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Households are expected to see further rises in the cost of living after the annual inflation rate climbed for a 13th month to its highest point in almost 30 years. This will put further pressure on already stretched household budgets. The increase reflects a bounceback in demand for goods and services after lockdowns, when prices fell sharply. It also reflects the impact of supply-chain disruptions as Covid-19 hit factory production and global trade.

The biggest concern, however, is the impact it will have on those already hard-pressed families across the UK. According to official figures, prices are rising at similar rates for richer and poorer households. However, household income levels will determine personal experiences of inflation. Poorer households find it harder to cope than richer families as essentials, such as energy and food, form a larger proportion of their shopping basket than discretionary items. On average the lowest-income families spend twice as much proportionately on food and housing bills as the richest. So low-income households, if they are already spending mainly on essentials, will struggle to find where to cut back as prices rise.

Latest Inflation figures

Latest figures from the ONS show that the Consumer Prices Index (CPI) rose by 5.5% in the year to January 2022, with further increases in the rate expected over the next couple of months. In measuring inflation, the ONS takes a so-called ‘basket of goods, which is frequently updated to reflect changes in spending patterns. For example, in 2021, hand sanitiser and men’s loungewear bottoms were added, but sandwiches bought at work were removed.

Annual CPI inflation is announced each month, showing how much the weighted average of these prices has risen since the same date last year. The weighted average is expressed as an index, with the index set at 100 in the base year, which is currently 2015.

Consumers would not normally notice price rises from month to month. However, prices are now rising so quickly that it is clear for everyone to see. What is more, average pay is not keeping up. There are workers in a few sectors, such as lorry drivers, who are in high demand, and therefore their wages are rising faster than prices. But the majority of workers won’t see such increases in pay. In the 12 months to January, prices rose by 5.5% on average, but regular pay, excluding bonuses, on average rose by only 4.7%, meaning that they fell by 0.8% in real terms.

The Bank of England has warned that CPI inflation could rise to 7% this year and some economists are forecasting that it could be almost 8% in April.

Why are costs rising?

From the weekly food shop, to filling up cars, to heating our homes, the cost of living is rising sharply around the world. Global inflation is at its highest since 2008. Some of the reasons why include:

  • Rising energy and petrol prices
    Oil prices slumped at the start of the pandemic, but demand has rocketed back since, and oil prices have hit a seven-year high. The price of gas has also shot up, leaving people around the world with eye-watering central heating bills. Home energy bills in the UK are set to rise by 54% in April when Ofgem, the energy regulator, raises the price cap.
  • Goods shortages
    During the pandemic, prices of everyday consumer goods increased. Consumers spent more on household goods and home improvements because they were stuck at home, couldn’t go out to eat or go on holiday. Manufacturers in places such as Asia have struggled to keep up with the demand. This has led to shortages of materials such as plastic, concrete and steel, driving up prices. Timber cost as much as 80% more than usual in 2021 in the UK.
  • Shipping costs
    Global shipping companies have been overwhelmed by surging demand after the pandemic and have responded by raising shipping charges. Retailers are now having to pay a lot more to get goods into stores. These prices are now being passed on to consumers. Air freight fees have also increased, having been made worse by a lorry driver shortage in Europe.
  • Rising wages
    During the pandemic many people changed jobs, or even quit the workforce – a problem exacerbated in the UK by Brexit as many European workers returned to their home countries. Firms are now having problems recruiting staff such as drivers, food processors and restaurant waiters. This has resulted in companies putting up wages to attract and retain staff. Those extra costs to employers are again being passed on to consumers.
  • Extreme weather impact
    Extreme weather in many parts of the world has contributed to inflation. Global oil supplies took a hit from hurricanes which damaged US oil infrastructure. Fierce storms in Texas also worsened the problems in meeting the demand for microchips. The cost of coffee has also jumped after Brazil had a poor harvest following its most severe drought in almost a century.
  • Trade barriers
    More costly imports are also contributing to higher prices. New post-Brexit trading rules are estimated to have reduced imports from the EU to the UK by about a quarter in the first half of 2021. In the USA, import tariffs on Chinese goods have almost entirely been passed on to US customers in the form of higher prices. Chinese telecoms giant Huawei said last year that sanctions imposed on the company by the USA in 2019 were affecting US suppliers and global customers.
  • The end of pandemic support
    Governments are ending the support given to businesses during the pandemic. Public spending and borrowing increased across the world leading to tax rises. This has contributed to rises in the cost-of-living, while most people’s wages have lagged behind.

