Research report – UK Essentials Index

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Essentials index Nov 2013

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The TM UK Essentials Index

Measuring the real cost of living

This report inaugurates publication of the TM UK Essentials Index, successor to the index previously published by Tullett Prebon.

Data for October shows that the cost of household essentials is increasing at an annual rate of 3.0%. Though an improvement over September (3.3%), the cost of essentials continues to out-pace both official (CPI) inflation (of 2.2%) and increases in average wages (0.8%). What this means is that the longest and deepest period of household impoverishment for at least 80 years is continuing to erode the real value of incomes. 

The impairment of disposable incomes by an escalation in the cost of non-discretionary purchases (such as energy, fuel and food) is a long-established trend. Since 2007, the cost of essentials has increased by 37%, far more than official inflation (21%), let alone average wages (11%). Measured solely against essentials, the real value of wages has declined by 19% over that period.

This quantification of the impact of escalation in the cost of essentials reinforces the “cost of living crisis” that Labour has identified, surely correctly, as a pivotal battleground for the next election. In fact, this process began long before the current government took office, and the deterioration in net-of-essentials earnings was at least as bad during 2007-10 under Labour as it has been since the coalition took office. Even so, the Conservatives and Liberal Democrats have been in office for too long for this to cut much ice with voters.

This report identifies four principal reasons for the escalation in the cost of essentials. Devaluation has played a significant part, as has the on-going tightening of energy markets. Wage stagnation has been the price paid to keep unemployment in check. Additionally, there is a severe lack of competition in critical industries including energy supply, water services and food retailing. 

 

Headline indicators
Monthly TM UK Essentials Index rates of change: October 2013: 3.0% September 2013: 3.3% October 2012: 3.6%	Annual TM UK Essentials Index values: 2012: 162.2 2011: 156.4 TM UK Essentials Index rates of change: 2012: 3.7% 2011: 7.8%

 

Overview

Figures for October confirm that the cost of household essentials continues to rise much more rapidly than wages, so that the real value of incomes continues to erode. What British working people are experiencing is almost certainly the deepest and most protracted deterioration in living standards in modern times, and probably exceeds the pain suffered during the Great Depression of the 1930s.

Compared with an increase of 11% in average wages since 2007, the cost of essentials has increased by 37%, which means that the real value of wages, measured against the cost of essentials, has decreased by 19% over that period.

Since 2007 there have been particularly sharp rises in the costs of gas (+57%), electricity (+32%), food (+30%) and water (+23%). It is significant that each of these sectors is dominated by a small number of players, which denies consumers the benefits of competition. It is significant, too, that each is an energy-intensive industry.

As figs. 1 and 2 show, above-CPI escalation in the cost of household essentials is a long-established phenomenon. Since 2007, however, nominal wages have stagnated, with average total weekly earnings just 11% higher now (at £474) than in 2007 (£427).

In round terms, whilst annual average pre-tax wages have increased by £2,470 since 2007, the cost of essentials has increased by £3,320, making the average working person worse off by £16.40 per week. This has been exacerbated by increases in taxation, most notably the increase in the rate of VAT.

The charts and table on the following two pages amplify the disparate movements in wages, CPI inflation and the cost of essentials since 2002 and 2007.    

 

Fig. 8: summary statistics

	2002		2007		2008	2009	2010	2011	2012	2013*
TM UK Essentials Index:
Index value**	100		127		138	143	151	163	169
Annual change	+1.9%		+4.5%		+8.4%	+3.8%	+5.7%	+7.8%	+3.7%	+3.0%
Consumer Price Index:
Index value**	100		112		117	119	123	128	132
Annual change	+1.3%		+2.3%		+3.6%	+2.1%	+3.3%	+4.5%	+2.8%	+2.2%
Average wage:
Index value**	100		124		128	128	131	134	136
Annual change	+3.2%		+4.9%		+3.5%	0.0%	+2.2%	+2.4%	+1.6%	+0.8%
Real wages measured against:
CPI**	100		110		110	108	106	104	103
Annual change			+2.5%		-0.1%	-2.1%	-1.1%	-2.0%	-1.2%
TM UK Essentials**	100		97		93	89	86	82	80
Annual change			+0.4%		-4.5%	-3.7%	-3.3%	-5.0%	-2.0%

* Year to October 2013 ** Indexed, 2002 = 100

Commentary

Although the British economy is now recovering, the vast majority of working people could be forgiven for doubting the reality of the upturn. According to the most recent numbers from the Office for National Statistics (ONS), average wages are growing at 0.8%, far below CPI inflation of 2.2%, so working people are getting poorer.

