This weeks blog is an article by NERI Co-director, Dr. Tom McDonnell from the Irish Examiner on Monday 18th April, 2022.
Cost of living pressures are creating almost daily demands for wage increases and other measures to relieve the burden on households. So what happened during the last period of high inflation in the 1970s and 1980s?
Inflation during this period was driven by the twin oil crises of 1973 and 1979. The cost of living increases lead to significant industrial unrest in the 1970s. The Central Statistics Office compiled real earnings data for the period 1938 through to 2015 and as it turns out, national earnings in industry increased by an average of 18.1% a year through the 1970s. When inflation is removed real earnings increased by an impressive average of 4.8% a year through the decade.
However, real earnings fell by 4.5% between 1980 and 1982 as the economy went into recession after the 2nd oil crisis. Real earnings growth eventually ended up at a modest 0.9% in the 1980s. Social partnership in the 1990s then lead to a period of moderate but consistent wage growth that was at least implicitly linked to price inflation and labour productivity.
Cost of living crisis
We are highly unlikely to experience sustained price inflation as extreme as the 1970s and 1980s. Energy is a smaller component of the economy, while inflation expectations and labour market dynamics are very different. Indeed, the NERI’s projection prior to the invasion of Ukraine was that high inflation would prove transitory as the supercharged Covid economic cycle played itself out, as supply and demand pressures in energy markets normalised, and as global supply chain pressures were gradually resolved.
The outlook is now of course very different. The price of energy products is up 44% in the last year and the Consumer Price Index is up 6.7%. Price inflation averaging close to 7% this year and then a further 4% to 5% next year might be a reasonable baseline, although we must acknowledge that current projections are clouded by very high levels of uncertainty.
Real incomes are likely to fall for most households this year. This will put particular pressure on low income households as these groups must spend all or almost all of their incomes on consumption goods. They already do not have sufficient incomes to save for the future. In addition, lower income households are on average disproportionately hit by the cost of living crisis as they spend a higher portion of their incomes on the type of necessities that are experiencing the sharpest price increases. We will see a significant rise in poverty and deprivation rates this year without meaningful policy interventions from government.
On the other hand, higher income households built up significant savings during the pandemic with aggregate household deposits rising sharply and accumulated net savings amounting to €24.5 billion according to the Central Bank. Many of these households can absorb the hit to their real incomes by reducing their rate of savings. Such households do not need fiscal support from government and are unlikely to experience deprivation. Government should directly help low-income households with targeted income supports, while higher income households should look more towards wage increases.
More universal measures such as free public transport could help address urban cost of living pressures while simultaneously supporting our carbon reduction targets. The political economy of this is obviously difficult as rural households would not benefit. Medium term measures to reduce the cost of living ought to focus on areas where Ireland is particularly out of line with other countries, for example via subsidies for childcare and via measures to directly increase the supply of affordable housing.
Wage increases
There have been a number of calls in recent weeks for workers to temper their wage claims and not to trigger a wage price spiral via higher wage demands. However, it is unreasonable to expect workers to passively accept a decline in their living standards. A tight labour market should enable workers in most economic sectors to achieve significant nominal wage increases this year and next.
Real outcomes will vary significantly from sector to sector and there is a strong rationale for government to develop European style collective bargaining and wage setting infrastructure to enable both employees and employers to exit the crisis as strongly as possible.
Finally, the disproportionate impact of the cost of living crisis on low wage workers points to the need for an increase in the national minimum wage. The government has committed to raising the national minimum wage to the level of the living wage during its term in office. The living wage is likely to increase by somewhere in the region of 7% this year. This should represent the floor for the next increase in the national minimum wage. In addition, the timing of the next increase should be brought forward to the Summer in order to protect low income workers as soon as possible.