Main concerns for the UK inflation

With rapidly rising prices, the economic decisions people will have to make are much harder. The main concerns for UK households include increases in energy costs, food prices, rent and interest rates on borrowing. All of these concerns come at a time when the government prepares to increase national insurance contributions for workers in April. There has been some pressure from MPs to scrap the tax rise so as to ease the pressure on living costs. It can be argued that there are fairer ways to increase taxes than through national insurance. However, the plan is relatively progressive, and scrapping the rise could be a badly targeted way of helping the poorest households with their energy bills.

Energy Bills
Electricity and gas bills for a typical household are expected to increase on average by £693 a year in April, which, as we have seen, is a 54% increase. Around 18 million households on standard tariffs will see an average increase from £1277 to £1971 per year. And around 4.5 million prepayment customers will see an average increase of £708 – from £1309 to £2017. Energy bills won’t rise immediately for customers on fixed rates, but many are likely to see a significant increase when their deal ends.

Bills are going up because the energy price cap is being raised. The energy price cap is an example of a maximum price being imposed on the market; it is the maximum price suppliers in England, Wales and Scotland can charge households for their energy. Energy firms can increase bills by 54% when the new cap is introduced in April. The price cap is currently reviewed every 6 months and it is expected that that prices will rise again in October.

Energy price rises are likely to hit Britain’s poorest households the hardest as they spend proportionately more of their income on energy, a problem exacerbated by many living in poorly insulated homes. More people are thus expected to find themselves facing fuel poverty. This means that they spend a disproportionate amount of their income on energy and cannot afford to heat their homes adequately. According to the Resolution Foundation, the poorest will see their energy spend rise from 8.5% to 12% of their total household budget, three times the percentage for the richest.

The way fuel poverty is measured varies around the UK. In Scotland, a household is in fuel poverty if more than 10% of its income is spent on fuel and its remaining income isn’t enough to maintain an adequate standard of living. It is expected that the number of homes facing ‘fuel stress’ across the UK will treble to 6.3 million after April. It will, however, have the greatest impact on pensioners, people in local authority housing and low-income single-adult households who on average could be forced to spend over 50% of their income on gas and electricity. The Resolution Foundation thinktank has warned that UK households are facing a ‘cost of living catastrophe’.

Food
Low-income households also spend a larger proportion than average on food and will therefore be relatively more affected by increases in food prices. Food and non-alcoholic drink prices were up by 4.2% in the year to December 2021. The Monetary Policy Committee has stated that food price inflation is expected to increase in coming months, given higher input costs. It has been estimated by the thinktank, Food Foundation, that 4.7m Britons, equivalent to 8.8% of the population, are struggling to feed themselves and are regularly going a day without eating.

Supermarkets have also raised their concerns about future increases. Tesco’s chairman John Allan has predicted that the worst is yet to come, pointing to 5% as a likely figure for food price inflation by the spring. He cited high energy prices, both for Tesco and its suppliers, as a key factor behind the expected rise.

It has been observed that the Smart Price, Basics and Value range products offered by supermarkets as lower-cost alternatives are stealthily being extinguished from the shelves. This is leaving shoppers with no choice but to ‘level up’ to the supermarkets’ own better-quality branded goods – usually in smaller quantities at larger prices. The managing director of Iceland, Richard Walker, has stated that his stores are not losing customers to other competitors or to better offers, but to food banks and to hunger. This is a highly concerning statement given that 2.5m citizens were forced by an array of desperate circumstances to use food banks over the past year.

Rent
Private rents are also rising at their fastest rate in five years, intensifying the increase in the cost of living for millions of households. Data from the ONS reveal that the average cost of renting in the UK rose by 2% in 2021. This was the largest annual increase since 2017. The East Midlands had the biggest increase in average rental prices, with tenants paying 3.6% more than a year earlier. However, due to falling demand for city flats during lockdown, as people favoured working from home, London had the smallest increase at 0.1%. Nevertheless, as Covid restrictions are removed, renters, including office workers and students, are now returning back to cities. This is now pushing up rental prices with demand outpacing supply.

The property website Zoopla found newly advertised rental prices were rising much faster across the UK. It said the average rent jumped 8.3% in the final three months of 2021 to £969 a month. This increase in rental prices, combined with the general rise in prices will place additional pressure on the government to increase support for vulnerable families. The housing charity, Shelter, has reported an increase in people who are struggling to pay their rent and even pay their electricity. With Covid-era protections having ended, if people struggle to pay, they are faced with eviction or even homelessness. There are calls for the government to support such people by reversing welfare cuts.

