As we saw in Part 1, households are seeing a rise in the cost of living, which is set to accelerate. Inflation in the year to January 2022, as measured by the Consumer Prices Index (CPI), was 5.5%, the highest rate for over 30 years, and it is expected to reach more than 7 per cent by April. This has put great pressure on household budgets, with wage rises for most people being below the rate of price inflation. The poor especially have been hard hit, with many struggling to meet soaring energy, food and transport prices and higher rents.
In Part 2 we look at the UK government’s response to the situation, a similar response to that in many other countries.
Effects on government finances
The Chancellor, Rishi Sunak, has stated that the government understands the pressures families are facing with the cost of living. However, rising interest rates mean that it will cost the Treasury considerably more to service the UK’s national debt of more than £2tn.
Interest payments on index-linked debt are calculated using an alternative measure of inflation, the retail prices index (RPI), which is running at 7.8%, considerably higher than anticipated in last October’s Budget. It is now projected that central government spending on debt interest this financial year will come in at around £69bn, some £11bn higher than the £58bn forecast in the October 2021 Budget and £27bn above the £42bn forecast in the March 2021 Budget.
In addition, it is expected that the latest rise in CPI will increase the chances of the Bank of England raising interest rates and thereby further increasing the costs of servicing national debt. If this is the outcome when its Monetary Policy Committee meets next month, then it would be the third successive time interest rates have been raised.
There is also concern that this, in addition to the direct effects of higher costs, will push more firms towards insolvency. It is argued that if government wanted to prevent this, it would need to cut business taxes in order to boost investment and productivity and to allow businesses to provide annual wage rises that are affordable.
Monetary policy
The Bank of England’s traditional response to rising inflation is to raise interest rates, which it has done this twice in the past few months. This means that people who have borrowed money could see their monthly payments go up, especially on mortgages tied to Bank Rate.
An aim of this policy is to make borrowing more expensive resulting in people spending less. As a result, they will buy fewer things, and prices will stop rising as fast. However, when inflation is caused by external forces, this might have a limited effect on prices and would put a further squeeze on household budgets.
Fiscal policy
Alternatively, the government might choose to cut taxes for consumers on items whose prices are rising quickly. It is taking some measures to reduce the impact of energy price rises. For example, the Treasury has announced that it would provide millions of households with up to £350 to help with their rising energy bills and in April the lowest-paid will see the National Living Wage rise by 6.6%, which is higher than the current inflation rate.
The chief economist of the British Chambers of Commerce has said that tightening monetary policy too quickly risks undermining confidence and the wider recovery, arguing that more needs to be done to limit the unprecedented rise in costs facing businesses, including financial support for those struggling with soaring energy bills and delaying April’s national insurance rise.
Conclusion
Rising inflation affects all our living standards. It a global issue with causes beyond government control.
Rising prices together with planned tax increases mean that real average take-home pay is likely to fall over the coming year. The extra energy costs and tax rises will force families to make savings elsewhere, meaning business revenues may fall, and the economic recovery could be negatively impacted.
However, it is those on low incomes that tend to find it hardest to cope with the rising cost of living. Those impacted the most will be faced with difficult decisions over the coming months as they try to cope with falling real incomes. With food price inflation expected to rise further, a likely rise in interest rates and a further increase in the energy price cap in October, these tough decisions are set to get harder for poorest households in the economy.
Articles
See articles in Part 1
Podcast
Questions
These questions are based on the podcast.
- What elements are there in household energy prices? Which element has gone up most?
- What are the arguments for and against the government delaying the rise in the rate of national insurance by 1.25 percentage points?
- What can be done to help people on modest earnings who earn just too much to receive benefits?
- Are government loans to help people with higher bills a good idea?
- What are the advantages and disadvantages of removing VAT on domestic energy?
Households are expected to see further rises in the cost of living after the annual inflation rate climbed for a 13th month to its highest point in almost 30 years. This will put further pressure on already stretched household budgets. The increase reflects a bounceback in demand for goods and services after lockdowns, when prices fell sharply. It also reflects the impact of supply-chain disruptions as Covid-19 hit factory production and global trade.
