Allister Heath

Forget the cuts

While Westminster is fixated on public sector cuts, no one has noticed that the cost of living is surging. Ministers ignore the ‘misery index’ at their peril

Forget the cuts
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To listen to the reporting of the Chancellor’s phased and rather limited spending cuts, you would think that the gates of fiscal hell opened at 12.30 p.m. on Wednesday. They are the ‘most savage cuts in our lifetime’, said an ITV reporter. The ‘fastest, deepest cuts in public spending ever mounted by a government in modern times’, declared a hyperventilating Will Hutton, a newspaper columnist and government adviser. It has been so long since Britain attempted fiscal restraint that a cut in total government spending of under 4 per cent in real terms over four years is treated like the coming of the apocalypse.

That there will be severe pain is not in question. There will be real hardship for the soldiers and public-sector workers who are laid off. But job losses will not be the main problem the British economy faces over the next few years. The overall British story now is one of steadily rising employment, with 300,000 more jobs this year. The private sector continues to create jobs faster than the government is cutting them, and by the end of the cuts there should be a million more jobs than there are today.

Yet as the average voter focuses on the cuts in front of him — and not without reason — a meteor is hurtling towards him from behind. Since the recession started, there has been an increasingly large gulf between what politicians are focusing on (public spending and taxes) and what real voters are most worried about (low wages and rising inflation). The real financial burdens on everyday people might do more to undermine support for the government than any cuts programme — yet those burdens are going almost entirely ignored by ministers, who are unable to recognise pain which is not inflicted by the government.

David Cameron sometimes refers to having taken a pay cut, by which he means that he accepted a smaller pay rise when becoming Prime Minister than the one to which he was entitled. The outside world has harsher definitions of pay restraint. Average earnings are up by 1.7 per cent over the past year. Strip out the protected public-sector workers, and this is just 1.2 per cent. But worse, the value of this money is shrinking at an accelerated rate. Inflation, supposed to be killed off in the new era of Bank of England independence, is running at an extraordinarily high 4.6 per cent a year on the Retail Prices Index.

Once, this figure would have been a matter of national debate. Now, it goes almost entirely unnoticed. Yet its effects are real, and suffered nationwide: the purchasing power of wages is being slashed by stealth. While the Bank is undoubtedly committed to fighting inflation, the suspicion remains that there are some in government who are secretly delighted to see prices spiralling out of control.

Inflation has long been used as a tool to finance the misbehaviour of unscrupulous governments. Just as £5,000 of savings becomes less impressive due to inflation, £5,000 of debt also shrinks. This is why hugely indebted governments often turn a blind eye to inflation: it is an easy way out. It helps employers: staff are cheaper, if their salaries do not keep pace with inflation. This cuts costs, thereby reducing the need for redundancies. So inflation suits a great many people, but it does not come without pain — and that pain is felt by savers and consumers.

Given that this category covers almost everyone in Britain, it’s remarkable that no one seems to care how much pain they might be suffering. For those who care to look, the indicators are flashing red. The Tax and Prices Index, perhaps the best cost of living measure as it takes account of direct tax increases, shows the burden is 5.1 per cent higher than last year. Analysis from Deloitte, the professional services firm, shows that real average take-home pay started to drop last Christmas. The results are shown in the Barometer column on the right. They show that the last time ordinary folk were being squeezed as much by inflation and tax hikes was in 1982 — at the height of the recession and Falklands war. Even in the intervening years, real take-home pay after tax and inflation only ever dipped for a few short periods, and always bounced back quickly.

A quick rebound is unlikely this time around, with inflation out of control, the economy slowing again, a further rise in national insurance in April and tax thresholds remaining frozen. For the vast majority of voters, it is this national pay cut — not the reductions in government spending and jobs — that will really hurt.

It is against this grim backdrop that George Osborne intends to raise the rate of VAT in January to 20 per cent, up from today’s 17.5 per cent (and the 15 per cent it was this time last year). Such a move would be far less noticeable in, say, Germany or Denmark, where inflation is around the 1 per cent mark. Or even Ireland, where average prices are actually falling. But the VAT rise comes as British shoppers already confront the highest inflation in Western Europe.

Dip into the official inflation figures and you find that the average orange cost 33p last month, a third higher than last year. The average pack of butter was £1.22, up 22p in a year. Salmon fillets are up 25 per cent in a year. Cauliflower: 91p, up 15 per cent. Even a kilo of onions is now 91p, up from 81p. This is not George Osborne’s fault: VAT is not applied on food. But those who face price hikes due to VAT hikes in other goods in their shopping bag may be tempted to forget this — and just blame him for everything.

It should not be forgotten, moreover, that the value of the average home is starting to drop again. During the bubble years, buoyant house prices were one of the key factors driving the feel-good factor, as homeowners kept remortgaging, treating their homes like giant cash machines from which they could regularly extract equity. Now, the opposite is true; as prices fall and incomes come under pressure, panicky homeowners are desperately repaying their mortgages. This may be sensible, but it means that there is less money around to spend or save. And those who do have cash in the bank have been hit by ultra-low interest rates, and can only watch in horror as the real value of their savings dwindles.

Artificial prosperity was the Teflon coating that protected New Labour. Shopping was cheaper, inflation minimal, house prices booming and the living rooms of middle England filled with hardware bought on credit. The reverse could well be true this time around. Osborne’s moderate cuts agenda will — in time — make everyone better off. But voters may be ill-inclined to agree if they feel poorer. And this misery factor, rather than anything in the spending review, is what may yet do for this coalition.

Allister Heath is editor of City AM and associate editor of The Spectator.