This continues a pattern of impoverishment which has become well-established. At present, wages are 11% higher than the average for 2007, but cumulative CPI inflation over the same period has been 18%.

Disturbing though these figures are, there are reasons to suspect that the reality on the ground is even worse, because of the particularly sharp increases that have impacted the prices of essential, unavoidable purchases such as food, energy and fuel. Between 2007 and 2012, for example, the prices of electricity, gas, petrol, fuel, food, water, vehicle tax and insurance, travel fares, alcohol and tobacco all outstripped broad (CPI) inflation, let alone average wages.

Statisticians and politicians may differ about whether Britain has been getting better or worse off, but these calculations make it very clear that the average British wage-earner has become a great deal poorer, and that this process of impoverishment is continuing.

This process – very probably the deepest as well as the most protracted deterioration in prosperity ever recorded in Britain – divides into two distinct chapters.

From 2002 to 2007:

• Average wages improved by 24%.
• This kept pace with the cost of essentials, which rose by 22%.
• But average household debt increased by £24,000 (77%).

Since 2007, by contrast:

• Average household debt has been flat.
• But wages have increased by only 11%.
• The cost of household essentials has risen much more rapidly (37%), leading to a sharp (19%) fall in real earnings as measured against essentials.

These periods, though distinct, illustrate a common feature – essentially, Britain has seemed increasingly incapable of achieving debt-free growth.

Expressed at constant (2012-13) values, GDP increased by £287bn (22%) between fiscal years (FYs) 2001-02 and 2007-08, but combined individual and government debt increased by £825bn over the same period. Since 2007-08, debt levels have continued to rise (by £440bn), but the economy has contracted.

The skewed relationship between borrowing and growth has long been a key interpretive tool for the British economy.

• During the period before 2001-02, growth and borrowing were largely in balance.
• Between 2001-02 and 2006-07, average growth (of 3.5%) was far adrift of annual incremental debt (11.6% of GDP), with private borrowing (8.6% of GDP), rather than fiscal deficits (3.0%), bearing the brunt of the escalation in debt.
• From 2007-08, the almost overnight collapse of net private borrowing was replaced by state borrowing, with deficits averaging 8.6% of GDP between 2007-08 and 2012-13 whilst overall growth slumped to zero.

Now, all the indications are that the government wants to revive private borrowing, both through both Funding for Lending (FfL) and Help to Buy (H2B). This policy may boost near-term economic growth, but will also add to levels of private indebtedness that are already uncomfortably high. 

Measurement of the cost of essentials provides a vital referencing point for the affordability of incremental household debt. At its peak (at the end of 2008), average household debt was £55,100, a figure that had fallen to £53,200 today. Over that time, nominal incomes have improved by 11%, seemingly reducing average household indebtedness ratios.

Realistically, though, the critical income parameter for debt sustainability is disposable income net of essential outgoings, not gross income. On this basis, disposable incomes have fallen by far more (19%) than the decrease of just 3.4% in average household indebtedness. The government’s plans to encourage private borrowing may indeed boost the economy, but are the equivalent to pouring petrol onto a blaze where household indebtedness is concerned.

However we look at it, the key economic (as well as political) battleground is the escalating cost of essentials, and this is what makes the TM UK Essentials Index so important.

In terms of the economy, the equation is simply stated – for as long as the cost of essentials continues to out-grow earnings, people will get poorer, private discretionary consumption will lag (even if individuals can be persuaded to take on yet more debt), and the ratio between average debt and average disposable incomes will worsen.

From a political perspective, a continued deterioration in real disposable incomes will reinforce Labour’s “cost of living crisis” campaign theme.