The biggest concern, however, is the impact it will have on those already hard-pressed families across the UK. According to official figures, prices are rising at similar rates for richer and poorer households. However, household income levels will determine personal experiences of inflation. Poorer households find it harder to cope than richer families as essentials, such as energy and food, form a larger proportion of their shopping basket than discretionary items. On average the lowest-income families spend twice as much proportionately on food and housing bills as the richest. So low-income households, if they are already spending mainly on essentials, will struggle to find where to cut back as prices rise.
Latest Inflation figures
Latest figures from the ONS show that the Consumer Prices Index (CPI) rose by 5.5% in the year to January 2022, with further increases in the rate expected over the next couple of months. In measuring inflation, the ONS takes a so-called ‘basket of goods, which is frequently updated to reflect changes in spending patterns. For example, in 2021, hand sanitiser and men’s loungewear bottoms were added, but sandwiches bought at work were removed.
Annual CPI inflation is announced each month, showing how much the weighted average of these prices has risen since the same date last year. The weighted average is expressed as an index, with the index set at 100 in the base year, which is currently 2015.
Consumers would not normally notice price rises from month to month. However, prices are now rising so quickly that it is clear for everyone to see. What is more, average pay is not keeping up. There are workers in a few sectors, such as lorry drivers, who are in high demand, and therefore their wages are rising faster than prices. But the majority of workers won’t see such increases in pay. In the 12 months to January, prices rose by 5.5% on average, but regular pay, excluding bonuses, on average rose by only 4.7%, meaning that they fell by 0.8% in real terms.
The Bank of England has warned that CPI inflation could rise to 7% this year and some economists are forecasting that it could be almost 8% in April.
Why are costs rising?
From the weekly food shop, to filling up cars, to heating our homes, the cost of living is rising sharply around the world. Global inflation is at its highest since 2008. Some of the reasons why include:
- Rising energy and petrol prices
Oil prices slumped at the start of the pandemic, but demand has rocketed back since, and oil prices have hit a seven-year high. The price of gas has also shot up, leaving people around the world with eye-watering central heating bills. Home energy bills in the UK are set to rise by 54% in April when Ofgem, the energy regulator, raises the price cap.
- Goods shortages
During the pandemic, prices of everyday consumer goods increased. Consumers spent more on household goods and home improvements because they were stuck at home, couldn’t go out to eat or go on holiday. Manufacturers in places such as Asia have struggled to keep up with the demand. This has led to shortages of materials such as plastic, concrete and steel, driving up prices. Timber cost as much as 80% more than usual in 2021 in the UK.
- Shipping costs
Global shipping companies have been overwhelmed by surging demand after the pandemic and have responded by raising shipping charges. Retailers are now having to pay a lot more to get goods into stores. These prices are now being passed on to consumers. Air freight fees have also increased, having been made worse by a lorry driver shortage in Europe.
- Rising wages
During the pandemic many people changed jobs, or even quit the workforce – a problem exacerbated in the UK by Brexit as many European workers returned to their home countries. Firms are now having problems recruiting staff such as drivers, food processors and restaurant waiters. This has resulted in companies putting up wages to attract and retain staff. Those extra costs to employers are again being passed on to consumers.
- Extreme weather impact
Extreme weather in many parts of the world has contributed to inflation. Global oil supplies took a hit from hurricanes which damaged US oil infrastructure. Fierce storms in Texas also worsened the problems in meeting the demand for microchips. The cost of coffee has also jumped after Brazil had a poor harvest following its most severe drought in almost a century.
- Trade barriers
More costly imports are also contributing to higher prices. New post-Brexit trading rules are estimated to have reduced imports from the EU to the UK by about a quarter in the first half of 2021. In the USA, import tariffs on Chinese goods have almost entirely been passed on to US customers in the form of higher prices. Chinese telecoms giant Huawei said last year that sanctions imposed on the company by the USA in 2019 were affecting US suppliers and global customers.
- The end of pandemic support
Governments are ending the support given to businesses during the pandemic. Public spending and borrowing increased across the world leading to tax rises. This has contributed to rises in the cost-of-living, while most people’s wages have lagged behind.
