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Cooking the Books 2: Wages, prices and profits

Mervyn King, as Governor of the Bank of England, is supposed to know all about inflation. After all, his remit, now that the Bank no longer takes direct orders from the government, is to keep inflation below 2 per cent a year.

Inflation proper, as the name suggests, is not just any rise in the general price level but a rise caused by over-issuing the currency, something which is entirely under the Bank’s control. However, the word has come to mean, even to the Bank’s Governor, any rise in the general price level whatever the cause.

Judging by his comments in a speech he gave in Bradford on 13 June, King also subscribes to the view that wage increases cause inflation. The Guardian (14 June) reported his speech under the headline “Migrants hold down inflation says governor”:

“Mr King said that the 120,000 eastern Europeans who had arrived in Britain since 10 more countries joined the European Union in May 2004 had kept the lid on wages and prevented inflation from rising . . . ‘Without this influx to fill the skill gaps in a tight labour market it is likely that earnings would have risen at a faster rate, putting upward pressure on the costs of employers and, ultimately, inflation,’ he said.”

At least King had the honesty to make it clear that employers (whatever vote-catching politicians might say) welcome immigration of workers from other countries to help both ease skills shortages and keep wages down, but he seemed to be suggesting that, faced with a wage increase, employers can simply pass this on as increased prices.

Later on in his speech, however, he had to admit that employers are not at liberty to raise prices at will:

“May's figures for producer prices showed the cost of the fuel and raw materials used by manufacturers still growing strongly but the increases being largely absorbed in lower profit margins. According to the Office for National Statistics, input prices increased by 7.8% last month compared with a year ago and increased by 0.2% compared with April. In contrast, the weakness of demand and the strength of competitive pressures meant the price of goods leaving factory prices fell by 0.2% last month.”

But why, if employers couldn’t pass on increases in energy and materials costs, why could they have done so if wages had increased? The answer is that they can only increase their prices, when their costs increase, if the market will allow this. Otherwise the cost increase, including wages, has to be “absorbed in lower profit margins”.

Marx made the same point 140 years ago in a speech he gave to British Trade Unionists.  “A general rise of wages would”, he said, “result in a fall in the general rate of profit, but not affect values” (Value, Price and Profit, chapter XII).