The critical questions, then, must be:

(a)   Why does the cost of essentials continue to out-grow incomes?

(b)  What, if anything, can be done about it?

Why has this happened?

Where causes are concerned, analysis identifies four critical variables:  

The first of these is wage stagnation. Here, the trade-off has been that unemployment has been lower than might have been expected, but that the price of this can be measured in the depressed level of wages.

Second, devaluation has played a significant role in the surge in the cost of essentials. The slump in the value of sterling since the financial crisis has shielded Britain from some of the worst effects of the downturn, but the price has been an escalation in the cost to British households of purchases which are priced internationally, an effect evident not just in direct pricing but in input costs as well.

Third, it is clear that escalating energy costs have played a significant role in the rising cost of essentials. As well as direct energy purchases (such as gas, electricity and fuel), the costs of many essential purchases (such as food) are extensively geared to the price of energy inputs.

Lastly, lack of competition has clearly worsened the surge in the cost of essentials. The supply of energy, food and water account for more than half of the TM UK Essentials Index, and each of these sectors is dominated by a small number of companies.

What can be done?

Even though some factors (such as the sterling exchange rate, and the global prices of food and energy) are not under domestic control, there are two things that government could do to stem the escalation in the cost of household essentials.

1. Adopt a much more proactive energy strategy.
2. Act to transform competition in key sectors. 

The government should prioritise securing energy supplies for the future. Production of oil and gas in the North Sea is declining steeply, coal-fired power stations are subject to accelerated closure, and a high proportion of Britain’s nuclear reactors are nearing their decommissioning dates, despite life extensions.

Although energy consumption may continue to decline, the gap between demand and indigenous production seems certain to widen (fig. 10).

This is a chart that should shock anyone out of energy complacency. Between 2000 and 2012, the production of fossil fuels plus nuclear energy declined by 62%, from 260 mmtoe (million tonnes of oil equivalent) in 2000 to just 100 mmtoe last year. Though energy consumption has declined slightly (by 15 mmtoe, or 7%), Britain has swung from being a net exporter of conventional fuels to a very big importer. Production of renewables increased sharply between 2000 (2 mmtoe) and 2012 (15 mmtoe), but still accounts for only 7% of domestic energy consumption.

Britain now imports 44% of its total energy requirements, and this gap seems certain to widen as hydrocarbon production declines, coal-fired power stations close and nuclear capacity decreases. Together with food imports and a slump in net overseas income from investments, energy has been a major contributor to the alarming deterioration in Britain’s current account balance with the rest of the world.

To counter this, government should invest in an accelerated programme of building nuclear power stations, and should also invest in enhancing gas storage so that gas can be bought in the summer, when prices tend to be a lot lower than in winter.  

Second, government could do far more to promote competition in the supply of essentials. The industries which supply electricity, gas, water and food are far too concentrated for effective competition to operate. Government could use competition law to break-up Britain’s concentrated energy, water and food retail sectors, ideally so that no single company controls more than 10% of these markets.

As an interim measure, it is imperative that energy suppliers be required to disclose the input costs of energy that is on-sold to consumers.

 

Tim Morgan

November 2013

#9 The real cost of living – the Essentials Index is back

Even if Ed Miliband hadn’t identified the “cost of living crisis” as a potent political weapon, I had already planned to resume tracking the price of a basket of household essentials. With the blessing of my former colleagues at Tullett Prebon, publication of the TM UK Essentials Index will proceed on a monthly basis, starting with the November issue.

To get the new report (and its successors), please sign up using the contact form which you can find at www.surplusenergyeconomics.com.

The basic story, of course, is a familiar one. Between 2007 and 2012, the price of essentials increased by +33%, a far bigger increase than CPI inflation (+18%), let alone average wages (+10%). If you measure the average wage against essentials alone, its purchasing power declined by 17% between those years. This trend is continuing – as of October, the cost of essentials is rising at an annual rate of 3.0%, well ahead of CPI (2.2%).

The current rate of increase is a marked improvement over recent years – the cost of essentials rose by 8.4% in 2008, 3.8% in 2009, 5.7% in 2010, 7.8% in 2011 and 3.7% last year.

This is pretty cold comfort, however, for two main reasons. First, wage growth is extremely low at the moment (0.8%). Second, the soaring cost of essentials is a cumulative process – the latest figure makes essentials 37% more expensive now than they were in 2007, whilst wages are only 11% higher.

As far as I can discover, this is a deeper and more protracted deterioration in living standards than anything that we’ve experienced before, certainly in living memory.

So far as I’m aware, Ed Miliband isn’t aware of the TM UK Essentials Index, but it certainly seems to reinforce his point about the “cost of living crisis”. Actually, the blame for this process of impoverishment isn’t as clear-cut as you might think, since things were at least as bad between 2007 and 2010, under Labour, as they have been since then under the Coalition. This said, blaming the slump in living standards on events before 2010 isn’t going to cut much ice with voters in 2015.

My report identifies four main causes behind the escalating cost of essentials. First, devaluation has obviously increased the sterling cost of commodities (and inputs) such as energy and food, which are priced on international markets. There’s not much that any British government can do about this    

Second, there has been a severe squeeze on wages, which is, in part anyway, the price that has been paid for avoiding an escalation in unemployment. There’s not too much that the government can do about this, either.  

But the tightening in international energy markets is not something that the government should be complacent about. My November Essentials report contains a chart of UK energy production and demand which is truly scary. We really do need to be investing in British-owned nuclear power generation, as well as increasing storage capacity so that we can buy more of our gas imports in the summer, when they are cheaper. We also ought to be developing waste-to-heat conversion as an urgent priority.

Lastly, some of the big “essentials” sectors – including the supply of energy, water and food – suffer from a woeful lack of competition. Ideally, we would ensure that no company has greater than, say, a 10% share of any of these markets. Competition is the most powerful economic force favouring the customer, and it really needs to be unleashed in the interests of hard-pressed working households.

 

#8 The wrong kind of recovery

A broadly-based recovery would involve interest rates high enough to encourage capital formation – not low enough to stimulate yet more borrowing.

The true magnitude of the British economic recovery is a subject for legitimate debate, but this debate largely misses the point. The real issue is the nature of the recovery.

Some believe that Britain deserves its place at the top of the developed nations’ “growth league”, and that the government has confounded the doomsayers who argued that fiscal austerity would prove a disaster.

Others retort that this is nothing more than a “fluff bounce”, in which an economy that has not been rebalanced plays the debt-funded consumption card yet again. To such sceptics, the recovery is built on borrowing, and is inconsistent both with an appalling current account deficit and with interest rates that are far too low for capital formation to happen.

For me, the real issue is the contradiction between positive economic stats, on the one hand and, on the other, an on-going deterioration in living standards. It is a strange recovery indeed that coincides with an ever-growing recourse to food banks and the first shipment of Red Cross food parcels to Britain since 1945.

What we need, then, is “a different kind of recovery”. The kind of recovery that I have in mind is broadly-based and sustainable.

What do I mean by this?

Well, a broadly-based recovery would involve the living standards of the majority improving, not deteriorating. It would be driven by exports and investment, not by a debt-fuelled spurt in consumption. Interest rates are the bellwether here – a broadly-based recovery would involve interest rates high enough to encourage capital formation, not low enough to stimulate yet more borrowing.

To be sustainable, a recovery would need to be about securing the economy of the future, not just the spending of today. Such a recovery would involve pain now for gain later. For example, higher interest rates might stem growth in current consumption, but would stimulate capital formation so that we can invest in the future.

As business leaders have been telling government for longer than I can remember, we need infrastructure investment. This investment, though, should be immediate, and high-return. Fixing potholed roads, for instance, would do far more good than the ludicrous HS2 vanity project. Building council houses would make far more sense than borrowing to inflate the values of houses that already exist. Above all, we should be trying to shore up our energy supplies, rather than expecting foreign investors to do it for us.

In short, a recovery based on property price inflation, vanity projects and consumer-funded debt is a cop-out.

What we need instead is a recovery based on investment, which in turn requires capital formation. Thus understood, it is the continuation of ultra-low interest rates that gives the lie to any solidity claimed for the recovery.