The Earnings Expectations Gap – 18% worse off than expected by 2013?

Please click on graph for larger image.UK real earnings analysis 2000 - 2013

With the latest inflation figures and earnings growth being announced this week there has been a lot of talk about the squeezing of real incomes. A few weeks ago I put together this graph but hadn’t got round to publishing it.

The graph shows the trend in average real earnings (the black line) based on earnings growth less the CPI measure of inflation since 2000. I used CPI to reflect buying power though some might suggest RPI would be better to reflect total living costs. However I suspect the story would be similar. The future data is based on the May Bank of England quarterly inflation report and I have assumed earnings growth of 2.5% per annum for the next two and half years.

You can see that the trendline steadily rises to a peak in March 2008 when on average we were around 22% better off apparently than eight years before.

Since then things have gone rapidly south. The graph estimates we are about 5% worse off now than in March 2008 and will be a further 4% worse off by the end of December 2013. In fact by the end of December 2013 the analysis predicts we will be only as well off on average as we were at the end of 2004, nine years earlier.

But worse still is the “Expectations Gap”. This represents the difference between what we would have expected had the pre recessionary trend continued and what we are actually likely to experience.

This gap says we are 11% worse off now, and will be 18% worse off at the end of 2013 on average than we expected to be.

No wonder it feels so painful.

Monty Python and the 0.5% base rate cut

I replied to a question posted by @wadds this morning about when the base rate economic stimulus would kick in. My answer was that the problem is there is little point in reducing the price of something that you can’t buy.

As I have said before many lenders are not passing on cuts unless they have to contractually and consumers are trapped in current deals because of reducing equity levels. The reality is therefore that for many the base rate reduction doesn’t have much impact.

For businesses it is great as long as they have a fixed margin above base rate. But with most overdraft facilities being on annual terms these margins are likely to be revised upwards offsetting the impact. That is if the facility isn’t pulled completely of course.

Hence the second part of my answer to Wadds. It is like Monty Python’s Cheese Shop sketch. What’s the point of advertising something if you haven’t got the product to sell? Quantitative easing, printing money or any other term you like to use might solve this problem though it could have its own risks. Arguably like waiving chocolate bars in front of someone who is trying to lose weight! Still it would at least mean that the shop would have more products to buy.

IMHO though the real answer lies in creating true wealth not manufactured wealth. To do this requires investment in the one part of the economy that actually creates real jobs – the SME sector. As I have also said in the past the current government has actually taken steps to discourage this not the opposite. Next month Mr Darling should announce radical tax and spending plans to boost the prospects of the engine room of the economy and link this to the government’s apparent Digital agenda. But I won’t hold my breath.

Anyway enough of this lets get to the best part of this post! For anyone who hasn’t seen this sketch before I heartily recommend it and for anyone who has it is always worth another look :-)