Policy Tightropes in Singapore and the UK — Inflation, the Wage-Price Spiral, the Budget Deficit and Inclusive Growth

Answers

(a)(i) The inverse relationship between unemployment and inflation [4] — explain

A rise in aggregate demand, with aggregate supply constant, raises output, so firms employ more labour and unemployment falls. As the economy nears full employment, the same rising demand meets a shortage of goods and factors, bidding up the general price level — inflation rises. Lower unemployment thus tends to accompany higher inflation: an inverse relationship.

The data reflect this only partly. In 2019–2020 inflation fell (1.8% to 0.9%) while unemployment rose (3.8% to 4.5%), and in 2021–2022 inflation rose (2.6% to 7.4%) while unemployment fell (4.6% to 4.2%) — both consistent with the inverse relationship. But in 2020–2021 both rose (inflation 0.9% to 2.6%, unemployment 4.5% to 4.6%), so the relationship does not hold throughout — unsurprising, since the 2022 inflation is largely a cost-push, supply-driven episode rather than demand-pull.

(a)(ii) What the change in the Gini coefficient suggests [2] — explain

The UK’s Gini coefficient fell from 35.4% in 2019 to 34.4% in 2021, suggesting that income in the UK became slightly more evenly distributed — a modest improvement in income equality.

(b) How global events raised consumer prices [3] — explain

Global supply-chain disruption from the Russia–Ukraine war and China’s zero-COVID lockdowns (Extract 7) reduced the availability of commodities and raised the prices of imported factor inputs. Higher input costs raise firms’ unit cost of production, shifting short-run aggregate supply left from SRAS₀ to SRAS₁, which raises the general price level from P₀ to P₁ — cost-push inflation, so consumer prices rise.

(c) How inflation can cause a wage-price spiral [3] — explain

When inflation is high, workers demand higher wages to restore the purchasing power eroded by rising prices. Granting higher wages raises firms’ cost of production, shifting SRAS further left and raising the general price level again. The higher prices prompt fresh wage demands, shifting SRAS left once more — a self-reinforcing spiral of rising wages and prices. (Extract 8 notes this is less likely in Singapore, where automatic wage indexation is uncommon and the price-to-wage pass-through is historically weak.)

(d) Tax cuts for growth versus tax rises to close the deficit [8] — discuss

The UK’s budget deficit — spending exceeding tax revenue — is set to exceed £100bn (Extract 9). The question is whether to cut taxes to spur growth that indirectly shrinks the deficit, or to raise taxes to close it directly.

The case for tax cuts. Lower income tax raises disposable income and consumption (C); lower corporate tax raises after-tax profit and investment (I). Both raise AD, and via the multiplier national income rises more than proportionately. Faster growth then improves the deficit indirectly: higher incomes and profits yield more tax revenue and less welfare spending (Extract 9, Philip Shaw). Tax cuts also have supply-side effects — higher investment raises productive capacity and potential growth, tempering inflation and, over time, the inflation-linked debt.

The case against — and for tax rises. Higher AD risks demand-pull inflation (Extract 9, Rishi Sunak), which is dangerous when CPI is already 7.4% and a quarter of the debt is index-linked, so the cuts could raise debt-servicing costs. Tax rises close the deficit directly by lifting revenue, and by reducing C and I they lower AD and ease inflation. However, tax rises also lower national income and employment, which can raise welfare spending and partly offset the gain.

Judgement. Whether tax cuts are preferable hinges on whether the growth they induce actually materialises. If households and firms are confident, the cuts raise C and I, growth pays for the borrowing, and the supply-side effects temper inflation — making cuts the better route. But if agents are pessimistic and simply save the windfall, AD does not rise, the deficit widens, and inflation-linked debt grows. Given that the UK’s 2022 inflation is already severe, the safer course is a targeted approach: tax cuts should be modest and paired with measures to contain inflation, rather than the large, unfunded cuts that risk fuelling it. On balance, prioritising growth via tax cuts is defensible only if confidence is strong and inflation is managed; otherwise direct consolidation is the prudent choice.

(e) Are supply-side policies alone sufficient for inclusive growth? [10] — discuss

Inclusive growth is broad-based growth that creates employment for the majority and does not worsen income inequality; it requires sustained — actual and potential — growth shared across the population. My thesis is that supply-side policy is necessary but not sufficient on its own: a policy mix is needed to secure actual growth, price stability and equity together.

Supply-side policies contribute to inclusive and potential growth. Singapore’s labour-market measures — calibrating foreign-worker inflows by raising minimum salaries and levies (Extract 8) — raise demand for and wages of local low-skilled workers, making growth more inclusive, while pushing firms towards training and automation that raise productivity and LRAS (potential growth). The Progressive Wage Model raises lower-wage pay alongside skills upgrading, again lifting both equity and capacity. In the UK, the Kickstart scheme tackles youth unemployment and builds skills, and the National Infrastructure Strategy’s universal internet plan widens access to online learning, raising productive capacity and equity (Extract 9).

But supply-side policies alone are insufficient. Inclusive growth also needs actual growth and price stability, which other policies deliver. Singapore’s exchange-rate policy — an appreciating dollar — stems imported inflation and lowers import costs for exporters, raising net exports and AD (actual growth), while shielding lower-income households from rising prices (Extract 8). Fiscal policy — spending on healthcare, education, infrastructure, R&D and targeted relief — raises both AD and LRAS and benefits the poor disproportionately, making growth inclusive. And the UK’s monetary tightening (base rate 0.1% to 1.0%, Table 2) targets the 7.4% inflation that most hurts the poor and limits inflation-linked debt. Supply-side measures are also slow and costly, doing little for the immediate inflationary storm.

Judgement. Supply-side policies are genuinely useful — indeed indispensable for the productivity and equity dimensions of inclusive growth — but they are not sufficient alone. They cannot, by themselves, deliver the actual growth and price stability that inclusive growth also requires, and they act too slowly against an immediate cost-of-living shock. Achieving inclusive growth needs the right policy mix: supply-side reform for capacity and equity, demand-management and exchange-rate policy for actual growth and price stability, and targeted fiscal support so the gains reach all households. Supply-side policy is one essential strand of the answer, not the whole of it.