Research report – UK Essentials Index

Please note – the full report can be downloaded here:

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

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