Timelines differ, but similarities to the 1970s indicate a potential return of stagflation. There are differences, including the aggressiveness of the unions, the power of public opinion, the degree of indexation and an independent Bank of England. Private sector unions are less aggressive today, but the few skilled workers are more powerful. Public sector workers enjoy popular support.

For years wages barely kept pace with prices and real wages stagnated. Cheap labor is gone. When workers recoup the real income lost without equal increases in productivity, firms either raise their prices or go bankrupt. Retirees and government beneficiaries will demand inflation protection. Hence stagflation.

Between 1973 and 1974, an oil shock transferred income to Arab oil producers with high savings. The rise in prices reduced the real national disposable income of importers, affecting global demand and production. The Covid-19 caused a global supply shock pushing up prices.

The 1971 Nixon shock triggered the collapse of the Bretton Woods system and the British pound was introduced in 1972, easing fiscal and monetary discipline in the UK. The float today eliminates fears of a forced devaluation, even if the pound still counts.

Fiscal lavishness in the 1972 budget’s “race for growth” led to Barber’s short-lived boom, fueled by monetary laxity as a result of competition and credit control reforms. The pandemic has created a huge budget deficit. Quantitative easing and sub-zero interest rates have been ubiquitous since the 2008 financial crisis, distorting markets, financing asset price inflation and dramatically increasing inequality.

The UK joined the then European Economic Community in 1973 and Brexit came in 2020. The first had less immediate impact than the second.

Stagflation was brewing before 1970, but not 50 years later. Inflation was already 6% when the Heath government was elected, with an unemployment rate of 3.75%, representing 800,000 people looking for work, inexorably reaching the politically disturbing threshold of 1 million and in the end. -of the. 2020 was preceded by years of tame inflation in the prices of goods and services

The pandemic and the lockdowns have devastated real gross domestic product. If and when GDP returns to its 2019 level, there will always be permanent losses unless growth accelerates. Household income and profits have been temporarily protected by budget deficits, but support is now removed. Price inflation is accelerating. Everything now depends on whether this triggers a full-blown wage-price-pension-tax-pound depreciation spiral.

The primary division of income, between labor and capital, is essentially determined by market forces and is the springboard for wage-price inflation. The secondary division, taxes and transfers, is led by the political forces. There are clear differences here compared to recent years.

The mistaken austerity of the Cameron-Osborne government will not be repeated. The pressure to increase public spending is overwhelming. Cuts can be made to some social security benefits, such as removing the temporary £ 20 universal credit increase and easing the triple lock-in on pensions. But the benefit inflation recovery rate (R) will remain close to unity. As the share of taxes increases to cover higher expenses without borrowing, the R board will also be close to unity.

Firms are unlikely to ultimately be able to recoup all increases in wages and input costs from higher prices. It will be somewhat offset by a drop in employment, both in staging and in flat. But general increases in costs in a weak monetary environment are much more easily passed on.

The story of the recent docile wage inflation has led many commentators to blame today’s faster increases on labor shortages. One newspaper even reported that the Bank of England believed this reflected labor market pressures from the rapid pick-up in demand. This is more likely to reflect longstanding flaws in education and training. In the early 1960s, 22 universities were awarding university degrees. Only 4% of school leavers attended them. Technical colleges offering specific trades and professional skills have multiplied, as have apprenticeships (35% of school leavers). Many polytechnics have become universities, which now number 140 and accommodate 50% of students who leave school.

With the supply of cheap labor reduced by Brexit and the increase in the skills premium, it is no longer realistic to expect real wages to stagnate or fall. Combined with the business environment, R in the market economy is likely to equal or exceed unity. Moderation in the non-market economy is unlikely to compensate.

In the 1950s and 1960s, the wages of coal miners steadily rose from above to below average, leading to strikes in 1972 and 1974. These cannot be repeated. Public sector strikes, work to rule and go slowly, as in the winter of discontent, are predictable.

It will be impossible for the Bank of England to promote inflation through continued monetary easing. The Bank is holding back the fire for fear that a premature tightening could cause a crisis and delay the recovery. He claims that the inflationary surge will be transitory. The crisis will be greater and the collapse deeper when he is forced to act. Coming from distorted markets and inflated asset prices, a financial crisis greater than 2008 threatens.

Brian Reading was economic adviser to British Prime Minister Edward Heath and the first economic editor of The Economist in 1972. He is a member of the advisory board of OMFIF.

This is the second part of a two-part series. The first part can be found here.