Main concerns for the UK inflation
With rapidly rising prices, the economic decisions people will have to make are much harder. The main concerns for UK households include increases in energy costs, food prices, rent and interest rates on borrowing. All of these concerns come at a time when the government prepares to increase national insurance contributions for workers in April. There has been some pressure from MPs to scrap the tax rise so as to ease the pressure on living costs. It can be argued that there are fairer ways to increase taxes than through national insurance. However, the plan is relatively progressive, and scrapping the rise could be a badly targeted way of helping the poorest households with their energy bills.
Energy Bills
Electricity and gas bills for a typical household are expected to increase on average by £693 a year in April, which, as we have seen, is a 54% increase. Around 18 million households on standard tariffs will see an average increase from £1277 to £1971 per year. And around 4.5 million prepayment customers will see an average increase of £708 – from £1309 to £2017. Energy bills won’t rise immediately for customers on fixed rates, but many are likely to see a significant increase when their deal ends.
Bills are going up because the energy price cap is being raised. The energy price cap is an example of a maximum price being imposed on the market; it is the maximum price suppliers in England, Wales and Scotland can charge households for their energy. Energy firms can increase bills by 54% when the new cap is introduced in April. The price cap is currently reviewed every 6 months and it is expected that that prices will rise again in October.
Energy price rises are likely to hit Britain’s poorest households the hardest as they spend proportionately more of their income on energy, a problem exacerbated by many living in poorly insulated homes. More people are thus expected to find themselves facing fuel poverty. This means that they spend a disproportionate amount of their income on energy and cannot afford to heat their homes adequately. According to the Resolution Foundation, the poorest will see their energy spend rise from 8.5% to 12% of their total household budget, three times the percentage for the richest.
The way fuel poverty is measured varies around the UK. In Scotland, a household is in fuel poverty if more than 10% of its income is spent on fuel and its remaining income isn’t enough to maintain an adequate standard of living. It is expected that the number of homes facing ‘fuel stress’ across the UK will treble to 6.3 million after April. It will, however, have the greatest impact on pensioners, people in local authority housing and low-income single-adult households who on average could be forced to spend over 50% of their income on gas and electricity. The Resolution Foundation thinktank has warned that UK households are facing a ‘cost of living catastrophe’.
Food
Low-income households also spend a larger proportion than average on food and will therefore be relatively more affected by increases in food prices. Food and non-alcoholic drink prices were up by 4.2% in the year to December 2021. The Monetary Policy Committee has stated that food price inflation is expected to increase in coming months, given higher input costs. It has been estimated by the thinktank, Food Foundation, that 4.7m Britons, equivalent to 8.8% of the population, are struggling to feed themselves and are regularly going a day without eating.
Supermarkets have also raised their concerns about future increases. Tesco’s chairman John Allan has predicted that the worst is yet to come, pointing to 5% as a likely figure for food price inflation by the spring. He cited high energy prices, both for Tesco and its suppliers, as a key factor behind the expected rise.
It has been observed that the Smart Price, Basics and Value range products offered by supermarkets as lower-cost alternatives are stealthily being extinguished from the shelves. This is leaving shoppers with no choice but to ‘level up’ to the supermarkets’ own better-quality branded goods – usually in smaller quantities at larger prices. The managing director of Iceland, Richard Walker, has stated that his stores are not losing customers to other competitors or to better offers, but to food banks and to hunger. This is a highly concerning statement given that 2.5m citizens were forced by an array of desperate circumstances to use food banks over the past year.
Rent
Private rents are also rising at their fastest rate in five years, intensifying the increase in the cost of living for millions of households. Data from the ONS reveal that the average cost of renting in the UK rose by 2% in 2021. This was the largest annual increase since 2017. The East Midlands had the biggest increase in average rental prices, with tenants paying 3.6% more than a year earlier. However, due to falling demand for city flats during lockdown, as people favoured working from home, London had the smallest increase at 0.1%. Nevertheless, as Covid restrictions are removed, renters, including office workers and students, are now returning back to cities. This is now pushing up rental prices with demand outpacing supply.
The property website Zoopla found newly advertised rental prices were rising much faster across the UK. It said the average rent jumped 8.3% in the final three months of 2021 to £969 a month. This increase in rental prices, combined with the general rise in prices will place additional pressure on the government to increase support for vulnerable families. The housing charity, Shelter, has reported an increase in people who are struggling to pay their rent and even pay their electricity. With Covid-era protections having ended, if people struggle to pay, they are faced with eviction or even homelessness. There are calls for the government to support such people by reversing welfare cuts.
