Is high inflation here to stay? The case for and against

By: John Bee, Managing Director, White Space Strategy

Here’s a graph of inflation in the UK before the financial crash in 2008. It’s the red line. What do you notice?

It’s fairly clear: the recent close-to-zero levels of inflation are not normal. Rates around 5% have been commonplace across the UK’s economic history. This is also true in other developed countries that have had similarly low rates of inflation recently.

Even a few years of persistent high inflation would be hugely damaging to the UK economy – and extremely damaging to households if wages lag behind.

It would be easy to conclude from this graph that this is what we’re in for, despite what politicians are currently telling us.

I don’t think it’s this simple – but agree that the answer to the question, whatever it ends up being, will be of critical importance to our future prosperity, at a household level, for businesses and for the country.

I’ve therefore looked at the question from both sides: what’s the evidence for high inflation persisting; and why do others think it will fall away quickly?

The case for: persistent high inflation sets in

To understand these arguments in context, it’s useful to understand some of the economics which underpin inflation. Generically, there are two types: supply side and demand side. Supply side inflation is caused by something happening which triggers a shortage of goods (the same number of people chasing fewer goods = higher prices). Demand side inflation is caused by people or businesses wanting to buy more goods and services, and having access to cash to do so (the same number of people having more money and wanting to buy more goods = higher prices). Layered on top of this are two other types of inflation: internal inflation (caused by things within your country) and imported inflation (caused by things happening abroad).

The current inflation globally is all four of these things together at once – this is why it’s beginning to get so bad. This will make it extremely hard to control: what capability do the French government have, say, to increase the supply of semiconductors (which are mainly made in China)? What capability do the US government have to reduce the global demand for lithium, which is currently surging as it’s needed to make EV batteries?

Working from this starting point, there are four significant reasons why high inflation could be here to stay:

1. The energy crisis could get worse: if Russia further restricts gas supply to Europe, we’ll get more supply-side inflation. If we have a cold winter, we’ll get more demand-side inflation. Both are possible, and if they happen together, inflation could surge.
2. Raw materials shortages look set to continue: this is causing inflation, as well as the energy crisis. Remember all of the problems we had before the Ukraine crisis with shipping containers being in short supply and in the wrong places? These problems have not fully gone away – and some key raw materials are heavily sourced from places that are increasingly hard to trade with (like China, home to most of the world’s solar panel and battery production).
3. Corporate cash piles and profitability: some companies are sitting on a lot of cash and are very profitable. This means they will be able to afford higher prices and wage increases (sustaining demand-side inflation). I’ve written more about this in my ’15 forces article’ but here’s a quick outline of the situation that’s built up, especially in the US. Thirteen firms in the US are sitting on cash and investments worth more than $1 trillion (Apple alone is sitting on $202bn). Fortune 500 companies made a record $3.1 trillion of profits in 2021, up 88% in a year.
4. Protectionism & tariffs: as a recession hits, protecting domestic industry through tariffs and local subsidies is a common government response. This makes a lot of sense at a local level – but globally pushes prices up and restricts supply. It’s very easy to imagine countries limiting export of key raw materials over the next few years. Lithium, for example, is mainly found in China, Chile, Australia, Argentina and the Democratic Republic of Congo. There’s huge demand for it currently to make batteries for EVs. If the world runs short, would China allow access to its reserves to European or American car manufacturers? If it doesn’t, prices would spike for lithium mined elsewhere. A similar scenario could play out for many other goods and raw materials, that have become essential to production in our globalised economy.

These four forces will affect every country in the world in 2023 (and beyond).

Then there’s Brexit, which will make sure the UK’s hit even harder. We used to be able to buy all goods and services from our biggest trading partner tariff and bureaucracy free. Now we can’t.

This is the case for – and I think it’s compelling.

The case against: inflation falls back to low levels by the end of 2023

Many politicians think inflation will fall back to manageable levels quickly. Supply will respond to match demand, with global businesses meeting the challenge.

