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10 March 2023

Public sector pay rises would not drive inflation, say leading economists

Christopher Pissarides, the Nobel prize-winning economist, says the government is misrepresenting the effects of pay rises.

By Will Dunn

A group of senior economists, including the Nobel laureate Christopher Pissarides, has published a paper which concludes that rises in public sector pay would not prolong or increase inflation, even if they matched the 10.1 per cent rise in the consumer prices index.

This rebuts the claim made by Rishi Sunak in January that raising the pay of nurses and teachers would lead to a “wage-price spiral” in which higher pay increases the cost of providing goods and services, which causes prices to rise still further, meaning workers ask for still higher pay. That claim was echoed by Andrew Bailey, governor of the Bank of England, last month when he told the Treasury Select Committee, “I don’t think you can say there is no effect” of public sector pay on inflation.

Speaking exclusively to the New Statesman, Pissarides, who is regius professor of economics at the London School of Economics and winner of the 2010 Nobel prize for economics, said Sunak and Bailey were “wrong” in their characterisation of how inflation is created, because the work of the public sector is to produce services that are not paid for by consumers, but by the state. Changes in the pay of workers cannot, therefore, affect what we pay for these services, because we don’t pay for them except through taxation or government borrowing, neither of which has to be inflationary.

Pissarides explained that higher wages would only be inflationary if they were funded by the Bank of England through money creation, and that the Treasury and the Bank of England were misrepresenting this as the only option. “It’s a political choice, whereas they’re presenting it as the only economic choice available – which it isn’t,” he said. “They are not very transparent. They’re not putting forward all the options that they have, and then telling us which ones they’re excluding, and for what reason.

“When Sunak says we cannot afford to give more pay rises, what he means is, ‘I don’t want to raise taxes’.” 

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Pissarides said that it was “absurd” for the government to pursue a narrow policy of reducing inflation, when it is the Bank of England’s job to fight inflation, and when the leading cause of that inflation is the cost of energy and food driven by Russia’s invasion of Ukraine. More important, he argued, is the chronic decline in productivity growth caused by the UK’s very low level of capital investment. The Prime Minister, he said, “should be taking action to increase investment, because investment leads to job creation, it leads to new technology, to rising productivity”.

With less than two years until the next election setting an arbitrary inflation target is the expedient choice – but Pissarides said doing so would come at a significant cost. “If you focus on inflation, you might see results in the next two years, but you will also see a recession in terms of growth.”

The paper is published today in the Journal of the British Academy and is co-authored by Pissarides and five other senior academics, including Jill Rubery, professor of comparative employment systems at the University of Manchester, and Paul Edwards, professor of industrial relations at Warwick University.

[See also: Why Britain’s economy has never been worse, with Duncan Weldon]

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