Here’s how governments can tackle the cost-of-living crisis and protect workers from inflationary pressures

Here's how governments can tackle the cost-of-living crisis and protect workers from inflationary pressures

Protesters in Nantes hold a banner against inflation during a nationwide day of action on 13 October 2023 called by French trade unions to push for an end to austerity measures, and to demand wages hikes and equal pay for workers.

(Sebastien Salom-Gomis/AFP)

The cost-of-living crisis is hitting workers hard. Starting in 2021 and continuing over 2022, accelerating inflation hollowed out the purchasing power of wages. The International Labour Organization’s Global Wage Report 2022-23 disclosed that global monthly wages fell by 0.9 per cent to 1.4 per cent in the first half of 2022. A decline in the purchasing power of wages continued with real wages across the OECD (Organisation for Economic Co-operation and Development) shrinking by almost 4 per cent in the year up to the first quarter of 2023.

The policy response leaves much to be desired. Many governments, to their credit, did try to shelter households and firms from the worst of inflation by providing financial support, for example for gas and electricity prices. But the actions of central banks – raising interest rates at a pace unseen over the last four decades, and now keeping interest rates ‘higher for longer’ – counteract these efforts to reduce the impact of inflation on working people.

Central bankers take the view that high inflation is a sign of an overheating economy, which requires credit to become more expensive in order to squeeze aggregate demand, slow down the economy and get inflation back under control. This view is wrong.

It was clear from the start that inflation accelerated in 2021 and 2022, not because of excessive demand, but because of a series of disruptions to global supply creating inflationary shocks.

First, the Covid-19 pandemic wreaked havoc on global supply chains, affecting everything from the production of computer microchips to timber, long after the lockdowns ended. This was followed by energy, food and commodity prices surging again when Russia invaded Ukraine. A third wave of inflation struck when businesses profited from the general trend of accelerating inflation, not only to pass on higher input costs but also high or enhanced profit margins into selling prices.

The fact is that monetary policy can do little about these supply shocks. The main tool central banks have at their disposal is to manipulate the cost of credit. This will hit workers by triggering an economic slowdown and destroying jobs. But it will not halt a Russian offensive or stop El Nino from destroying harvests. If anything, tighter monetary policy will be a major obstacle to the massive investments we need to end our overdependence on fossil fuels and make our economies less prone to inflation.

Five steps to protect workers from inflationary pressures

Instead, we need new economic policies where governments and social partners are driving policy and steering markets in the right direction while central banks take a back seat.

First, governments should not focus only on public financial support after inflation has been triggered. They should also prevent inflation in the first place. This requires a price policy to guard against businesses using a general cost shock to increase profits by pushing prices higher than just the cost increase. This does not mean that governments should micro-manage the economy by setting prices for every single product or service. It does mean, however, that the price of key goods and services that are essential for the functioning of an economy should be capped when necessary. For example, when gas prices soared on international markets, Spain capped the price of gas to be used in the production of electricity, with good results on overall inflation. Moreover, price control policy has the added advantage of mobilising consumers against opportunistic business greed. Consumers who are aware of corporate ‘greedflation’ will not so easily accept everything becoming more expensive and resist price hikes of their favourite products.

Secondly, strong wage formation institutions together with robust social dialogue allow workers to catch up with inflation by bargaining for higher wages and, more generally, to negotiate a fair sharing of the cost-of-living crisis.

It is shocking to observe that in 2022 top CEOs benefitted from substantial pay rises while workers took a pay cut in purchasing power. Well-coordinated collective bargaining, by reducing uncertainty about future wage developments, also helps to stop central banks making the mistake of fighting imaginary wage-price spirals.

Over the past decades however, wage institutions have been weakened, particularly because of labour market deregulation. With a few exceptions, trade union membership density and collective bargaining coverage rates have gone down substantially. Another line of action is to strengthen and support collective bargaining and minimum wages with social partners. For example, the 2022 tripartite agreement in Portugal sets the objective of increasing the part of national income flowing to wages by three percentage points by 2026 and provides fiscal incentives for companies that conclude collective bargaining agreements that increase wages in line with this objective and that narrow the gap between the 10 per cent highest and 10 per cent lowest paid workers. Another example is Colombia, where minimum wage indexation kicks in when social partners fail to agree on a way forward.

Third, alongside wages catching up with inflation, social safety benefits also need to be upgraded, especially to prevent child poverty. Low-income earners are disproportionately bearing the cost-of-living crisis as they spend a higher share of their income on basic goods such as energy and food. As a result, efforts to make social benefits poverty resilient are particularly important. Trade unions have an important role to play in pushing governments to strengthen social benefit systems, a fact evidenced by research from the International Monetary Fund (IMF) which found a close association between trade union density and the capacity of social benefit systems to redistribute income more equally.

Fourth, windfall taxes on corporate profits – as imposed by countries such as the United Kingdom and Spain on the energy sector – can target excessive corporate profit-making and redistribute it back to workers, social benefits and/or public investment. Similarly, the global minimum tax of 15 per cent on profits of multinational enterprises – which is part of the OECD agreement of October 2021 to reform the international system of corporate taxes signed by 136 countries and jurisdictions – could generate around US$150 billion in additional global tax revenues annually, if applied.

Last but not least, this leads us to the longer-term objective of building an economy more resilient to the inflationary consequences of external shocks.

The age of a global and open economy delivering stability and low-cost inputs (often at the expense of workers and labour rights) is behind us. Inflationary shocks related to climate change, geopolitical tensions and other disruptions in global supply chains are increasingly likely.

To limit sourcing fossil fuel and key components of global value chains from unstable countries or countries not sharing a set of core values and principles including poor human rights records, a massive investment program in energy efficiency, sustainable energy production, smart electricity grids, reshoring or ‘friend shoring’ of essential goods and services is indispensable.

These are huge challenges, requiring policies that need to be decided and implemented by accountable governments and responsible social partners, with monetary policy supporting, not obstructing, the policies and public investments that are chosen.