Global inflation is expected to total 8.8% in 2022 according to the International Monetary Fund. This will be the highest rate in almost 30 years. Whilst most economies are suffering at the hands of rising price levels, some are more impacted than others. Its impact is being felt in the form of higher priced goods and services while individuals are seeing their real wages fall.

Inflation arises due to an increase in the demand for goods and services or a reduction in the supply, or a combination of both. Russia’s invasion of Ukraine has caused global inflation to rise. Food and fuel costs have been the main drivers of overall price rises.

Inflation causes individuals to be worse off if pay levels do not keep pace with its rate of increase. In cases of a sharp spike in price levels, they rarely do.

Real wages plummet in the UK as inflation rises

The latest comparable price and wage data for the UK shows that the consumer price index (CPI) reached 9.9% in August 2022, while the consumer prices index including owner occupiers’ housing costs (CPIH) rose annually by 8.6%. This growth in price levels was outstripped by than of pay. Total and regular nominal pay increased by 5.8% and 5.5% respectively in August 2022.

Total nominal pay (wage) is effectively 4.1 percentage points below the rise in consumer prices. In fact, total real pay in the UK, taking inflation into account, declined by 2.8% in August 2022. This means that individuals are effectively 2.8% worse off in August 2022 compared to August 2021.

The trend shows nominal and real pay growing in parallel up until April 2021, when we see the start of the inflation jump. The CPI increases by 0.8% between March and April 2021 – the beginning of a steep upward ascent. During this period, the gap between nominal and real pay begins to slightly widen. However, this begins to deepen around March 2022 as we see the start of the impact of Russia’s invasion of Ukraine on the UK economy. As price levels continue to rise more steeply, total nominal pay becomes more volatile, while total real pay begins its nosedive towards negative annual growth. 

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The UK is not unique

The UK is not the only country to be experiencing real wages declines. In the US, nominal wages increased by 4.1% in September 2022 compared to September 2021. Yet real wages fell by 3.8% as inflation smoothed to 8.2%.

Like the UK, the trend nominal wage and real wage growth in the US is parallel until April 2021. Although nominal wages grew by 2.69% in April 2021, real wages declined by 1.4% as inflation rose to 4.2%.

More pay rise requests

According to research from HR technology company Applaud, almost two thirds of UK business decision makers said employees are asking for higher wages. The frequency of the pay rise request was also increasing. Employees are concerned that their standards of living are falling. Households are having to pay out more money in bills with the cost of utilities and food increasing. This leads to a lower level of disposable income.

The difficulty is businesses are finding it near impossible to keep pace with spiralling inflation. It is unaffordable for most businesses to give all its employees a 10% pay rise to offset the rise in inflation. Additionally, employers do not want to be burdened with permanent wage hikes given such a spike in inflation is generally an anomaly which should come under control in the next year.

The research also finds that half of those businesses surveyed are experiencing higher than normal attrition rates. Although employees can be more attracted to other jobs paying higher salaries, equally we are seeing a higher number of people becoming economically inactive.

The UK is seeing economic inactivity and job vacancies reach peak levels in 2022. The increase in economic inactivity could be workers removing themselves from the workforce as wage levels are not attractive enough. The weighing up of childcare costs versus money earned is also becoming a more complex paradigm. Similarly, companies are finding it more difficult to find workers – there were an estimated 1.25 million job vacancies in Jul-Sep 2022. This is much higher than the UK’s normal job vacancy rate.

Impact of inflation and wages on FDI

According to GlobalData's FDI Projects Database, several other site selection determinants are cited more frequently than costs. Access to customers is the primary FDI motive, however access to talent is second. We can deduce from this that FDI companies are fine in paying a (small) premium in wages to secure the best workforce. However, it is safe to assume cost is very much an important determinant, perhaps just not cited as much by companies who prefer to cite more positive reasons rather than cost savings.

A high inflation rate may make it more difficult to attract talent. If employers are unable to match pay increases to the growth of inflation, then employees may find roles in the location less appealing. Most employees want to see rising, not falling, standards of living.

If wages rise too much and companies are unable to maintain their margins, they could then be forced to trim their labour force, leading to increased unemployment in the country.

Inflation control is a key component of economic strength. Countries that get inflation under control quicker will be more prosperous in the short- and medium-term than those that don’t.