Insurer, Legal & General, has announced an additional investment over the next 5 years of £2.5bn on its ‘build to rent’ schemes. The aim is to provide more than 7000 purpose-built rental homes in UK towns and cities. L&G claims that the additional homes are part of the solution to the rental problem, with rent increases being capped at 5% for five years. However, sceptics claim the company is simply trying to cash in on the booming market and there are calls for further government action. The Joseph Rowntree Foundation claim that renters will struggle as rents in some areas have risen as much as 8%. Despite this, housing benefit has been frozen for two years and therefore there are calls for government to urgently relink housing benefit to the real cost of renting.
Articles
- UK inflation forecast to hit 8% in April amid cost of living crisis
The Guardian, Phillip Inman (16/2/22)
- Inflation: Seven reasons the cost of living is going up around the world
BBC News, Beth Timmins and Daniel Thomas (20/1/22)
- Why are gas bills so high and what’s the energy price cap?
BBC News (4/2/22)
- What is the UK’s inflation rate and why is the cost of living going up?
BBC News (16/2/22)
- In numbers: what is fuelling Britain’s cost of living crisis?
The Guardian, Richard Partington and Ashley Kirk (3/2/22)
- Rising cost of living in the UK
House of Commons Library, Research Briefing, Brigid Francis-Devine, Daniel Harari, Matthew Keep and Paul Bolton (8/2/22)
- Rising cost of living leaves 4.7mn Britons struggling to feed themselves
Financial Times, Bethan Staton (6/2/22)
- UK cost of living crisis merits a full response
Financial Times, The editorial board (3/2/22)
- UK cost of living crisis intensifies
Financial Times, Darren Dodd (19/1/22)
- The cost of living crisis – who is hit by recent price increases?
IFS, Peter Levell and Heidi Karjalainen (17/11/21)
- The cost of living crunch
IFS, Robert Joyce, Heidi Karjalainen, Peter Levell and Tom Waters (12/1/22)
- Fastest rent rise in five years adds to concerns over UK cost of living crisis
The Guardian, Georgina Quach (16/2/22)
Questions
- What other measures of inflation are used beside CPI inflation? How do they differ?
- If all consumers are facing approximately the same price increases for any given good or service, why are poor people being disproportionately hit by rising prices?
- For what reasons might the rate of inflation (a) rise further; (b) begin to fall?
- Examine a developed country other than the UK and find out how inflation is affecting its population. Is its experience similar to that in the UK? Does it differ in any way?
The development of open-source software and blockchain technology has enabled people to ‘hack’ capitalism – to present and provide alternatives to traditional modes of production, consumption and exchange. This has enabled more effective markets in second-hand products, new environmentally-friendly technologies and by-products that otherwise would have been negative externalities. Cryptocurrencies are increasingly providing the medium of exchange in such markets.
In a BBC podcast, Hacking Capitalism, Leo Johnson, head of PwC’s Disruption Practice and younger brother of Boris Johnson, argues that various changes to the way capitalism operates can make it much more effective in improving the lives of everyone, including those left behind in the current world. The changes can help address the failings of capitalism, such as climate change, environmental destruction, poverty and inequality, corruption, a reinforcement of economic and political power and the lack of general access to capital. And these changes are already taking place around the world and could lead to a new ‘golden age’ for capitalism.
The changes are built on new attitudes and new technologies. New attitudes include regarding nature and the land as living resources that need respect. This would involve moving away from monocultures and deforestation and, with appropriate technologies (old and new), could lead to greater output, greater equality within agriculture and increased carbon absorption. The podcast gives examples from the developing and developed world of successful moves towards smaller-scale and more diversified agriculture that are much more sustainable. The rise in farmers’ markets provides an important mechanism to drive both demand and supply.
In the current model of capitalism there are many barriers to prevent the poor from benefiting from the system. As the podcast states, there are some 2 billion people across the world with no access to finance, 2.6 billion without access to sanitation, 1.2 billion without access to power – a set of barriers that stops capitalism from unlocking the skills and productivity of the many.
