King’s Speech: Bank Governor highlights 12% cut in take home pay
In an astonishingly frank speech yesterday, Mervyn King explained that high inflation had squeezed real take-home pay by 12% over the last few years. And this was on the day we learned that the economy had shrunk by 0.5% in the final quarter of 2010. Mervyn King also said that he expects CPI inflation to head to between 4% and 5% in the coming year so there will be no respite from this reduction in disposable income.
It seems without precedent for the Governor of the Bank of England to carefully calculate how much worse off we all are as a consequence of wage increases consistently falling below inflation and then to broadcast this to the whole nation. This might normally be calculated in-house and kept under wraps. Although IDS analysis of pay rises and inflation has been pointing to the differences over the past year or so.
In his speech, he explains how inflation has risen, driven by high import prices, world energy prices, and the combined effects of the increases in VAT. The Governor says the rise in VAT this month will push up the level of prices by 1.5%. He explains:
‘The three factors I described – higher import and energy prices and taxes – have squeezed real take home pay by around 12%. Average real take-home pay normally rises as productivity increases – money wages normally rise faster than prices. But the opposite was true last year, so real wages fell sharply. As a result, in 2011 real wages are likely to be no higher than they were in 2005. One has to go back to the 1920s to find a time when real wages fell over a period of six years.’
You can hear the sharp intake of breath as both employers and unions involved in pay negotiations take in what the Governor is saying. How do employees seek to regain this lost income? Can employers meet higher expectations through productivity or work re-organisation? Can higher profitability in large companies turn into inflation matching pay increases in 2011? Are long–term pay agreements the answer with further increases linked to the RPI? Will the Government continue to impose a two-year pay freeze on the public sector with its implication of further reductions in disposable income over 2011 and 2012?
We are aware that these are real discussions taking place up and down the country at the moment and that the median pay rise is now nearly 3% in manufacturing, which has enjoyed a better recovery than elsewhere. For the moment, though, most pay rises are falling short of the CPI and the RPI, both of which are heading for 5% in the near-term. Is this drop in disposable income compatible with economic recovery?