The cost of living through austerity

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The economic recovery remains elusive, but the cost of living remains high and looks set to go even higher in 2011.

Rising energy bills, higher rail fares, increases in rents (if many councils get their way) and the hike in VAT to 20 percent this month are all likely to combine and force the various measures of inflation upwards this year.

The most comprehensive official measure of inflation is the retail price index (RPI). This covers almost all elements of expenditure, including the costs associated with housing, and it currently stands at 4.5 percent. Considering that this index actually went negative last year under the impact of recession, this is a significant rise. In fact it isn't far off the levels of inflation last seen just before the economy crashed in the final months of 2008.

Even the government's preferred measure of inflation, the consumer price index (CPI), stands at 3.2 percent, significantly above the government's target for inflation of 2 percent. The government prefers the CPI because it excludes housing costs, which means that in Britain it is almost always lower than the RPI. This way, the government can almost always look like it has inflation under control.

Why is this important? Ever since the 1970s successive governments have been obsessed with the prospect of the so-called "wage-price spiral" making a return. Then inflation rocketed in response to the US government printing dollars to pay for its war in Vietnam. The response of workers in Britain and elsewhere, understandably, was to press for (and in most cases win) wage rises, rather than see their standards of living fall. This frequently, though not always, involved strikes and was, most establishment commentators agreed, a jolly bad thing. So "combating inflation", alongside avoiding stagnation, has been top of the macroeconomic agenda for Labour and Tories alike.

Given the state of the economy, and the fact that inflation is relatively high, the Con-Dems aren't doing very well on either front. But will rising inflation spark strikes by workers? One consideration here is that inflation affects the rich and the poor very differently. Essentials like bills (including rent), clothing, food, drink and transport cost poor households over two thirds of their expenditure. However, this drops to below a third for the richest.

Significantly, these "essentials" are precisely the items that are most susceptible to price inflation. Take rent, for instance. Poorer people spend a much greater proportion of their incomes on rent. So if council rents are increased, as many councils are planning in response to the government's funding cuts, those who are already badly off will be even worse off. In London, for instance, some councils are talking about rent hikes of as much as 7 percent.

In the private sector wages are rising at comparatively low levels - around 2 percent on average. Adjusted for inflation, this amounts to a wage cut in real terms. In the public sector things are even worse. Here workers face a two-year pay freeze. If the government also succeeds in raising employee pension contributions, public sector workers will receive a double whammy. If pension contributions rise by, say, 2 percent and wages not at all, inflation of around 4 percent will mean a 6 percent wage cut in real terms. Factor in a rent rise of 7 percent or similar and you get an idea of the scale of the likely squeeze on people's incomes.

In the short term, workers may be more worried about jobs than pay. