Inflation has caused the steepest rise in food prices in the UK in 40 years, the latest official figures show. But it’s not just food costs that skyrocket, or energy prices, for that matter. Consumer price inflation could also impact bills for services such as the Internet and mobile phones.
Many people are not particularly careful about the contracts they sign up for such services. It is common not to read clauses written in small print. When I recently checked my broadband contract, I was certainly surprised to find that I had signed up for an annual price hike in line with the January 2023 inflation rate plus an additional 3.7%.
While this would be a noticeable increase at any time, inflation is expected to be just under 10% in January 2023, according to the Bank of England. This could increase my account by almost 14% when my contract is renewed next year.
These so-called “inflation-plus” clauses fix contracts at the CPI inflation rate plus an additional amount, in my case, 3.7% of my current monthly broadband rate. For some broadband customers, these clauses could add more than £ 100 to their annual bills next year, consumer controller Which one? He says.
The inflation plus clauses are legal. They are written in the contract (although often in lowercase letters) and by signing them we accept them. But they are not fair and the government, as well as regulators, have a responsibility to look into this rising cost of living issue.
The first part of the clause – the element linked to inflation – is called “indexing the whole price to current or past inflation”. It is a strategy that is often used to update price contracts, particularly when inflation is high, to protect contract signers from rising costs.
The second part of the clause – the additional percentage on inflation – is a phenomenon that has not yet been labeled by macroeconomists, as far as I know. But after calculating the effect of inflation plus a 3.7% increase on my bill, I like to think of it as “turbo price indexing.”
What is indexing?
During times of rising inflation, companies need to make frequent price adjustments to compensate for rising costs. Indexing provides a simple rule of thumb to help companies update their prices between optimal adjustments designed to maximize profits.
There are several types of indexing. Full indexing to current inflation, for example, aligns prices exactly with the current inflation rate. Other types can increase with inflation but at a lower or higher rate, such as with turbo price indexing on inflation-plus contracts.
Indexing isn’t just used by companies that provide goods and services. Workers, as well as homeowners and some mortgage lenders, also use this strategy to keep up with changing costs. But the stronger the power of the person or organization that renegotiates a certain contract – whether it is a worker discussing an employment contract or a company setting new prices for its services – the easier it is to negotiate for the indexation of inflation.
So when inflation rises, indexing protects companies from rising costs. But when it comes to contracts for services like broadband, consumers generally don’t have the same bargaining powers as large companies. Also, because most employment contracts aren’t fully indexed, wages don’t rise to match the rise in our bills.
This is one of the reasons why high inflation can hurt low-income families the most. Unlike higher-income earners who often have more bargaining power to negotiate higher pay when prices rise, the wages of those with lower incomes typically aren’t fully indexed to inflation, let alone turbo-indexed. This means that these clauses can not only increase inflation, but they can also exacerbate income inequality.
Spiral of wage prices
Of course, if inflation remains high for a long time, workers can start organizing through trade unions to demand that their pay be linked to inflation. We have seen this in recent months. In this situation, governments often worry about creating a wage price spiral where rising wages encourage higher spending, further pushing inflation and causing more wage negotiations.
And by updating prices more than the rate of inflation, these turbo-pricing clauses could further contribute to that spiral, worsening the economic environment. In fact, research shows that the use of indexing makes it more difficult to reduce inflation in this type of scenario.
Economic policy can be used to address this situation. But in a time of high inflation and low GDP growth, a government’s fiscal policy may be at odds with a country’s monetary authority or central bank, which typically want to reduce inflation. This is because the government can benefit when high inflation reduces the cost of a tax cut or increased spending. This is the situation right now in the UK.
What can you do?
An independent regulator such as the UK Competition and Markets Authority could help consumers combat price increases linked to indexation. Research has found that wage indexation occurs less when markets are more competitive. Likewise, price indexation should be lower in highly competitive markets.
In other words, multiple instances of price indexation clauses can signal insufficient competition in an industry, allowing companies to raise prices. The Competition and Markets Authority is responsible for investigating these concerns about the structure of the market, with the aim of increasing competition and protecting consumers.
Otherwise, just like workers, consumers can negotiate to reduce inflationary price increases in the cost of services such as the Internet or cell phone coverage. Not everyone has the time, patience, or confidence to call suppliers to secure a less expensive deal at the end of a contract. But research shows that people who stay on more expensive rates usually fund the cheaper deals of savvy consumers who are willing to bargain.
With more savvy consumers around, businesses wouldn’t find it convenient to introduce such clauses, as they wouldn’t generate enough additional profits from these turbo price hikes.
This article was republished by The Conversation under a Creative Commons license. Read the original article.
Lorenza Rossi does not work, consult, own stock or receive funding from any company or organization that would benefit from this article and has disclosed no relevant affiliations beyond their academic tenure.