Government is gambling on cost of living crisis easing as it holds firm on public sector pay

When the Chancellor told me that he suspects things will get worse before they get better, he was talking about the state of the economy.

And he has a point. The squeeze on household finances is already bad but it will probably worsen – or at the very least continue – all the way through next year, depending on what happens with energy prices.

Even though October’s gross domestic product (GDP) figures, published earlier on Monday, were relatively strong, we are still in the teeth of what looks like a recession.

And while the dip in GDP is unlikely to be as severe as the one during the pandemic lockdowns or the financial crisis of 2008, it will feel particularly painful, since this is a consumer recession.

This is a recession which will be felt directly in our pockets rather than in the balance sheets of banks or the public finances – as our standard of living is eroded by higher bills and mortgage payments.

So yes, it is very likely to get worse before it gets better. But the chancellor’s statement isn’t just true of household finances, it’s also likely to be true about the government’s popularity, for even as we enter this recession, it is trying out a… challenging political position with the British people.

There is a logic to it.

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The UK is facing an inflationary spike – the highest rate of price increases since the early 1980s.

There are deep fears among the establishment that if it allows those wages it controls to rise too sharply, then that will “bake in” the inflation.

Back in the 1970s it was this toxic interaction between prices and wages, one pushing the other up until they both spiral out of control. The Treasury wants to do everything it can to avert that this time around.

But while this argument has some economic cogency, there are also some problems with it.

The first is that public sector wage settlements are running far, far below where their private sector counterparts are.

Everyone is getting worse off in real terms – in other words once you adjust for inflation. But since private sector workers are seeing annual earnings increases of around 7%, they are faring far better than their public sector counterparts, whose earnings are up by barely 2%.

And while public sector workers tend to have more generous pensions than their private sector counterparts, there is nonetheless a strong case to say they deserve to “catch up” rather than fall further behind.

Now, the Treasury’s position is that instead of trying to decide these pay settlements on a political basis, it has outsourced those decisions to pay review bodies.

The NHS pay review bodies decided earlier this year upon a set of rewards that roughly equate to 4.8%. The Whitehall argument is that by overriding these expert bodies, it sets a worrying precedent. It privately fears that to do so would force it to do precisely the same thing with all the other pay review bodies as well.

However, these are not normal times. We are facing the biggest inflation spike in a generation. In hindsight, this award, decided in July, back when inflation expectations were lower than they are today, is somewhat out of date.

And the longer NHS earnings are held down, the harder it will get for the health service to attract the workers it needs to help clear the backlog of waiting lists from after the pandemic.

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And this is before one considers the implications from the strikes of nurses and paramedics in the coming weeks.

Having tried in recent weeks to argue that it would be unaffordable to pay nurses what they want, using some somewhat questionable calculations (£1,000 per household – a totally implausible figure) it is now arguing that the main risk here comes back to that wage-price spiral.

But this argument, compelling as it might sound for some economists, is unlikely to win it many plaudits with the public.

So the government is instead gearing up for a miserable winter.

It will be grisly, cold and tough for everyone. The bad news will continue.

It is just hoping that it can absorb all that misery and that the news will get better in the spring. The problem is that it’s not altogether clear that being especially tough on public sector pay this side of the winter will make the likely post-recession bounce any better.

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