Are falling living standards inevitable?
Today’s IFS report sets out the scale of the living standards falls that families across the UK are set to experience in the years ahead. The impacts are significant, with the consequences of public spending cuts and tax rises on UK household incomes set to be felt for up to 10 years and with households having already experienced a 3.5% fall in median net household income in the year to April, the largest drop since 1981. As our own research showed last week, for an average household the living standards gap is likely to be equivalent to a loss of £4,600 a year by 2013.
But a key question, as was put to me as I Woke Up to Money this morning, is whether these living standards falls are inevitable. The Government would have us believe there is no other way. Their story is that without sharp and immediate cuts interest rates will rise, growth will be stifled, confidence will plummet and the outcomes for everyone will be worse. But the facts don’t bear this interpretation out – indeed the Government’s worst case economic picture is looking increasingly similar to our economic reality, with an additional dose of austerity on the side.
There are two key reasons the Government story doesn’t stack up.
Austerity is a direct cause of falling living standards
Falling living standards are a result of real incomes not keeping up with inflation, which has in part been directly caused by Government cuts and tax rises: incomes are being squeezed by higher VAT, tax credit and benefit cuts and a change in the inflation measure these payments are uprated by (from the higher RPI measure to CPI). These measures are all a direct result of the Government’s decision to attempt to cut the deficit over 4 years with an 80:20 split between spending cuts and tax rises (and significant corporation tax cuts for large businesses and banks).
Slow growth and a weakening labour market are also contributing
The other reason is that wages are trailing inflation. In the public sector this is because of a continuing pay freeze, while in the private sector it’s because weak growth in the economy and a slack labour market mean that few industries are in a position to bargain for pay rises that match or exceed inflation.
And crucially, austerity is playing a role in limiting the economic recovery (and therefore exacerbating the problem of falling real wages). As the global economic outlook darkens, consumers have less to spend and when Government simultaneously cuts back on expenditure demand in the economy remains weak and confidence falls. It’s this combination of factors which has led to growth of only 0.2% in the second quarter of 2011 and which means that GDP per worker in the UK remains 13% below trend, the worst in the G7 by some margin. With growth slowing, unemployment rising and underemployment at its highest levels for decades it is no wonder wages are trailing inflation.
The Economist recently spelled out the impact that austerity is having for recoveries around the world:
The left is right on one thing: the main cause of the current high joblessness is the severity of the last recession and the weakness of the subsequent recovery…the main culprit is a collective, premature shift to fiscal austerity by governments.
And as the Managing Director of the IMF has said:
Slamming on the brakes too quickly will hurt the recovery and worsen job prospects.
Without Government stimulus our economy will remain at high risk of continued stagnation and at worse a double dip recession – and the further decline in jobs and incomes that either scenario would bring. In contrast a focus on boosting demand and a slower deficit reduction timetable has potential to improve living standards and support growth, which in turn would further support jobs and incomes.
Of course the deficit can’t just be ignored. But austerity is proving to be self-defeating. Government support for a strong and growing economy provides our best chance of rebalancing our public finances – and of improving living standards and job prospects in the process.