Insurer, Legal & General, has announced an additional investment over the next 5 years of £2.5bn on its ‘build to rent’ schemes. The aim is to provide more than 7000 purpose-built rental homes in UK towns and cities. L&G claims that the additional homes are part of the solution to the rental problem, with rent increases being capped at 5% for five years. However, sceptics claim the company is simply trying to cash in on the booming market and there are calls for further government action. The Joseph Rowntree Foundation claim that renters will struggle as rents in some areas have risen as much as 8%. Despite this, housing benefit has been frozen for two years and therefore there are calls for government to urgently relink housing benefit to the real cost of renting.

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Questions

  1. What other measures of inflation are used beside CPI inflation? How do they differ?
  2. If all consumers are facing approximately the same price increases for any given good or service, why are poor people being disproportionately hit by rising prices?
  3. For what reasons might the rate of inflation (a) rise further; (b) begin to fall?
  4. Examine a developed country other than the UK and find out how inflation is affecting its population. Is its experience similar to that in the UK? Does it differ in any way?

Inflation has surged worldwide as countries have come out of their COVID-19 lockdowns. The increases in prices combined with supply-chain problems has raised questions of what will happen to future prices and whether it will feed further inflation cycles.

Inflation targeting

Inflation is a key contributor to instability in an economy. It measures the rate of increases in prices over a given period of time and indicates what will happen to the cost of living for households. Because of its importance, many central banks aim to keep inflation low and steady by setting a target. The Bank of England, the Federal Reserve, and the European Central Bank all aim to keep inflation low at a target rate of 2 per cent.

Inflation-rate targeting has been successfully practised in a growing number of countries over the past few decades. However, measures to combat rising inflation typically contract the economy through reducing real aggregate demand (or at least its rate of growth). This is a concern when the economy is not experiencing a strong economic performance.

Current outlook

Globally, rising inflation is causing concern as a surge in demand has been confronted by supply bottlenecks and rising prices of energy and raw materials. As the world emerges from the COVID-19 lockdowns, global financial markets have been affected in recent months by concerns around inflation. They have also been affected by the prospect of major central banks around the world being forced into the early removal of pandemic support measures, such as quantitative easing, before the economic recovery from the coronavirus is complete.

The Chief Economist at the Bank of England has warned that UK inflation is likely to rise ‘close to or even slightly above 5 per cent’ early next year, as he said the central bank would have a ‘live’ decision on whether to raise interest rates at its November meeting. Although consumer price inflation dipped to 3.1 per cent in September, the Bank of England has forecast it to exceed 4 per cent by the end of the year, 2 percentage points higher than its target. UK banks and building societies have already started to increase mortgage rates in response to rising inflation, signalling an end to the era of ultra-low borrowing costs and piling further pressure on household finances.

In the USA, shortages throughout the supply chains on which corporate America depends are also causing concern. These issues are translating into widespread inflationary pressure, disrupting operations and forcing companies to raise prices for customers. Pressure on every link in the supply chain, from factory closures triggered by COVID-19 outbreaks to trouble finding enough staff to unload trucks, is rippling across sectors, intensifying questions about the threat that inflation poses to robust consumer spending and rebounding corporate earnings. Reflecting concern over weaker levels of global economic growth despite rising inflationary pressures, US figures published at the end of October showed the world’s largest economy added just 194 000 jobs in September, far fewer than expected.

There are also fears raised over high levels of corporate debt, including in China at the embattled property developer Evergrande, where worries over its ability to keep up with debt payments have rippled through global markets. There are major concerns that Evergrande could pose risks to the wider property sector, with potential spill-overs internationally. However, it is argued that the British banking system has been shown in stress tests to be resilient to a severe economic downturn in China and Hong Kong.

Central bank responses

The sharpest consumer-price increases in years have evoked different responses from central banks. Many have raised interest rates, but two that haven’t are the most prominent in the global economy: the Federal Reserve and the European Central Bank. These differences in responses reflect differing opinions as to whether current price increases will feed further inflation cycles or simply peter out. For those large central banks, they are somewhat relying on households keeping faith in their track record of keeping inflation low. There is also an expectation that there are enough underutilised workers to ensure that wage inflation is kept low.

However, other monetary authorities worry that they have not yet earned the record of keeping inflation low and are concerned about the risk of wage inflation. In addition, in poorer countries there is a larger share of spending that goes on essentials such as food and energy. These have seen some of the highest price increases, so policy makers are going to be keen to stamp down on the inflation.

The Federal Reserve is expected to announce that it will start phasing out its $120bn monthly bond-buying programme (quantitative easing) as it confronts more pronounced price pressures and predictions that interest rates will be lifted next year. However, no adjustments are expected to be made to the Fed’s main policy rate, which is tethered near zero. Whilst financial markets are betting on an rise in Bank Rate by the Bank of England as early as next month, spurred by comments from Governor Andrew Bailey in mid-October that the central bank would ‘have to act’ to keep a lid on inflation.