These problems were made worse by the response to the financial crisis of 2007–8, when governments chose to save the existing model of capitalism by propping up financial markets through quantitative easing, which massively inflated asset prices and aggravated the problem of inequality. They missed the opportunity of creating money to invest in alternative technologies and infrastructure.
New technology is the key to developing this new fairer, more sustainable model of capitalism. Such technologies could be developed (and are being in many cases) by co-operative, open-source methods. Many people, through these methods, could contribute to the development of products and their adaptation to meet different needs. The barriers of intellectual property rights are by-passed.
New technologies that allow easy rental or sharing of equipment (such as tractors) by poor farmers can transform lives and massively increase productivity. So too can the development of cryptocurrencies to allow access to finance for small farmers and businesses. This is particularly important in countries where access to traditional finance is restricted and/or where the currency is not stable with high inflation rates.
Blockchain technology can also help to drive second-hand markets by providing greater transparency and thereby cut waste. Manufacturers could take a stake in such markets through a process of certification or transfer.
A final hack is one that can directly tackle the problem of externalities – one of the greatest weaknesses of conventional capitalism. New technologies can support ways of rewarding people for reducing external costs, such as paying indigenous people for protecting the land or forests. Carbon markets have been developed in recent years. Perhaps the best example is the European Emissions Trading Scheme (EMS). But so far they have been developed in isolation. If the revenues generated could go directly to those involved in environmental protection, this would help further to internalise the externalities. The podcasts gives an example of a technology used in the Amazon to identify the environmental benefits of protecting rain forests that can then be used to allow reliable payments to the indigenous people though blockchain currencies.
Podcast
Questions
- What are the main reasons why capitalism has led to such great inequality?
- What do you understand by ‘hacking’ capitalism?
- How is open-source software relevant to the development of technology that can have broad benefits across society?
- Does the current model of capitalism encourage a self-centred approach to life?
- How might blockchain technology help in the development of a more inclusive and fairer form of capitalism?
- How might farmers’ co-operatives encourage rural development?
- What are the political obstacles to the developments considered in the podcast?
In a series of five podcasts, broadcast on BBC Radio 4 in the first week of January 2021, Amol Rajan and guests examine different aspects of inequality and consider the concept of fairness.
As the notes to the programme state:
The pandemic brought renewed focus on how we value those who have kept shelves stacked, transport running and the old and sick cared for. So is now the time to bring about a fundamental shift in how our society and economy work?
The first podcast, linked below, examines the distribution of wealth in the UK and how it has changed over time. It looks at how rising property and share prices and a lightly taxed inheritance system have widened inequality of wealth.
It also examines rising inequality of incomes, a problem made worse by rising wealth inequality, the move to zero-hour contracts, gig working and short-term contracts, the lack of social mobility, austerity following the financial crisis of 2007–9 and the lockdowns and restrictions to contain the coronavirus pandemic, with layoffs, people put on furlough and more and more having to turn to food banks.
Is this rising inequality fair? Should fairness be considered entirely in monetary terms, or should it be considered more broadly in social terms? These are issues discussed by the guests. They also look at what policies can be pursued. If the pay of health and care workers, for example, don’t reflect their value to our society, what can be done to increase their pay? If wealth is very unequally distributed, should it be redistributed and how?
The questions below are based directly on the issues covered in the podcast in the order they are discussed.
Podcast
Questions
- In what ways has Covid-19 been the great ‘unequaliser’?
- What scarring/hysteresis effects are there likely to be from the pandemic?
- To what extent is it true that ‘the more your job benefits other people, the less you get paid’?
- How has the pandemic affected inter-generational inequality?
- How have changes in house prices skewed wealth in the UK over the past decade?
- How have changes in the pension system contributed to inter-generational inequality?
- How has quantitative easing affected the distribution of wealth?
- Why is care work so poorly paid and how can the problem be addressed?
- How desirable is the pursuit of wealth?
- How would you set about defining ‘fairness’?
- Is a mix of taxation and benefits the best means of tackling economic unfairness?
- How would you set about deciding an optimum rate of inheritance tax?
- How do you account for the growth of in-work poverty?
