One theme threads its way through almost all the headline news of the last two weeks: higher costs. Most of the coverage — from gas price spikes to labour shortages — has rightly focused on the short-term nature of these pressures, stemming from the rapid economic restart after the pandemic. But there are also deeper, longer-term trends at work that could end up being far more important for our future living standards. As party conference season unfolds, a key question for our politicians is whether they have answers to these challenges.
There are at least four long-term and slow-moving trends that will put upwards pressure on the cost of doing business and the cost of living over the next decade. The first is the need to re-engineer supply chains. This isn’t just about the short-term chaos inflicted by the pandemic, with shipping containers, computer chips, gas supplies and people either in short supply or stuck in the wrong place. Those pressures are real, but they will eventually unwind and sky-high prices will fall back down.
The longer-term cost pressures on supply chains come from the need to switch from the “just in time” mentality of the last 20 years to a “just in case” one. The pandemic showed us quite how fragile international supply chains could be, and how vulnerable they were to disruption. Building in simplicity and resilience will come at a cost.
The second trend is more specific to the UK: a reduction in the supply of cheap labour due to Brexit. This is undoubtedly contributing to labour shortages across a number of industries — though it’s far from the only reason. But for many Brexit voters this was exactly the point — the solution will be for employers to raise wages in order to attract more workers into the areas with shortages. It won’t happen overnight, but the basic laws of supply and demand will work their magic in the end.
Higher wages in shortage sectors are a good thing, especially for those receiving them, but for everyone else this won’t be a free lunch. In fact quite literally the opposite — if the person making your sandwich or the delivery driver dropping off your burger are getting higher wages then you’ll be paying more for your lunch. The third trend relates to China.
The rapid integration of China’s huge labour force into the global economy over the last 30 years has been a massive source of downwards pressure on the cost of goods — sometimes at the expense of developed world workers, but always to the benefit of developed world consumers. But now the Chinese economic model is changing rapidly — the focus is switching from low wages and exports towards higher wages and more domestic consumption. This reduces an important source of downwards pressure on our cost of living.
The fourth, and potentially most significant, trend is the transition to net zero. Greening our economies will limit the costs of climate change and create economic opportunities, but also bring higher costs along the way, especially for energy. As well as the up-front costs of switching to a new energy mix, car fleet and new boilers, the focus on net zero is also increasing energy costs right now.
Financial markets are sending signals to energy firms to reduce their investments in new fossil fuel supplies. The result is lower supplies of oil and gas now in anticipation of lower consumer demand in the future, and that timing mismatch will likely keep prices high.
None of this necessarily means we’re heading for sustained, Seventies-style inflation. These are slower moving trends that will gradually eat into our incomes and make it harder for earnings growth to outpace the cost of living.
For governments this joins the long list of challenges that risk undermining the feel-good factor, like the upwards pressure on health costs from an ageing population, or the difficulties of improving productivity in our services-driven economy.
Governments will no doubt continue to pull the few short-term levers available to them, like excise duties. But in the long term the only route to higher living standards is the slow, hard work of raising productivity and wages —improving skills, investing in infrastructure, encouraging innovation.
Of course if we’re lucky then technology will surprise us with lower costs in ways that we can’t imagine today. In the meantime, it makes sense to plan for the worst while hoping for the best.
Rupert Harrison is a former chair of the Council of Economic Advisers and a multi-asset portfolio manager at BlackRock
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