What's behind Brown's pay freeze?

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As public sector unions organise to resist Gordon Brown's pay freeze Kevin Devine asks what lies behind the government's obsession that higher wages cause inflation

Gordon Brown was more direct than usual in his response to a parliamentary question on the possibility of negotiations in the postal dispute. But he didn't say he welcomed the prospect of talks. "We must... tackle inflation, and people have to accept settlements that will ensure that inflation is low in the years to come," he said. "All workers should look at pay settlements as a means by which we can conquer inflation."

The common factor behind the current disputes across the civil service, local government and the NHS is Brown's public sector pay policy. Brown is adamant that public sector pay must not go over his inflation target of 2 percent. Even in Royal Mail, where there are also other issues, Brown's heavy hand can be seen. The policy has caused tremendous anger. If Brown isn't careful he may face strikes in more than one part of the public sector at the same time, something both his predecessors managed to avoid.

Brown's argument is that in keeping pay rises low, prices will fall too. When you put it this way, you can see how it might not be so simple. But it's an idea that's widely accepted in government and establishment circles and, as such, it deserves closer examination.

The idea that pay rises fuel inflation goes back, at least in the memory of the current crop of politicians, to the 1970s. Then, so the account goes, workers striking for higher pay rises fed a "wages-prices spiral" that resulted in the rash of strikes during the "Winter of Discontent" in 1978-9. In the election that followed, Labour lost to the Tories under Thatcher, and would be out of office for the best part of the next two decades. For Gordon Brown, who was well on his way to building a political career in the late 1970s, the lesson was no doubt a salutary one.

But the idea that strikes for higher pay caused inflation in the 1970s is a myth. In fact, it was the other way round: strikes for higher pay followed increases in inflation. In their recent book, Fantasy Island, Larry Elliot and Dan Atkinson argue that spiralling inflation in the early 1970s was not caused by British workers' wage claims, but by the US government's refusal to pay for the Vietnam War by raising taxes. Instead the federal government printed more and more dollars to pay for the slaughter. The main effect was that as the supply of dollars increased its value as a currency fell.

But there was another unforeseen effect. Commodities priced in dollars, like oil, also fell in value, at least at first. But because the producers sought to maintain their profits, they soon hiked up the price. The result was a massive increase in the price of oil and other vital industrial inputs, which, because of their reliance on them, had a huge knock-on effect on the major Western economies. The figures give an indication of how much - inflation was running at 8.9 percent in August 1972. A year later it had increased to 16.9 percent and a year after that, in August 1974, it was 26.9 percent. This was the real background to the "Winter of Discontent" a few years later.

What happened was that as the cost of living increased, workers tried to protect their living standards, and were forced to take industrial action as they came up against the intransigence of the then-Labour government, which tried to make workers pay for the economic crisis by imposing wage restraints. The establishment's thinking then was much the same as it is today: workers need to curb their pay demands for fear of fuelling inflation.

On one reading, the idea of a "wages-prices spiral" seems to make sense, even if we accept that pay rises weren't initially to blame. But the problem with this view is that workers' actions on the wages front aren't the main factor behind price rises.

To understand why, it's worth going back to Marx's pamphlet, Wages, Prices and Profit. This text, first aired in a speech to the General Council of the First International in 1865, was aimed at showing how workers' struggles for improved wages and working conditions can spill over into a fight for a better society. At the time some on the left argued that trade unionism was a waste of energy since any pay rises won by workers would simply lead to price increases, thereby wiping out the workers' gains. But Marx showed that there are many examples of wages increasing without prices following suit.

In particular, he showed how the cut in the working day in 1848, and the real rise in wages that it produced, did not result in price rises, but instead: "a great increase in the number of factory hands employed, a continuous fall in the prices of their products, a marvellous development in the productive powers of their labour, an unheard of progressive expansion of the markets for their commodities". In other words, the reduction in daily working time was accompanied by a substantial increase in productivity, which permitted the goods produced to be sold more cheaply, but in greater quantities.

Similar sequences have occurred since Marx spoke, whenever workers have won wage rises, or reductions in working hours that result in wage rises. One way management attempt to offset these increases in their labour costs is by making changes to working practices aimed at ensuring higher productivity. In the motor industry, for example, successive reductions in the basic working week during the last decade of the 20th century were relatively easily borne by the employers. These reductions in standard hours were invariably accompanied by new working practices which boosted the number of cars produced and kept prices at competitive levels. For many smaller models, prices even fell as new production methods took hold.

