, after a decade or so (longer for Japan) of mostly downside disappointments, inflation overshoots its target.”

The second is that central banks might tolerate higher inflation or even raise their inflation targets (a view that is increasingly popular among academics) so as to make monetary policy more manageable in the post-quantitative easing era. Crucially, the existence of very high levels of public and private debt means the case for a higher, sustained level of inflation is stronger than it has been for a long time. This is because higher inflation will erode the real value of those debts. If Reinhart is right, this bout of inflation will last longer because central banks will let it, seeing benefits for the wider economy.

Meanwhile in Europe, Dieter Wermuth, a German economist and banker, sees German inflation staying above 2% for 2017, a welcome sign that the Eurozone economic recovery is gradually gathering momentum. But in the labour market he sees no major signs of significant wage increases, with unit labour costs rising by only 1.2%. Because of this, and the weaker inflationary pressures in the southern European nations, he doesn’t think that inflation will be sustained for very long.

A similar pattern can be found in the US. Dan Crawford, of the Angry Bear Blog, analysing trends in wages, doesn’t see much prospect of increases in real wages in the US soon. Recent increases in real wages were to do with falling gas prices, he thinks, and won’t be repeated. He argues that since the financial crisis there has been a weakening in the power of workers to command higher pay:

“…there has been an undeniable slowdown in wage growth, which was 4-6% in the late 1990s peak, 3-4% at the 2000s peak, and so far in this expansion is no better than 2-3%. I believe this is in part due to how weak the employment situation was for so long into this expansion, but also secularly due to shifts in bargaining power, as employers learn over time that employees can be retained with lower and lower annual increases in compensation.”

In other words, employers and employees have got very used to low pay increases – it has become normal – and that will act to prevent wage pressures from creating renewed bouts of inflation. The same pattern is visible in the UK where, despite low unemployment and decent economic growth, wage increases are still subdued.

Another part of the explanation for this might be recent changes in the labour market: the rise of self-employment, part-time and zero hours contracts – the so-called ‘gig economy’. These workers, in insecure work and often paid very poorly, even if they do win a few concessions in court cases, are not going to be in a position to demand higher wages any time soon.

As Ben Chu, writing in the Independent, puts it:

“The headline unemployment rate might be close to a record low, but the rise of gigging, the explosion of zero hours contracts and chronically weak pay growth, gives this the feel of a market still very much skewed towards the buyer of labour rather than the worker. And this, in turn, suggests that there remains disinflationary slack in the economy.”

On this argument, since the last reflationary cycle of 2003-2007 the labour market in many Western countries has changed. The rise of self-employment, small business ownership, zero hours contracts, and the normalisation of pay freezes have all weakened the bargaining position of workers with respect to employers. That suggests the economy can tolerate a lower level of unemployment than before without generating inflation. If this is true, then the outlook for inflation depends on whether the determination of central bankers can outstrip the recent weakness of the labour market. And, of course, the great imponderable of whether the Trump Administration will win Congressional support for a major reflationary package of tax cuts and spending increases.

Edited by Bill Emmott