- In what ways could wealth be taxed? What are the advantages and disadvantages of such taxes?
The IFS has launched a major five-year review into all aspects of inequality. The review is led by Sir Angus Deaton, the Scottish-born Professor of Economics and International Affairs at Princeton University. In 2015, he was awarded the Nobel Prize in Economic Sciences for his analysis of consumption, poverty, and welfare. The review will cover all aspects of inequality, including inequality of income, wealth, health, life-span, education, social mobility, housing, opportunity and political access, and by gender, age, ethnicity, family and geography. It will look at trends in and causes of inequality, the impacts of globalisation and political change, barriers to tackling inequality and poverty, and at various policy measures.
Although the published Gini coefficient in England and Wales has not changed much over the past 15 years, largely because of support given to the poor by tax credits, it did rise from 31.7 to 33.2 from 2015/16 to 2017/18 (the latest year for which figures are available). Other measures of inequality, however, have changed more dramatically. There is huge geographical inequality in income in the UK, reflected in inequality in health. Average weekly earnings in London are 66% higher than in the north east of England. And, according to the IFS, ‘Men in the most affluent areas can expect to live nearly 10 years longer than those in the most deprived areas, and this gap is widening’.
The UK has the greatest inequality of income of developed countries, with the exception of the USA. The IFS warns that the UK could follow the USA:
…where wages for non-college-educated men have not risen for five decades, and where rising mortality for less-educated white men and women in middle age has caused average life expectancy in America to fall for the last three years – something that has not happened for a century. We have not experienced anything similar in the UK but we have now had a decade of stagnant wages and there is recent evidence that ‘deaths of despair’ – deaths from suicide and drug and alcohol abuse – are now rising among middle-aged Britons. Sir Angus will go on to say:
‘I think that people getting rich is a good thing, especially when it brings prosperity to others. But the other kind of getting rich, “taking” rather than “making”, rent-seeking rather than creating, enriching the few at the expense of the many, taking the free out of free markets, is making a mockery of democracy. In that world, inequality and misery are intimate companions.’
The initial report, which introduces the IFS Deaton Review, points to some possible causes of growing inequality, including the dramatic decline in union membership, which now stands at just 13% of private-sector employees, with more flexible labour markets with growing numbers of workers on temporary or zero-hour contracts. Other causes include growing globalisation, rapid technological change making some skills redundant, the power of large companies and their shareholders, large pay rises given to senior executives, growing inequality of access to education and changing family environments with more single parents.
About one in six children in the UK are born to single parents – a phenomenon that is heavily concentrated in low-income and low-educated families, and is significantly less prevalent in continental Europe.
Then there is the huge growth in housing inequality as house prices and rents have risen faster than incomes. Home ownership has increasingly become beyond the reach of many young people, while many older people live in relative housing wealth. Generational inequality is another major factor that the Deaton Review will consider.
Inequalities in different dimensions – income, work, mental and physical health, families and relationships – are likely to reinforce one another. They may result in, and stem from, other inequalities in wealth, cultural capital, social networks and political voice. Inequality cannot be reduced to any one dimension: it is the culmination of myriad forms of privilege and disadvantage.
The review will consider policy alternatives to tackle the various aspects of inequality, from changes to the tax and benefit system, to legislation on corporate behaviour, to investment in various structural resources, such as health and education. As the summary to the initial report states:
The Deaton Review will identify policy responses to the inequalities we face today. It will assess the relative merits of available policy options – taxes and benefits, labour market policies, education, competition policy, ownership structures and regulations – and consider how policies in different spheres can be designed to complement each other and minimise adverse effects. We aim not just to further our understanding of inequalities in the twenty-first century, but to equip policymakers with the knowledge and tools to tackle those inequalities.
Articles
IFS Deaton Review
Questions
- Identify different aspects of inequality. Choose two or three aspects and examine how they are related.
- Why has inequality widened in most developed countries over the past 20 years?
- What is meant by ‘rent seeking’? Why may it be seen as undesirable? Can it be justified and, if so, on what grounds?
- What policies could be adopted to tackle poverty?
- What trade-offs might there be between greater equality and faster economic growth?
- What policies could be adopted that would both reduce inequality and boost long-term economic growth?
What should the government do about rising energy prices?