Wage push inflation is an idea that economists and governments often use as a reason that it could be difficult to increase minimum wage in a country. But what does it actually mean?

Put simply, the term refers to a situation where a rapid increase in the wages of employees causes the rate of inflation to increase at the same time. It is explained by the fact that when workers’ incomes rise, they will have more disposable income to spend. Once their money enters the economy, the competition for goods increases, and prices rise over time.


Understanding Wage Push Inflation

The most common reason for a company to increase its wages is an increase to the national minimum wage, as decided by the government. Many companies also increase the minimum wage of their employees incrementally, meaning that to make back the profit they are losing on raising their wages across the entire company, they have to put up their prices at the same time.

If the government or a company decides to raise wages, this will naturally lead to a spike in consumer spending, as their employees have more money available to spend. A significant increase in the minimum wage could lead to higher growth, and contribute towards inflation due to two factors:

  • Higher costs for firms
  • More spending by workers

Industry factors may also play a part in wage increases. In industries that are experiencing growth, surging profits and higher demand for products/services, companies might decide to raise their wages in order to make jobs more competitive, and attract more skilled or talented workers. These factors often have a wage push inflation effect on the products and/or services that the company provides.

However, when it comes to growth and inflation, minimum wage, according to many, is the single biggest factor in driving inflation.


The Minimum Wage

A minimum wage is the lowest legal remuneration that any employer is allowed to pay their employees in a country. In the UK in 2019, the minimum wage was set at £8.21 per hour for workers over 25, £7.70 for workers aged between 21 and 24, and £6.15 for those aged 18 to 20.

When it comes to economic growth and inflation, the minimum wage has been proven to be a factor that affects both, although economists disagree on the significance of the minimum wage to either. Whilst many experts argue that a raise in the minimum wage will, through wage push inflation, naturally lead to significant economic growth and inflation, history shows that when the UK has seen above inflation increases in the minimum wage, there hasn’t been any negative impact on inflation or unemployment, and there has been almost no noticeable change to economic growth.

In theory, if all workers receive a pay increase, then there should be a rise in consumer spending across the board. Low income workers tend to spend a higher percentage of their extra pay than high earners, a multiplier effect (an increase in overall spending coming from a new injection of cash into the monthly income of a household) that should boost economic growth.

However, by the same token, when minimum wages are raised there is more competition for work, as companies are forced to pay more and hire less, and thus there should be more unemployment as a result. People who are unemployed will spend much less, thus balancing out the effect of rising wages amongst the low earners.


Does A Minimum Wage Raise Actually Cause Inflation?

The best way to assess the real threat of a minimum wage hike on inflation is to estimate how it would, by necessity, raise businesses’ costs.

Whilst many businesses will raise prices, it is important to note that there are other ways to adjust costs, such as raising employee productivity, or laying off unnecessary staff members. However, say a business were to simply raise the prices in response to a minimum wage hike. In this case research suggests that a 10% minimum wage hike will generate a cost increase of less than 1/10 of 1% of their sales revenue. This amount is worked out based on three factors:

  1. Mandated raises – the raise that employers must provide to all staff members to ensure that they are being paid the legal minimum wage
  2. ‘Ripple-effect’ raises – the raises that employers must give throughout the company to ensure the wage hierarchy is maintained for employees with already higher wages and authority
  3. Higher payroll taxes – a higher wage means paying more employer tax

The average business, wanting to cover the cost increase from a 10% minimum wage raise through higher prices, would only need to raise their wages by less than 0.1%. In real terms, this would take a £100 item up to £100.10


Is Wage Push Inflation A Myth?

Whilst some experts believe that higher wages lead to higher prices and thus inflation, economists are beginning to understand that this could well be a myth. In fact, many economists now argue that wage and price increases are actually a reflection of inflation, rather than the cause of it.

Whilst both wages and prices tend to rise at the same time, it is actually prices that lead wages, as opposed to the other way around

The best way to understand this is with an example.

Say an entrepreneur creates a new product. After a short time, word gets out about his company, and very soon his products are selling out faster than he and his small team of staff can make them.

He can’t keep making them on his own if he wants to keep up with demand, so what is his next port of call? The first step to take would be to raise his prices whilst he sells his (now limited) existing supply. This may mean that demand slows down and he can return to the way that things were, but he may also think about pushing his staff to increase their output, and accept that by paying overtime that productivity will increase enough to cover this extra cost. If demand is still too high, then he will have to think about adding staff members.

By contrast, if the world were to run as wage push inflation assumes that it does, the entrepreneur would respond to increased demand by paying workers more, in the hopes of attracting more workers, then raising the prices in order to balance profit margins.


Get In Touch

Are you thinking about increasing your wages in the hope of attracting a more talented and capable work force? Do you think this will boost your business profile and sales enough to compensate for the extra cost?

No course of action in business has a guaranteed end result, but by employing talented and experienced financial professionals to create accurate projections and forecasts, you can reduce the risk of failure and be in a position to make an informed decision on what are the best next steps for your business.

The team at An Accounting Gem can help you with this, as well as all your other accounting requirements, and can be reached by calling 01473 744 700 orvia email at contactus@aag-accountants.co.uk.