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Mon 1 Oct 2007 02:14 PM

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The need to cap pay rises

The Middle East needs to take the painful step of setting a cap for public sector-owned industries to rein in inflation.

Yesterday's news that pay increases in the GCC have hit 9% no doubt sent a warm glow through those about to embark on their annual round of pay negotiations, but it will also be a wake up call for companies and economies fighting a battle to keep their prices and economies stable.

The UK's first female prime minister, Margaret Thatcher, lost many battles but eventually won the war - and admiration and hatred in equal measure - for breaking a cycle of high inflation - or stagflation - and ever-rising wage demands.

What the U"S first female prime minister knew was that expectations of high inflation lead to demands for higher pay. And understandably so - everyone wants a better standard of life, not a worse one.

The problem for the UK was that its economy was fast becoming uncompetitive.

If salaries continue to rise as fast as inflation, inflation does not go away - prices of goods and services will continue to rise. And long term that means a country will slowly price itself out of the international market.

Some GCC countries are already beginning to feel this with the increasing cost of doing business forcing regional and international companies to look elsewhere to set up operations.

Britain was much further down this road. Her industries - once world beaters - were going under - and still people were demanding better pay, conditions - and job security - leading to increasing nationalisation of industries just to keep them solvent.

With little control over the private sector Margaret Thatcher's solution was to end the cycle of inflation and pay rises by turning off the tap to government-owned businesses and industries. She destroyed the biggest obstacle - the unions - who had previously collectively bargained - and threatened - for pay rises.

It was a hugely painful episode of UK history with high unemployment, high inflation, and much social pain and strife.

But it also led to the country's longest period of growth and a revitalisation of the British economy - the benefits of which have lasted until this day.

GCC economies are nowhere near where the UK was at the end of the 70s. But individually each market needs to pay attention to the cost of doing business within its borders if it wants to remain a competitive business hub.

And they will have to do this with one hand tied behind their backs.

Those countries with a dollar peg have been forced to cut interest rates at a time when they should be making borrowing harder. Employees who have felt the pain of rising prices have turned to easy credit to support their lifestyle, increasing the amount of money - or M0 for the economists out there - in the system.

Employees going into rounds of pay bargaining will also have factored inflation into their demands. They will want an 11% increase just to be as well off as last year - and then something on top to improve their living conditions.

Without attending to these two problems inflation is not going to go away. And as time goes on it will make the region less competitive, and a correction ever more painful as and when it happens.

Regional economies firstly need to begin to take control over their economies, raise interest rates and tighten their control of credit. The means dropping the dollar peg, which in turn means abandoning the idea of a single currency - for now.

That represents a significant but inevitable political blow.

Secondly regional governments need to begin to take a leading role on pay and set a cap for the public sector - the ministries and government-owned industries that are the largest employers of the local population - and use that as an example for the private sector.

This will be a painful step to take, but to rein in inflation, return business stability and guard competitiveness, it is a bullet that the region needs to bite down on. Hard.

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