In addition, the elements involved in the recent increases in inflation we have witnessed in this country are as varied as oil and gas, electricity, food (much of which now comes from overseas) and, of course, housing costs.

Price formation is an extremely complex process, and to assume that it happens in a straightforward way, beginning with rises in labour costs, is simplistic and naive. But Marx's key argument was that, while a general increase in pay levels wouldn't necessarily affect the prices of goods and commodities, it might affect profit rates.

This brings us much closer to the real meaning of the government's policy on public sector pay. If private sector workers' pay rises are not inflationary, then the idea that public sector workers, who do not produce commodities for sale, can also cause inflation by winning wage increases is equally nonsense. But this isn't Brown's intention. The policy is really aimed at keeping public spending low in most areas, to permit continued spending on the wars in Iraq and Afghanistan on the one hand, and allow the continuation of a benign tax regime for corporations and the rich on the other hand. Just look at the breaks they got in the last budget.

The last thing Brown wants to admit is that the policy is aimed at holding wages down while allowing profits to soar. He also wants to show the bosses that he's prepared to face down the unions, that Britain remains a prime location for business and profits. After all, wages are negotiated, while profits are not. And profits across private industry have never been better.

This is a key point. Because while all of this has been going on in the public sector, some private sector workers at least, especially in the City of London and other parts of financial services, have been doing very well indeed. This year saw record bonuses in the Square Mile and Canary Wharf. Pay rises for ordinary workers have been relatively modest, while those for directors have skyrocketed. But a gap has also opened between earnings in the public sector and those across the private sector more generally. Though not universal - low-paid jobs like cleaners, still fare better in the public sector - this is because wage rises in many parts of private industry have been responding to higher inflation.

Galling

Here lies one of the most galling aspects of the government's policy. Inflation has indeed been rising until recently, with the higher cost of living leading to a squeeze on workers' living standards. Private sector workers, where they have been organised, have tried to recoup these losses, and to an extent they have succeeded. But the government's policy has produced a double whammy, whereby public sector workers' "real wages", ie wages adjusted for inflation, have fallen sharply, at the same time as they are being made to feel responsible - if they demand higher wage rises - for inflation itself.

How has the government got away with this so far? Much of the policy relies on a sleight of hand over the way in which inflation is measured. The government uses a scale called the Consumer Prices Index (CPI) as its main measure of inflation, and as the basis of its "target" for public sector pay rises. The CPI is a European-designed measure that is normally used for economic policy purposes. Handily enough for Brown, it is usually much lower than the other main measure of inflation, the Retail Price Index (RPI). This is because the CPI excludes many of the elements of expenditure that are included in the RPI - crucially, housing costs like mortgage interest payments, which have been rising recently. As such, the government's use of the CPI has come in for some sharp criticism from the Bank of England, which is responsible for monetary policy.

By contrast, the RPI is the main measure of inflation used by wage negotiators in the private sector, for precisely the reason that it represents the best available measure of changes in the cost of living. And the RPI has been running at around 4 percent, double the government's target for public sector pay rises. So the true measure of the cost of living has been rising at a higher rate than under the government's preferred measure, but public sector workers must peg their pay claims to the latter.

Gordon Brown must think public sector workers exceedingly stupid if he thinks they'll continue to swallow this. But of course, the policy also relies on the government's calculation that many of the union leaders will be reluctant to sanction strikes against what they see as "their" government. The strikes called by the postal workers union, the CWU, have been determined and solid and show the government's assumption will not always hold. The union leaders are squeezed between pressure from the government to hold the line and the sometimes greater pressure from their members to act.

Many trade union members across the public sector can see the possibility of a rerun of events under the Tories in the 1990s, if not those under Labour in the 1970s. In both cases the public sector was starved of investment, with major consequences for staffing levels and a knock-on effect on the vital services provided to ordinary people. This realisation will place the union leaders themselves under pressure.

This portion of Brown's strategy is therefore a weakness. He is no longer the "Iron Chancellor" he once liked to imagine himself. He may think he can simply adopt the same approach as before, now he is prime minister. But the stakes are higher and problems with the economy loom.

For public sector workers, the "Brown bounce" has likely enough bottomed out on the back of the poverty pay rises on offer, and threats to privatise departments and move them to cheaper locations outside of London. At a time when the rich have never had it so good, exhortations to these workers to "combat inflation" are ringing increasingly hollow and will continue to fuel discontent. Only the struggles of the coming months will determine whether Brown gets away with this attack on public sector workers.