Inflation, wages and productivity: What remains of the ‘cost of living crisis’?

Ed Miliband talks to the people of Brighton about the 'cost of living crisis' in 2014

Ed Miliband talks to the people of Brighton about the ‘cost of living crisis’ in 2014

On which issue the election will be won (if it will be won by anyone…) remains unclear – immigration, Europe, benefits, health? It has however, been ascertained that the economy will be an important battleground.

The Labour Party website cites as a leading issue under David Cameron, the cost of everyday essentials has soared but pay has flat-lined’. ‘Cost of living crisis’ has cemented itself as a regular feature in Miliband’s speeches.

CPI inflation project

What did last weeks inflation report reveal about the reality of this so-called ‘crisis’?

Headline inflation was just 0.3% (revised from 0.5&) in January, largely as a result of tumbling oil prices. Furthermore, the Bank of England’s projections anticipate inflation falling further, briefly turning negative in the coming months. Deflation itself is likely to be of a benevolent kind, increasing consumer purchasing power and providing only a modest threat to the sustained output expansion of recent months– Miliband’s cost of living crisis on this front looks to be ceasing just in time for the election.

Perhaps though, this is not the whole story. What did the report have to say on wages?

In fourth quarter (Q4) of 2014, wages grew at an annualized (nominal) rate of 3% and the Bank of England predicts wages to continue growing on a sustained expansionary path. Indeed this is inline with unemployment projections that show the remaining slack in the economy subsiding in coming months.

average earnings chart

On both accounts, Miliband really seems to have picked the wrong issue to launch an attack on the Tories. This is, I hasten to add, not to say that Labour has not captured the reality of the situation; regular pay growth has been almost consistently below inflation since 2009. In fact real wages are down 7.5% on 2008 levels. Reading into the recent wage growth further, wage increases are largely accounted for by wage growth in higher skilled sectors – those on low incomes continue to suffer.

So while the Conservatives will cite expanding output, rising wages and falling prices as evidence that a vote for them is a vote for prosperity, this rhetoric should certainly be taken with a pinch of salt. The National Institute for Economic and Social Research recently published a report claiming that GDP took a 1% hit as a result of the Coalition spending cuts with correspondingly greater damage to GDP per capita (and individuals take home pay…). This measure does include the enormous productivity shortfall that Britain has suffered in the aftermath of 2008 (which has been largely ignored by this government). The productivity shortfall now stands at 16% and output per worker is still 2% below 2009 levels – while the Bank of England is hopeful that productivity will grow by 1.75% this year, it is far from optimistic of any prospect of making up lost ground. Without productivity growth, wages will be permanently subdued with a corresponding impact on living standards. (NB: low wage growth makes the task of reducing the deficit harder too!)

So what would the Conservatives have in store during the next parliament to deal with this? NIESR estimates that the Conservative Party spending plans will accommodate a 0.2pp rise in wages by 2019 – contrast this with the 0.5pp that Labour plans would facilitate. This may seem marginal but coupled with Labour’s cost of living contract, the contrast between how well-off we feel may be substantial under Labour and Conservative governments (although one might be skeptical of how many of these Labour policies will materialize).

So, recent data has certainly made the task of Cameron and Osborne slightly easier – they can now claim that ‘hard working families’ are feeling the benefits of Britain’s strong recovery. And yes, true, they are, however, this ignores the permanent damage that has resulted from 5 years of spending cuts and a weak economic recovery. Families are poorer now than they were in 2010 and we should not be fooled by the Tories capitalizing on the back of economic sanctions against Russia (oil).

By Georgina Evans, Junior Writer for Daily Political View.

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