Outlook for the UK

The Bank of England’s Chief Economist, Huw Pill, has warned that high rates of inflation could last longer than expected, due to severe supply shortages and rising household energy bills. He said inflationary pressures were still likely to prove temporary and would fall back over time as the economy adjusted after disruption caused by COVID and Brexit. However, he warned there were growing risks that elevated levels of inflation could persist next year.

The looming rise in borrowing costs for homeowners will add further pressure to family finances already stretched by higher energy bills and surging inflation. According to the Institute for Fiscal Studies, it is expected that households will face years of stagnating living standards, with predictions showing that households would on average be paying £3000 more each year in taxes by 2024/25, with the biggest impact felt by higher earners.

Investors are also reacting to concerns and have pulled $9.4bn out of UK-focused equity funds this year after hopes that a COVID-19 vaccination drive will fuel a vigorous economic recovery were overshadowed by questions about slow growth and high inflation. It is suggested that there is a general sense of caution about the UK when it comes to investing globally, driven by monetary, fiscal and trade uncertainties.

Given all the elements contributing to this outlook, The IMF has forecast that the UK will recover more slowly from the shocks of coronavirus than other G7 nations, with economic output in 2024 still 3 per cent below its pre-pandemic levels. Financial markets are predicting the Bank of England will lift interest rates as soon as the next MPC meeting. And while supply-chain bottlenecks and rising commodity prices are a global trend, the Bank’s hawkish stance has increased the possibility of a sharper slowdown in Britain than other developed markets, some analysts have said.

What next?

Some of the major central banks are poised to take centre stage when announcing their next monetary action, as it will reveal if they share the alarm about surging inflation that has gripped investors. Markets are betting that the Bank of England will begin raising interest rates, with Bank Rate expected to rise to around 1.25 per cent by the end of next year (from the current 0.1 per cent).

It is thought that the Fed will not raise interest rates just yet but will do so in the near future. Markets, businesses, and households globally will be waiting on the monetary decisions of all countries, as these decisions will shape the trajectory of the global economy over the next few years.

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Forecasts and commentary

Questions

  1. What is the definition of inflation?
  2. How is inflation measured?
  3. Using a diagram to aid your answers, discuss the difference between cost-push and demand-pull inflation.
  4. What are the demand-side and cost-side causes of the current rising inflation?
  5. Explain the impact an increase in interest rates has on the economy.

The UK government has made much of its spending commitments in the UK Budget and Spending Review delivered on 27 October 2021. Spending on transport infrastructure, green energy and health care figured prominently. The government claimed that these were to help achieve its objectives of economic growth, carbon reduction and ‘levelling up’. This means that government expenditure will be around 42% of GDP for the five years from 2022 (from 1988 to 2000 it averaged 36%). Although it temporarily rose to 52% in 2020/21, this was the result of supporting the economy through the pandemic. But does this mean that the government is now a ‘Keynesian’ one?

When the economy is in recession, as was the case in 2020 with the effects of the pandemic, increased government expenditure financed by borrowing rather than taxation is the classic Keynesian remedy to boost aggregate demand and close the output gap. The increased injection of spending works through the multiplier process to raise equilibrium national income and reduce unemployment.

But is this the objective of the extra spending announced in October 2021? To answer this, it is important to look at forecasts for the state of the economy with no change in government policy and at the balance of government expenditure and taxation resulting from the Budget. The first chart shows public sector net borrowing from 2006/7 and forecast to 2026/7. The green and red lines from 2021/22 onwards give the PSNB forecasts with and without the October 2021 measures.

As you can see, there was a large increase in the PSNB in 2020/21, reflecting the government’s measures to support firms and workers during the pandemic. (Click here for a PowerPoint of the chart.) This was very much a Keynesian response, where a large budget deficit was necessary to support aggregate demand. It was also to protect the supply side of the economy by enabling firms to survive.

