06 01 2022

Is inflation really back?

Shakopee, Minnesota December 14, 2018 Around 200 Amazon workers, mostly of East African descent, protested outside their workplace in Minnesota. Shakopee, Minnesota December 14, 2018 Around 200 Amazon workers, mostly of East African descent, protested outside their workplace in Minnesota. https://commons.wikimedia.org/w/index.php?curid=98348092

Inflation is suddenly back in the developed countries, a phenomenon many thought was something that belonged to the past. A year ago, most central bank governors assured that this was an expected and transitory phenomenon as the developed economies returned to growth after the Covid induced depression in 2020. Now it looks not to be that transitory. So has inflation come to stay?

After many years of close to zero inflation, consumer prices rose in 2021 close to 5% in the EU and 6.8% in the US (as of November 2021). The rise was more moderate in China (2.3%) and Japan (0.6%). In other places prices are rising faster, as in Brazil (10.2%), India (4.9 %), Russia (8.4%), Turkey (around 30%).

There are different underlying factors explaining this rise in inflation. As oil and gas prices returned to a more normal level in 2021 after hitting rock bottom in 2020, energy is one of the driving factors (explaining around half the rise in prices in the EU and almost a third of the rise in the US). Other factors contributing are the disruption of the international supply chains during the pandemic, the US trade war against China, and higher international prices for food products (grain, cattle, sugar, coffee) and many raw materials (copper, nickel etc.). At the same time, the flooding of the economies with liquidity by the Central Banks has inflated property markets and stocks.

Some of these factors are indeed transitory. Energy prices will not continue to increase, but should rather level out or fall in 2022, the supply chains should gradually normalise and prices of food products and raw materials should stabilise. But there are some factors that will continue to be in play in the coming years and which depend mainly on politics and hence are difficult to predict.

The one that interest us here is globalisation, mainly the moving of production to low-cost countries and migration, both of which have slowed during the last couple of years. If this slowing continues or the process goes into reverse, it has potentially huge repercussions.

Inflation used to be an important concern since the last half of the sixties to around the mid eighties, when inflation subsided and typically was restrained to 1-4% per year in the EU and the US (Japan was an outlier with its negative inflation/deflation). The main factor explaining this phenomenon was the introduction of neoliberal policies and globalisation gaining pace since the mid-eighties (The Reagan-Thatcher revolution). The globalisation increased international competition, implying that companies lost part of their pricing power, and immigration together with policies deregulating the labour market, lead to more competition for particularly manual jobs, and hence weakened the negotiation position of workers. Trade unions came under pressure and lost important parts of their membership, and in many countries labour legislation was weakened to “increase competitivity”. Precarious jobs started to spread, including “zero-hour” contracts where the insecurity caused by the variations in a company’s sales was shifted to the workers, or even more radically the employer-worker relation was completely cut off as the workers were converted to 'independent' service providers (sometimes called the Gig Economy). This of course has also changed the distribution of income, both between labour and capital, but also within the labour force according to where the competition for the jobs was strongest. Unsurprisingly, this has particularly hurt the workers with the lowest level of qualifications as they compete directly with the immigrants. This is where we were before the US ex-president Trump initiated the trade war with China, now continued and intensified by the present US president. And before the Covid crisis.

Demonstrations and protests against McDonald's, London 2016. https://commons.wikimedia.org/wiki/File:Fast_Food_Workers%27_Right_Demo_at_McDonald%27s.jpg

The panorama has thus shifted in the last couple of years. Partly due to Covid, partly due to a stricter immigration policy, the flow of immigrants to the EU diminished in 2020 and 2021 (but seems to be on its way up again). In the US, the total immigrant population (defined as foreign-born population) fell during the Trump administration, but has now returned to a record level. Even so, due to the rebound of the economy and the natural decline in the labour force, there are complaints of “labour shortages” in the US, the UK and in some EU countries (e.g. Netherlands, Belgium and Denmark), and of course the usual claims from the employers to increase the import of workers to prevent wages from going up. However, there is an observable shift in the power relations in at least part of the labour market, as it is seen by the record number of people in the US quitting jobs with low pay and miserable working conditions, and it is possible that real wages will actually start increasing, including for the lowest paid jobs. The creation of a trade union in Starbucks in the US is historic, but as a similar effort at Amazon failed it may not herald new times – yet. However, to the degree that workers succeed in exploiting the change of the labour market from a buyer’s to a seller’s market, this will create an upward pressure on wages, and this will also to some extent translate into higher prices, but only to the degree that the companies actually have market power to do so. This will mean a reversion of the trend towards an increasingly unequal income distribution.

India is hoping to take advantage of the US trade war against China, shifting outsourcing from China to India. Here the first in-person meeting in the QUAD alliance in 2021. Yoshihide Suga (Japan), Narendra Modi (India), Joe Biden (USA) and Scott Morrison (Australia). https://en.wikipedia.org/wiki/Quadrilateral_Security_Dialogue

The other change is the slowing of the movement of production to low-cost countries ('off-shoring'), even if it is too early to talk about a reversion of the trend ('on-shoring'), and in the US the imposition of punishing tariffs on imported goods from China. The US tariffs may be one of the reasons that the inflation there is higher than in the EU (which has not taken a similar step against China). The movement of off-shore production from China to other countries (Vietnam, India, Bangladesh etc.), may also contribute to increasing prices. Even if salaries in China are higher than in these countries, there are enormous economies of scale in China, and incredibly well-organised supply chains within the country, that will be difficult to match elsewhere, even with lower wages. It is understandable that India has high hopes for this shift in the offshoring pattern, as they are increasingly assuming the role of a key US ally (among others with the 'Quad alliance' of USA, India, Australia and Japan), and India is also well situated to profit from the US anti-China policy. However, even if India has experienced an impressive growth during the last decade, it is much poorer than China (in purchasing power per capita around a third of China), and still beset by many bottlenecks in the supply chains (e.g. transport, energy, water etc.) that means it cannot take over seamlessly. To the degree that this change in the off-shoring pattern is forced through for political reasons it will also contribute to the upward pressure on prices.

So the conclusion is that, yes, it is possible that inflation has come back to stay in the developed countries, and — even if it sounds contradictory — this should be welcomed, as it is likely to be accompanied by new power relations between labour and capital. This will potentially pave the way for a better and less unequal society.

And by the way, the rising commodity prices are a boon for many developing countries, but that is another story.

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Thorbjorn Waagstein

Thorbjørn Waagstein, Economist, PhD, since 1999 working as international Development Consultant in Latin America, Africa and Asia.

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