The prices of everyday goods and services are rising about twice as rapidly as average wages, Tuesday’s inflation figures confirmed – which means that the standard of living of many Britons is already falling.
According to the Bank of England, average pay at the end of this year will be able to buy no more than it could in 2005.
It is the first time that the purchasing power of earnings has fallen so far since the 1920s.
“Average real take-home pay normally rises as productivity increases – money wages normally rise faster than prices,” said Mervyn King, Bank governor, earlier this month.
“But the opposite was true last year, so real wages fell sharply. And given the rise in VAT [value added tax] and other price rises this year, real wages are likely to fall again.
“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.”
The Bank has not published its forecast for wage growth for the current year. But pay is rising at no more than 2 per cent annually.
Even though Income Data Services, a pay consultancy, estimates it may rise 3 per cent this year, Mr King wrote to George Osborne, the chancellor, on Tuesday that inflation might hit 5 per cent, so the maths behind the governor’s strictures is easy to grasp.
Paul Gregg, professor of economics at Bristol University and an expert in labour markets, highlighted an unusual combination of weak wage growth and high inflation.
“With the onset of recession, firms tend to cut prices,” he said, a move that tended to ease inflation.
Even if wages were stagnant, purchasing power should not fall by much. What was different now, aside from the inflationary pressures from higher taxes as Britain sought to tackle its yawning deficit, was strongly rising commodities prices.
“The developing world is booming,” he said. “It may be that the developed nations are no longer the driver of world demand.”
The Bank’s data show there have been other points since the 1920s when wages fell in real terms. Between 1976 and 1980, after a recession induced in part by a sharp rise in oil prices, and in the years after the recession of the early 1990s – between 1992 and 1993 and between 1994 and 1995 – wages fell behind prices.
But in none of those instances did pay and inflation go so far out of kilter as now.
Ray Barrell, senior research fellow at the National Institute of Economic and Social Research, said its inquiries going back a century suggested there was one reason for falls in real wages: the kind of crisis that left permanent economic scars.
The monetary policy committee’s decision to slash rates had thus far insulated households from the full pain of their diminishing purchasing power. It immediately added cash to households with mortgages, as did the cut in VAT to 15 per cent in December 2008. But VAT had now risen again and mortgage rates had no further to fall.
One characteristic of British pay scales – a rise in average pay that was 1.5 to 2 percentage points higher than inflation – might not be manifest again for many years, if ever, he said.
Inflation-plus wage rises disappeared from other economies such as the US and Germany more than a decade ago. “Trade-based competition is suppressing growth in real wages and there is no reason why wage rises above inflation should continue in Britain,” said Mr Barrell.
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