The Real Britain Index: a more accurate measure of living standards

Photo credit:   Franz Jachim

October 15, 2014 // By: James Meadway

Officially inflation has fallen again this week, down to just 1.2%. The rate at which prices are increasing is, according to the government’s preferred measure, gradually slowing down.

Yet as millions of people are only too aware, their own earnings are having to stretch further than ever before. Once rising prices are accounted for, average earnings have consistently fallen since 2008. This is the longest sustained decline in most people’s standard of living since records began – you have to go back to the 1870s to find anything similar. On official measures, average real earnings are down 8 per cent since 2008 - but new NEF analysis reveals that this is a significant understatement.

The official rate of inflation – the Consumer Price Index (CPI) – is designed to reflect changes in average prices. It is calculated according to what the “average” consumer buys, and by adding up the price changes within this average shopping basket.

But no one is truly average. We all buy different things, which means our own experience of inflation will vary from this official measure – and significantly according to how much we earn.

Because we all need to pay for essentials – food, housing, heating and so on – we aren’t completely free to choose what we buy. And if you have less money, you will have even less freedom: you will have to devote proportionately more of your income to essentials than someone with cash to spare.

Across the whole population, we find that the proportion of income spent on essentials falls with rising income – an observation known, in the case of food, as Engels’ Law – named after a 19th century statistician.

But if prices of these essentials rise faster than prices in general, the poorest will be squeezed harder than the average measure of inflation suggests. This is exactly what has happened over the last few years. As the graph below shows, prices of essentials – housing excepted – have shot way ahead of prices in general, as measured with the official Consumer Price Index (CPI) figure.

Price of selected items, 2005-2014

By taking account of how people on different incomes spend their money according to ONS survey data, we can show a rate of inflation for each income group that is a better reflection of their  experience. The graph below shows the cumulative impact of rising prices for the whole population, grouped in 10% chunks from the poorest to the richest:

 

Cumulative impact by income decile

Over the last 8 years those on the lowest incomes have experienced substantially more inflation than those further up the scale. They have less choice over how they spend their more limited funds, and so more directly suffer the impact of the rising price of essentials (in case you’re wondering, the slight increase for the richest 10% appears to be the result of rapid rises in school tuition fees).

Putting this together with ONS income data, taken after taxes and benefits, we can show the impact on real earnings across the population. The table below shows how incomes have changed for each group over the pre-crash period, the years immediately after the crash, and the period of Coalition government to now.

Income impact by decile

There has been a general decline in real incomes – although we note here that the data is not detailed enough to capture what has happened to the top 1% and 0.1%. It is those in the “squeezed middle” who have suffered the worst impact, with those in the 60-70% group earning an average of (pre-tax) £33,712 experiencing a fall in real income by 10.6% since 2006.

Breaking the figures down further reveals some disturbing trends. While real incomes held up comparatively well in the two years following the crash, the years since 2010 have seen a marked turn for the worse. This downward pressure has not been applied evenly: in the last year for which we have data, 2012/13, the real incomes of top 10% actually increased by 3.9%. Those in our 60-70% band fell 1.8%. But those in the very lowest group, the 0-10%, saw their already meagre earnings drop an extraordinary 15% in a single year – driven largely, it would seem, by welfare and benefits changes.

This analysis has troubling implications. The UK is rapidly becoming a more unequal country, with the inflation effect exaggerating and speeding up this transformation. It’s also a transformation barely hinted at by official measures of inflation.

That’s where our new RBI comes in. While the CPI might fail to accurately reflect the reality of skyrocketing prices and falling incomes, every month we’ll release updated figures that more closely align with the experiences of the majority of UK earners. As the scale of the problem becomes clear, so does the need for concerted action to boost wages for those on lower incomes and tackle the spiralling cost of food and other essentials.

Issues

Macroeconomics

The Real Britain Index: a more accurate measure of living standards

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