On the cost of living crisis

This started last year with the post pandemic wage recovery but what’s driving it today is the increasing imported energy prices, driven by the price of gas and to some extent the cost of food. There are two reasons why gas prices are critical, the first is that we burn it to make electricity and secondly, we use it to heat and cook in some of our homes and workplaces.

The UK privatised its energy distribution services in the late eighties and in doing so the planners had to solve two problems. The new market had to be both profitable and competitive.  They broke up the electricity generators and what today are called distributors but are in fact merely billing entities. They created a fake market and slapped a regulator, OFGEM, on top of it. The generator companies make electricity, from fossil fuels, nuclear, and renewables. OFGEM regulates the price onto and off the grid. Today it sets the price based on the highest cost source of supply i.e. Gas. The reason for this was to encourage investment in renewables, which are now capable of delivering to the grid at a considerably lower price.

The companies that are completely unaffected are the extraction companies, those who extract primary energy sources mainly fossil fuels from the ground. The UK quoted companies are BP & Shell, but several more of the UK’s primary energy suppliers are foreign owned. The current purchase price guarantees the extractors a profitable price which can be demonstrated by examining their profitability.

Both the Tories and Labour are planning to cap the consumer price for a limited period; the Tories plan to pay for this by a consumer tax (although they are calling it something else), Labour with a corporation “windfall” tax. The subsidy is needed but the critical reform would be to re-engineer the  fake energy market. I would also argue that there should be no public money without a public stake.

Another impact of the privatisation was that gas storage was sold off. Across Europe, the plan has been to buy gas in the summer, store it, and use it in the winter thus reducing the demand during periods of high prices. UK’s storage is now about 4 days; in Europe it is several magnitudes higher.

Privatisation has failed to deliver a resilient national energy plan, and the bulk of the current inflation is caused by the rising cost of imported primary energy.

The other cause is imported food prices, exacerbated by the falling domestic production. Reduced production, caused by a Brexit related labour shortage should lead to increased imports which the Brexit caused falling exchange rate makes it more expensive. This effect is reduced as we are importing less from Europe than we used to, as our European suppliers do not want to ship to the UK due to the increased trade friction costs and the opportunity cost of the transport. Importing substitutes from the US, India or even the antipodes is not cheaper due to the much higher transport costs. The reduced domestic food production also causes competition in the food supply chain which boosts costs.

On top of this, the Bank of England’s response to inflation will be to increase interest rates; this will make mortgages and rents higher which will squeeze family budgets more. Some people will have to walk away from their homes, and renters will face increased poverty as housing competes with food and warmth for a share of the family income.

The final driver for the cost of living crisis is falling real incomes making food and shelter consume a higher proportion of an ordinary family’s budget. The final obvious piece of the cost of living crisis is that there is an effective public sector pay cap. Public sector pay has been held to a 1.5% pay increase at a time of an effective increase in the Consumer Price Index of 10.1%.

James Meadway argues that wage increases are needed, prices should be fixed, and profits squeezed. It’s unlikely that the government will do this; it’s nit going to be pretty.