The cost of living crisis is going to hurt

Britain is at last stepping out of the pandemic that has dominated the last two years – only to step straight into a huge cost of living crisis that will be the defining economic feature of what remains of this parliament. The lives of those at risk from the unfolding nightmare in Ukraine are our top concern, but the return of war to Europe will also deepen the downturn in living standards here in the UK.

The scale and immediacy of the current income squeeze, combined with the distribution of pain it brings and the historical context of a decade of stagnation, help to explain why it will be so deeply felt. The fact that high inflation today is forecast to be followed by a continuation of Britain’s disastrous productivity stagnation tomorrow also  means the pain will last. This is crucial to understanding the task facing everyone in, or aspiring to be in, government during the 2020s.

The scale of the pain to come is hard to overstate. Inflation was already surging towards its highest level in three decades before president Vladimir Putin’s invasion of Ukraine, as the swift reopening of the global economy drove up prices – particularly for energy. Now it looks likely it will exceed 8  per cent, reaching levels not seen since the early 1980s. Even taking into account the support announced by the chancellor, the result will be the typical household’s income falling by 4 per cent – or £1,000 – in the year ahead. This is something only seen during major recessions.

The immediacy of hits to living standards is also very unusual. We started 2021 with inflation well under 1 per cent, but ended it at more than five times that level. As a result, real wages have been falling since before last summer. The energy price cap is now setting prices for many of us so unlike the gradual energy bill surges of the early 2010s, we saw a widespread, overnight 50 per cent rise in energy bills on 1 April. The following week tax rises totalling £14bn came into effect.

So far the high inflation squeeze has been broad-based – affecting those on low, middle and high incomes alike. But energy bill surges will hit poorer households harder – they spend three times as much of their family budgets on such bills as the richest fifth of households. And, unlike higher income households, lower income households have not built up extra savings during the pandemic that they can now draw down on. This will matter when, despite the chancellor’s measures to limit the scale of energy bill rises, the number of us suffering from ‘fuel stress’ – spending 10 per cent of their family budgets on energy bills – more than doubles to five million households after April’s bill rise.

This downturn in living standards is so tough because it comes on the back of over a decade of stagnating incomes. Policies like furlough and temporary benefit boosts protected household incomes from the huge falls in GDP during the pandemic. But we went into that pandemic with pay packets no higher than before the financial crisis. The poorest households have seen no income rises since the early 2000s. The tough year ahead might have been more manageable if it had come on the back of a living standards boom, but our recent history is one of  an almost unprecedented lack of growth.

Crucially, official forecasters at the Bank of England and Office for Budget Responsibility expect that stagnation to continue even once this inflation shock passes. If they are right that the poor productivity – and therefore wage – growth that plagued us during the 2010s will continue, the typical household’s income will still be lower in 2025–26 than in 2021–22: living standards-wise the pandemic would be as good as the first half of the 2020s got. The result is that absolute child poverty, something we always used to take for granted would be falling, is on the rise. In fact, according to our forecasts, over one million people could fall below the absolute poverty in the coming financial year.

So what is to be done?

The chancellor had an opportunity to soften the immediate pain ahead with his recent spring statement – but instead of prioritising those hit hardest by the cost of living crisis he focused on rebuilding his tax cutting credentials. The result, a 1p income tax cut for richer households in two years’ time while benefits fail to keep pace with price rises today, is deeply unsatisfactory.

This is all the more frustrating as the short-term  answer is staring us in the face. While we cannot protect Britain from the reality that rising energy prices make us poorer as a nation, we can decide where that pain falls. Benefit levels are rising by only by 3.1 per cent in April, when inflation may be running at over 8 per cent. Over 2022–23 this is equivalent to a one-off £11bn cut to benefits. The usual approach to setting benefits would then be a huge rise next April to catch up with prices – but this rollercoaster will leave the poorest households hugely exposed over the coming 12 months. Instead we need benefits to rise by more like 8 per cent immediately – and the Treasury can do so without permanently raising public spending with a lower increase next year. This was the big hole in the spring statement.

Allowing benefits to rise in line with prices would focus support on poorer households, while calls to scrap the planned rise in national insurance would overwhelmingly benefit the highest earners. The chancellor was right to rebuff this. That is not to say that national insurance – a tax purely on earnings – is a good way to raise revenue. Alongside an unprecedented squeeze on people’s earnings, Britain’s recent economic history includes a boom in wealth, even during the pandemic. So future tax rises need to shift away from taxes solely on earnings to wider sources of income and wealth.

On energy bills, the longer term shift towards renewables and nuclear power, or the badly needed acceleration of home insulation, will come too late to make any material impact this year. But some levies could be moved off electricity bills and instead be funded by general taxation. Moving renewables obligation costs, for example, would take around £70 a year off bills at a cost of around £2bn a year.

But current or would-be national leaders are not just being asked to fight the immediate cost of living crisis – but also to turn around the UK’s relative economic decline that underpins our stagnation in living standards. Had incomes grown in line with previous trends from 2005–06 to 2025–26 the typical income in 2025–26 would be 43 per cent (£11,000) higher than is currently projected.

The key task facing politicians of all stripes then is to renew the UK’s economic strategy for a 2020s shaped by Brexit, Covid-19 and the net zero transition. That requires us to be honest about our nation’s strengths – overwhelmingly made up by high-end services, unfashionable as they are – and the challenges we face. There is no route to economic success that ignores the facts that our economy is less open to the world post-Brexit, our firms refuse to invest, and that we live with the highest level of inequality among major European economies.

The job of politics is to address the immediate effects, and longer lasting drivers, of our living standards stagnation. Much as it pains us to admit it, the UK’s recovery from Covid-19 is now well underway, but our living standard downturn is just beginning.

This article was originally published by The Fabian Society