The key battleground for Labour in tomorrow’s local elections, and indeed in the run-up to next year’s general election is the “cost of living crisis”. With the Conservatives able to claim the credit for an albeit jittery economic recovery, Labour has turned its attention to the group that helped elect it in 1997, the “squeezed middle class”.
Labour claims working people are more than £1,600 a year worse off since David Cameron took office in 2010. George Osborne challenged this in a piece in The Times last year, by controversially claiming that households saw their incomes rising faster than inflation in 2012.
This striking figure was used by Labour in its campaign material. It presents monthly real wages since the last election: wages adjusted for inflation. According to the figure, prices have been rising faster than wages and so real wages are falling and the cost of living is rising.
But where does the £1,600 figure come from? It was generated by comparing the average wage in September 2013 and May 2010, and adjusting for inflation using the Retail Price Index (RPI). According to this calculation there was a fall of £31 per week in real wages over the entire period which amounts to 6.1% or £1,600 per year. However, this is not the same as being £1,600 worse off per year.
Further, the graph itself is misleading. By playing with the scale of the wage (y) axis (starting from £23,500 and finishing at £27,000) the fall in real wages appears more striking than it actually is.
The official figures from the Office for National Statistics, which show the percentage change in real wage and which is reproduced below, provides a more accurate picture of the overall trend in real wages.
Measure for measure
Labour have chosen one measure of the “cost of living”, but any measure requires a measure of wages or income, and a comparable measure of prices or costs. The choice of which affects the result. The difference between the two principal measures of inflation – Retail Price Index (RPI) and Consumer Price Index (CPI) – have been well covered elsewhere.
Both measure changes in the cost of bundles of goods and services, but only RPI includes housing costs such as rent, mortgage interest payments and council tax. As a result it is considered to overstate inflation. However, given about 14% of the average weekly income is spent on housing, the RPI is probably the more relevant measure for a cost of living calculation.
Figure 2 provides some potential ranges for the real wage by combining alternative measures of wages and inflation. The large divergence between the top of range and the RPI-adjusted figure (the blue line) in 2009 is largely due to the impact of the Bank of England introducing ultra-low interest rates, which pushed the RPI negative.
Another important element that Figure 2 depicts is that the choice of the two time points in the comparison is important. There was a much larger fall in real wages before the last election than since, and by the time we get to next May 2015 real wages will have recovered further.
Claim and counter-claim
Labour quote gross wages, but most voters may find net income – after adjusting for deductions (tax and national insurance), benefits and income from other sources to be a more relevant metric in cost-of-living comparisons. But many of Labour’s policies aimed at tackling the cost of living crisis would not be reflected in a change, all things being equal, in this gross wage measure because they adjust tax credits or income tax.
The government certainly thinks so with [George Osborne claiming](http://www.thetimes.co.uk/tto/opinion/columnists/article3825516.ece](http://www.thetimes.co.uk/tto/opinion/columnists/article3825516.ece) that real household disposable income rose by 1.6% in 2012, and is expected to have risen (by 0.5%) in 2013 as well.
While this is true this measure has two major flaws.
The first is that this is total real disposable household income and would be expected to rise if the population or employment is expanding. These kinds of aggregate measures tell us little about the standard of living. It isn’t a per capita measure, or representative of the average or typical household. Real disposable household income per capita rose by 0.9% in 2012 (and is expected to rise by 0.1% for 2013). They forget to mention, however, that even by their own measure it fell over the period since the last election.
Real disposable household income is a strange measure to choose for cost of living comparisons. It isn’t representative of actual households’ income and expenditure, and it includes non-profit institutions serving households. This includes organisations such as universities and many charities . As the [IFS explains](http://www.ifs.org.uk/comms/r81.pdf], a better measure is Households Below Average Income (HBAI) data, an annual household survey where the median household net income is calculated and equalised for the size and composition of the average household.
These alternative measures are compared in Figure 3, indexing them using 2006. Real Median Equalised Income using the households below average income data shows a much bigger fall than the real disposable household income: 5.8% compared to 2.5% over the same period.
Who is right?
There’s no simple answer. All measures of the cost of living per person have been falling, not only since the May 2010 General Election, but from the start of the recession in 2008. The IFS estimates that on average we’re about 3% worse off per year. However, in comparison to previous recessions, unemployment was less of a problem, which may have been at the expense of falling real wages. Which is the lesser of two evils is for individuals to decide.
While all of the measures used are factually correct, their use and presentation is often misleading. The government’s statement that real total household disposable income increased in 2012 is irrelevant for the average voter and does not correspond with their standard of living. Labour’s use of real gross wages is closer to the reality felt by many voters and tallies at 6.1% for the period with the IFS calculation of 5.8%. But it ignores the effects of the taxation and benefit system. The presentation of the data in Figure 1 is misleading, but this problem isn’t confined to Labour as a recent piece in The Guardian illustrates.
From the political perspective, what we don’t know is the counterfactual: whether there would have been any difference had Labour won the last election. Certainly fiscal policies aimed altering the tax and benefit system would not have altered Labour’s own choice of cost-of-living metric, and the effectiveness of proposed policies aimed at reigning in utility bills, housing rents and rail fares are yet to be shown.
What is undoubtedly true is that the effects are not uniform across society and that the use of averages (for example, average wages) will be uninformative for most voters.
Hard Evidence is a series of articles in which academics use research evidence to tackle the trickiest public policy questions.