UK living standards continue to drop

Earlier this year, Tulet Prebon released a report showing how UK households are being squeezed by falling real incomes and rising living costs since the onset of the Global Financial Crisis (GFC):

Between 2007 and 2012, growth of 10% in average nominal wages was far exceeded by cumulative CPI inflation of 17%, leaving real incomes 6.3% lower in 2012 than they were in 2007. In 2007, wage-earners were 13% better off, in real terms, than they had been in 2002. Since 2007, about half of that previous gain has been lost.

This is bad enough in itself, of course, and becomes even worse if high levels of household indebtedness – and increases in direct taxation – are taken into account. But we believe that there is another, highly significant factor to be considered. That factor is the above-CPI rate at which the prices of non-discretionary, essential purchases (including food and energy) have risen. The implications are, of course, that consumers’ capacity for discretionary spending has been eroded even more severely than data for real incomes might suggest.

Last week, new data was released by the Office of National Statistics (ONS) showing that the slide in UK real incomes has continued:

Wages did not merely fall relative to inflation in the year to March; they fell outright by 0.7 per cent. It was the first year on year fall since 2009. In the private sector wages fell by 1.3 per cent…

In the three months to March average wages – that’s with bonuses by the way – rose by 0.4 per cent. That was the lowest growth rate since the period March to May 2009.

Just remember inflation, as measured by the CPI, was 2.8 per cent in March.

So once again, workers are worse off. It is hard to see how the UK can see sustainable growth while wages relative to inflation are falling…

Mr Osborne may think he can create recovery by driving up house prices, thus making Brits feel richer and encouraging them to save less, borrow more and spend.

The Bank of England may think it can create recovery by trying to force up asset prices, including equities. But until wages rise, growth will have a bubble feel about it.

Wages can only really rise in a sustainable way once productivity improves, but that improvement remains elusive…

Maybe the problem is that there are underlying problems with the UK; problems that have been present for over a decade, or longer. Housing booms, low interest rates, and quantitative easing may be doing nothing to fix these underlying problems.

The perverse aspect about the UK situation is that while incomes are falling, UK house prices are once again on the rise, particularly in Greater London (see next chart).

To date, the UK has avoided a sharper downturn via stimulus – specifically, quantitative easing and near zero interest rates. However, the ultimate effect of these policies has been to drive-up asset prices, effectively re-distributing wealth to those who are asset rich, whilst squeezing real wages via increased inflation.

Now, the UK government is engaged in a cynical attempt to re-inflate the domestic property bubble by offering to underwrite deposits at scales of leverage far beyond those which commercial bankers consider prudent, via the Help-to-Buy Scheme and Funding For Lending. Though these policies might create a debt-funded boost in GDP in time for the next election, its longer-term effects are likely to exacerbate both household indebtedness and the UK’s extreme vulnerability to any upwards movement in interest rates.

Another key factor holding the UK economy back is it highly restrictive planning system, which is preventing lower interest rates and easier credit from stimulating new housing construction.

In the early-1930s, during the Great Depression, the UK authorities embarked on similar monetary stimulus measures, including near zero interest rates and monetary expansion. The years from 1933 through 1936 saw a very strong recovery with growth of over 4% in every year, due largely to a big pick-up in house building. From VOX (my emphasis):

Obviously, for the cheap-money policy to work it needed to stimulate demand – a transmission mechanism into the real economy was needed. One specific aspect of this is worth exploring, namely, the impact that cheap money had on house-building. The number of houses built by the private sector rose from 133,000 in 1931/2 to 293,000 in 1934/5 and 279,000 in 1935/6 – many of these dwellings being the famous 1930s semi-detached houses which proliferated around London and more generally across southern England. The construction of these houses directly contributed an additional £55 million to economic activity by 1934 and multiplier effects from increased employment probably raised the total impact to £80 million or about a third of the increase in GDP between 1932 and 1934. House building reacted to the reduction in interest rates and also to the recognition by developers that construction costs had bottomed out; both of these stimuli resulted from the cheap-money policy (Howson 1975).

Why was house-building so responsive in the 1930s? Two factors stand out.

First, the supply of mortgage finance grew rapidly and became more affordable in an economy in which there had been no financial crisis that curtailed lending.

Building society mortgage debt rose from £316 million with 720,000 borrowers in 1930 to £636 million with 1,392,000 borrowers in 1937 when about 18% of non-agricultural working-class households were buying or owned their own homes. In these years, deposits fell in some cases to 5% and repayment terms were extended from around 20 to 25 or even 30 years reducing weekly outgoings by 15% (Scott 2008).

Second, houses were affordable to an increasing number of potential buyers.

85% of new houses sold for less than £750 (£45,000 in today’s money). Terraced houses in the London area could be bought for £395 in the mid-1930s when average earnings were about £165 per year. Houses were cheap because the supply of land for housing was very elastic which in turn meant that there was no incentive for developers to sit on large land banks. Underpinning the availability of land for house-building was an almost complete absence of land-use planning restrictions which applied to only about 75,000 acres in 1932 – the draconian provisions of the 1947 Town and Country Planning Act were still to come.

The key differences this time around is that the UK planning system is now highly restrictive and housing construction is running near post-war lows. Mortgage debt is also already very high, thanks to the decade long boom in house prices (without expanding new home construction) prior to the GFC.

The UK experience provides a salutary lesson of what can happen when an economy embarks on an epic debt binge targeting consumption and asset speculation over productive investment, as well as when government policy works to continually pump housing demand whilst simultaneously choking supply. The UK’s future economic potential has been sacrificed, with adverse consequences for ordinary Briton’s living standards.

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