But could the October 2021 announcements also be seen as a Keynesian response to the macroeconomic situation? If we redraw Chart 1, focusing just on the forecast period and adjust the vertical scale, we can see that the measures have a net effect of increasing the PSNB and thus acting as a stimulus to aggregate demand. (Click here for a PowerPoint of the chart.) The figures are shown in the following table, which shows the totals from Table 5.1 in the Autumn Budget and Spending Review 2021 document:

Effects of Spending Review and Budget 2021 on PSNB (+ = increase in PSNB)

At first sight, it would seem that the Budget was mildly expansionary. To see how much so, the Office for Budget Responsibility (OBR) measures the ‘fiscal stance’ using the ‘cyclically adjusted primary deficit (CAPD)’. This is PSNB minus interest payments and minus expenditures and tax revenues that fluctuate with the cycle and which therefore act as automatic stabilisers. The OBR’s forecast of the CAPD shows it to be expansionary, but decreasing over time. In 2021/22, there is forecast to be a net injection of around 3.2% (excluding ‘virus-related’ support), falling to 2.7% in 2022/23 and then gradually to around 0.6% by 2026/27. So it does seem that fiscal policy remains expansionary throughout the period, but less and less so.

But this alone does not make it ‘Keynesian’. A Keynesian Budget would be one that uses fiscal policy to adjust aggregate demand (AD) according to whether AD is forecast to be deficient or excessive without the Budget measures. To operate a Keynesian Budget, it would be necessary to forecast the output gap without any policy measures. If was forecast to be negative (a deficiency of demand, with equilibrium output below the potential level), then an expansionary policy should be pursued by raising government expenditure, cutting taxes or some combination of the two. If it was forecast to be positive (an excess demand, with equilibrium output above the potential level), then a contractionary/deflationary policy should be pursued by cutting government expenditure, raising taxes or some combination of the two.

So what is the forecast for the output gap? The OBR states that, after being negative in 2020
(–0.4% of potential GDP), it has risen substantially to 0.9% in 2021 with the rapid bounce back from the pandemic. But it is forecast to remain positive, albeit declining, until reaching zero in 2025. This is illustrated in Chart 3. (Click here for a PowerPoint of the chart.) So fiscal policy remains mildly expansionary until 2025, after having provided a considerable stimulus in 2021.

This is not normally what a Keynesian economist would recommend. Fiscal policy should be designed to achieve a zero output gap. With the output gap being substantially positive in 2021, there is a problem of excess demand. This can be seen in supply-chain difficulties and labour shortages in certain areas and higher inflation, with CPI inflation predicted by the OBR to rise to 4.4 per cent in 2022. The combination of higher prices, the rise in national insurance from April 2022 by 1.25 percentage points and the freezing of income tax personal allowances will squeeze living standards. And the cancelling of the £20 per week uplift to Universal Credit and no increase in its rate for the unemployed will put particular pressure on some of the poorest people.

The government is hoping that the rise in government expenditure will have beneficial supply-side effects and increase potential national income. The aim is to create a high-wage, high-skilled, high-productivity economy though investment in innovation, infrastructure and skills. As the OBR states, ‘The rebounding economy has provided the Chancellor with a Budget windfall that he has added to with tax rises that lift the tax burden to its highest since the early 1950s’.

It remains to be seen whether the extra spending on education, training, infrastructure and R&D will be sufficient to achieve the long-term growth the Chancellor is seeking. The OBR is forecasting very modest growth into the longer term when the bounce back has worked through. Real GDP is forecast to grow on average by just 1.5% per year from 2024 to 2026. What is more, the OBR sees permanent scarring effects of around 2% of GDP from the pandemic and around 4% of GDP from Brexit.

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Analysis

Documents

Data

Questions

  1. What do you understand by ‘fiscal stance’?
  2. What are ‘automatic fiscal stabilisers? How might they affect GDP over the next few years?
  3. If the government had chosen to pursue a zero output gap from 2022/23 onwards, how would this have affected the balance between total government expenditure and taxation in the 2021 Budget and Spending Review?
  4. Provide a critique of the Budget from the left.
  5. Provide a critique of the budget from the right.
  6. Was this a ‘Green Budget’?
  7. Is the Budget following the ‘golden rule’ of fiscal policy?
  8. Look through Table 5.1 in the Budget and Spending Review document (linked below). Which of the measures will have the most substantial effect on aggregate demand?

Long queues at petrol pumps, with many filling stations running out of fuel; fears of shortages of food and various other items in supermarkets; orders by shops and warehouses unfilled or delayed. These have been some of the headlines in the UK in recent days.

The immediate problem is a shortage of over 100 000 lorry drivers, with thousands of drivers from EU countries, who were previously living and working in the UK, having returned to their home countries. Their numbers have not been replaced by British drivers, a problem exacerbated by a decline in HGV tests during the pandemic. Thus the supply of lorry drivers has fallen.

At the same time, as the economy recovers from the COVID-19 pandemic, aggregate demand has risen and with it the demand for lorry drivers.

The shortage is pushing up wages somewhat, but not enough to eliminate the shortage. What is more, the supply of lorry drivers is relatively wage inelastic: a higher wage does not attract many more drivers into the market. Also the demand is also relatively wage inelastic: a higher wage does not do much to dampen the demand for drivers.