Boris Johnson made a case for this in October 2021. His interview on Sky News has received a lot of coverage recently. The relevant section of the interview starts at 8 mins. 15 seconds:

In fairness to Johnson, this interview was before Russia’s invasion of Ukraine. If this hadn’t happened, global inflation would have taken a very different course. And the basis of his opinion has validity: global businesses have shown time and again that they can innovate and ramp up capacity when required, allowing supply to quickly catch up with demand.

From this starting point, there are four key reasons to believe that high inflation will be temporary:

1. It’s mainly about energy prices: these have gone through a one-off spike, and will stabilise or fall back sharply. This has happened before – energy prices have historically surged through peaks before crashing back to lower levels. Oil prices, for example, peaked at $150 a barrel in July 2008 before falling back to a low of below $40 as the financial crisis hit.
2. It’s been caused by demand surging as we come out of the pandemic: this is a one-off which will work its way through. Americans built up over $4 trillion in savings during the pandemic. A similar pattern played out across the developed world, with more affluent people able to funnel the benefits of working from home and forgoing holidays into their savings accounts. This won’t happen again, and, once the money’s spent, demand will fall away.
3. Governments and central banks have powerful tools in their armouries: these have the power to reduce prices both directly and indirectly. Increasing interest rates is the usual policy response to combat inflation. It reduces demand (by taking people’s money away through interest payments) and strengthens your currency (making imports cheaper). Central banks were slow to do this initially, but have begun to pull this lever. Interest rates are low by historical standards, so there’s more ability to do this in future. Also, they can cut sales tax. Liz Truss is rumoured to be considering this if (when) she becomes the UK’s next prime minister. A reduction to 10% would take 10% off the price of most UK goods bought by households, bringing inflation down sharply. There’s no VAT on most food in the UK, and it’s only 5% on household energy. This would restrict the impact of any reduction, but it would still be significant.
4. A recession will reduce demand: people’s incomes will be hit, and people will lose their jobs. This will reduce their ability to buy things at higher prices – so prices will have to come down. This isn’t a particularly pleasant way to combat inflation, but history shows that it’s effective.

The big worry of politicians is a wage-price spiral. In this scenario, inflation leads to workers demanding pay rises, which lead to more price rises, which lead to more pay rises, and so on. This happened in the 1970s in the United Kingdom. The argument against history repeating would focus on the power of labour. In the 1970s collective bargaining through trade unions was strong. Fifty years later, the world has changed: the unions are a lot weaker, and wage bargaining is less likely to succeed.

So, what’s it going to be?

Who’s right, then?

In reality, no one knows exactly what’s going to happen. I have a strong view on this, which is summarised in my 15 Forces Driving 2023 article. To summarise, I think we’re in for at least two years of high inflation, around or above current rates. This could be very damaging, especially if wages lag behind. I think inflation will be a lot higher in some countries, triggered by local currency crashes (dramatically increasing the cost of imports for them).

What do you think, though? Weigh up both sides of the argument, and think specifically about your country, industry and company (every household and every company has its own inflation rate, when you think about it, based on what it buys from where).

Is there anything you could do about this, whatever you think will happen? Critically, could you reduce costs, or pass on higher prices to your customers? These two questions will be on the mind of every CEO in 2023.

Why this matters? Especially for developing countries

Before I finish, let’s go back to the start.

The video at the very top of this post is from Somaliland, on the Horn of Africa. It shows the scenes at an open-air money market. Inflation in sub-Saharan Africa has hovered at or above 5% since the 1970s, having spiked at over 25% in 1994. To be precise – and with inflation, this matters – it averaged 8.25% from 1975 to 2021 (or a little bit lower than the levels we’re seeing in the developed world currently).

This means that prices in sub-Saharan Africa have gone up 41.5 times since 1975, a 45 year period. This is because of basic maths: if you make something 8.25% bigger, and then make that thing 8.25% bigger, and do this 45 times, it ends up being 41.5 times bigger than when you started. Something that cost $100 in 1975 would now cost over $10,000.

This is why there’s so much cash in the video.

And this is why persistent high inflation is such a big problem.

I don’t think we’re heading towards this kind of world, in the developed world at least. But I do think we need to prepare with our eyes open, including by speaking with economists and social policy experts from Africa and other regions that have experienced high inflation recently. History tells us that talking to people, and being open to new ideas, is a good way forward when times get hard.

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