But why has this happened? Why has the supply of drivers fallen and why is it inelastic? And what will happen in the coming months? The three main causes are Brexit, COVID-19 and working conditions.

Brexit

With Brexit, many EU workers left the UK, finding life and working conditions more conducive in the EU. Many EU drivers had faced discrimination and felt that they were not welcome in the UK. It has been difficult finding replacement drivers from the EU as the UK’s immigration system, which now applies to the EU as well as other countries, prioritises workers who are classified as high-skilled, and these do not include lorry drivers.

Those EU drivers who do want to stay as UK residents are finding that settled status or visas are not easy to achieve and involve filling in various documents, which can be an onerous and time-consuming process. As the writer of the first linked bog below, who is a Polish worker in the transport industry, states, ‘Would you rather come to Britain and jump through all the hoops, or choose any of the well-paying EU countries, for example, Germany that, if you live in Western Poland, is just a short drive across (virtually non-existent thanks to Schengen) border?’ Another problem is that with EU driving licences: it is harder for potential employers to check on their status and thus they may prefer to employ UK drivers. This, again, puts off EU drivers from seeking to stay in the UK.

Even in the case of EU drivers living in the EU but delivering to the UK there are problems. First there are the dangers for drivers of boarding ferries in France, where people from migrant camps seek to board lorries to get passage to the UK, often threatening drivers. If illegal migrants do succeed in boarding a trailer unseen by the driver, the driver can then be arrested in the UK. According to the Polish blogger, it’s ‘no surprise that I hear more and more drivers who, when taking on new jobs, demand guarantees from their employers that they won’t be sent to the UK’.

Then there is a decline in the system known as ‘cabotage’. This is where an EU driver delivers from the EU to destination A in the UK and takes back a load to the EU from destination B in the UK. To avoid having to travel empty between the two UK destinations, the driver could pick up a load to take from A to B. With a fall in imports and exports from and to the EU following Brexit, there are fewer EU lorries on UK roads. This means that there is now less capacity for transporting loads within the UK.

There has also been a large rise in ‘red tape’ associated with post-Brexit customs checks and border controls. This means that lorries can be held up at ports. This makes it much less attractive for EU haulage companies to export to the UK rather than to other EU countries, where paperwork is minimal. In addition, m many drivers are paid by the length of the journey rather than by the time spent, so delays result in them earning less per hour. Full checks have not been introduced yet. When they are, in January and July next year, the problem will be worse.

Tax changes make it more difficult for drivers to avoid taxes by claiming that they are self employed when they are in reality employees. This too is discouraging drivers from the EU from moving to or staying in the UK since many would now (since April 2021) be paying more tax.

COVID-19

Another contributing factor to the shortage of drivers has been COVID-19 and the government’s response to it. COVID rates are considerably higher in the UK than in most EU countries and, not surprisingly, many EU drivers are afraid to come to the UK.

The pandemic led to fewer HGV driver tests, with 25 000 fewer candidates passing their test in 2020 than in 2019. It takes time to train new drivers and then to test them. However, even if there had been no reduction in HGV drivers passing their tests, there would still be a significant shortage of qualified drivers.

A further problem with the effects of COVID-19 on the economy has been the initial recession and then the bounce back. The sheer size of the bounce back has exacerbated the problem of driver shortages, which otherwise would have been slower to develop, giving the market more time to respond. Real GDP grew by 5.5% from 2021 Q1 to 2021 Q2, giving an annual growth rate of 23.6%. Nevertheless, GDP was still some 3.3% below its 2019 Q3 level.

Pay and working conditions

Working conditions are very poor for many drivers. The following are common complaints:

  • Driving jobs are often very tightly controlled, with computer monitoring and little freedom for the driver. Some cabs have cameras aimed at the drivers so that they can be constantly monitored.
  • Drivers are subject to very stringent health and safety regulations, such as not being allowed to drive longer than a certain time, even when they are queuing in congested traffic. Whilst many of these regulations are desirable to protect both the public’s and the driver’s safety, they can discourage drivers from entering or staying in the industry. And some regulations are hard to justify on safety grounds (see second linked article below, point 13).
  • Just-in-time deliveries at supermarkets, regional distribution centres (warehouses) or factories make timing very important and add considerable stress to drivers who may face abuse if they are late, even though it was not their fault, with their employer perhaps facing a fine. And yet on other occasions they might have to wait a long time to offload if drivers before them have been delayed, and often the conditions in waiting areas are poor with few if any facilities.
  • Drivers often feel a lack of respect from employers, trainers and the general public.
  • Rest and refreshment facilities are often very poor in the UK and generally much worse than in the EU. In the EU, motorway service areas have better parking, toilets, showers and shops. Restaurants are better and cheaper. Dedicated truck stops have supermarkets, laundrettes, showers or even open-air gyms dedicated to making drivers’ lives easier and more pleasant. The UK by contrast often has very poor facilities. Unlike in most EU motorway services, drivers have to pay to park and are faced with poor toilet and eating facilities. ‘Meanwhile, a typical British truck stop is some dusty yard full of potholes on the side of some industrial estate with a portaloo and a “greasy spoon” burger van parked next to it.’
  • Hours are long. Even though driving hours are restricted to 10 hours per day (recently extended to 11 hours), the average working day may be much longer as drivers have to wait at distribution centres, fill in increasing amounts of paperwork and help load or unload their vehicle. Also drivers may have to work variable shifts, which leads to disturbed sleeping patterns.
  • The work is often physically demanding, especially when a large part of the job involves loading and unloading and moving items from the lorry to where the customer wants them.
  • Many vehicles are hard and unpleasant to drive, with leased vehicles often low-spec, dirty, uncomfortable and poorly maintained.
  • Many of the jobs are agency jobs that do not offer stable employment.

Although pay is higher than in some parts of the labour market where there are shortages, such as social care and hospitality, pay per hour is still relatively poor when compared with many industries which have better conditions of employment.

The future

The government is allowing more foreign workers into the UK from this month (October); more training places will be offered for potential drivers and the number of driving tests will increase; the government is also encouraging retired drivers or those who have left driving for other jobs to return to the industry.

However, there are shortages of drivers in other EU countries and so it will be difficult to attract additional drivers to the UK from the EU. What is more, with wages and working conditions remaining poor and the labour market remaining tight in other sectors, it might be hard to fill new training places and encourage workers to return to driving. Also, with the average age of drivers being 55, it is likely that the outflow of workers from driving jobs could be large in the coming years.

Articles

Questions

  1. Why are the supply of and demand for lorry drivers relatively wage inelastic?
  2. Use a marginal productivity diagram to explain the current situation in the market for lorry drivers.
  3. What policy measures could be adopted to increase the supply of lorry drivers? How successful would these be?
  4. Is it ‘rational’ for consumers to ‘panic buy’ fuel and other products in short supply?
  5. Find out why there is a shortage of lorry drivers in the EU. Are any of the explanations similar to those in the UK?
  6. What are the macroeconomic implications of a shortage of lorry drivers and other key workers?

With waiting lists in the NHS at record highs and with the social care system in crisis, there have been growing calls for increased funding for both health and social care. The UK government has just announced tax rises to raise more revenue for both services and has specified new limits on the amounts people must pay towards their care.

In this blog we look at the new tax rises and whether they are fair. We also look at whether the allocation of social care is fair. Clearly, the question of fairness is a contentious one, with people having very different views on what constitutes fairness between different groups in terms of incomes, assets and needs.

Funding

In terms of funding, the government has, in effect, introduced a new tax – the ‘health and social care levy’ to come into effect from April 2022. This will see a tax of 1.25% on the earned incomes of workers (both employees and the self-employed) and 1.25% on employers, making a total of 2.5% on employment income. It will initially be added to workers’ and employers’ national insurance (NI) payments. Currently national insurance is only paid by those below pension age (66). From 2023, the 1.25% levy will be separated from NI and will apply to pensioners’ earned income too.

The starting point for workers will be the same as for the rest of national insurance, currently £9568. Above this, the additional marginal rate of 1.25% will apply to all earned income. This will mean that a person earning £20 000 would pay a levy of £130.40, while someone earning £100 000 would pay £1130.40.

There will also be an additional 1.25% tax on share dividends. However, there will be no additional tax on rental income and capital gains, and on private or state pensions.

It is estimated that the levy will raise around £14 billion per year (0.7% of GDP or 1.6% of total tax revenue), of which £11.2 billion will go to the Department of Health and Social Care in 2022/23 and £9 billion in 2023/24. This follows a rise in income tax of £8 billion and corporation tax of £17 billion announced in the March 2021 Budget. As a result, tax revenues from 2022/23 will be a higher proportion of GDP (just over 34%) than at any time over the past 70 years, except for a short period in 1969/70.

Is the tax fair?

In a narrow sense, it can be argued that the levy is fair, as it is applied at the same percentage rate on all earned income. Thus, the higher a person’s earnings, the greater the amount they will pay. Also, it is mildly progressive. This is because, with a levy-free allowance of just under £10 000, the levy as a proportion of income earned rises gently as income rises: in other words, the average levy rate is higher on higher earners than on lower earners.

But national insurance as a whole is regressive as the rate currently drops from 12% to 2%, and with the levy will drop from 13.25% to 3.25%, once the upper threshold is reached. Currently the threshold is £50 270. As incomes rise above that level, so the proportion paid in national insurance falls. Politically, therefore, it makes sense to decouple the levy from NI, if it is being promoted as being fair as an additional tax on income earners.

Is it fair between the generations? Pensioners who earn income will pay the levy on that income at the same rate as everyone else (but no NI). But most pensioners’ main or sole source of income is their pensions and some, in addition, earn rent on property they own. Indeed, some pensioners have considerable private pensions or rental income. These sources of income will not be subject to the levy. Many younger people whose sole source of income is their wages will see this as unfair between the generations.

Allocation of funds

For the next few years, most of the additional funding will go to the NHS to help reduced waiting lists, which rocketed with the diversion of resources to treating COVID patients. Of the additional £11.2 billion for health and social care in 2022/23, some £9.4 billion will go to the NHS; and of the £9 billion in 2023/24, some £7.2 billion will go to the NHS. This leaves only an additional £1.8 billion each year for social care.

The funding should certainly help reduce NHS waiting lists, but the government refused to say by how much. Also there is a major staff shortage in the NHS, with many employees having returned to the EU following Brexit and fewer new employees coming from the EU. It may be that the staff shortage will push up wages, which will absorb some of the increase in funding.

The additional money from the levy going to social care would be wholly insufficient on its own to tackle the crisis. As with the NHS, the social care sector is facing an acute staff shortage, again aggravated by Brexit. Wages are low, and when travel time between home visits is taken into account, many workers receive well below the minimum wage. Staff in care homes often find themselves voluntarily working extra hours for no additional pay so as to provide continuity of care. Often levels of care are well below what carers feel is necessary.

Paying for social care

The government also announced new rules for the level of contributions by individuals towards their care costs. The measures in England are as follows. The other devolved nations have yet to announce their measures.

  • Those with assets of less than £20 000 will not have to contribute towards their care costs from their assets, but may have to contribute from their income.
  • Those with assets between £20 000 and £100 000 will get means-tested help towards their care costs.
  • Those with assets over £100 000 will initially get no help towards their care costs. This is increasing from the current limit of £23 250
  • There will be a limit of £86 000 to the amount people will have to contribute towards their care costs over their lifetime (from October 2023). These costs include both care in a care home and care at home.
  • These amounts will apply only to care costs and not to the board and lodging costs in care homes. The government has not said how much people could be expected to contribute towards these living costs. A problem is that care homes generally do not itemise costs and hence it may be hard to distinguish care costs from living costs.
  • Where people’s care costs are fully or partly covered, these will be paid by their local authority.
  • A house will only count as a person’s asset if the person is going into a care home and it is not occupied by a spouse or partner. All financial assets, by contrast, will count.
  • Many people in care homes will not be judged to be frail enough to be in receipt of support from their local authority. These people’s expenditure would not count towards the cap.

Setting the cap to the amount people must pay at the relatively high figure of £86 000 may ease the pressure on local authorities, as many people in care homes will die before the cap is reached. However, those who live longer and who get their care paid for above the cap, will pay no more no matter what their level of assets, even though they may be very rich. This could be seen to be unfair. A fairer system would be one where a proportion of a person’s assets had to be used to pay for care with no upper limit.

Also, the £1.8 billion is likely to fall well short of what local authorities will need to bring social care back to the levels considered acceptable, especially as the asset limit to support is being raised from £23 250 to £100 000. Local authority expenditure on social care fell by 7.5% per person in real terms between 2009/10 and 2019/20. This means that local authorities may have to increase council tax to top up the amount provided by the government from the levy.

Articles

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Government document

Data

Questions

  1. How would you define a ‘fair’ way of funding social care?
  2. Distinguish between a proportional, progressive and regressive tax. How would you categorise (a) the new health and social care levy; (b) national insurance; (c) income tax; (d) VAT?
  3. Argue the case for providing social care free at the point of use to all those who require it.
  4. Argue the case for charging a person for some or all of their social care, with the amount charged being based on (a) the person’s income; (b) the person’s wealth; (c) both income and wealth.
  5. Argue the case for and against capping the amount a person should pay towards their social care.
  6. When a tax is used to raise revenue for a specific purpose it is known as a ‘hypothecated tax’. What are the advantages and disadvantages of using a hypothecated tax for funding health and social care?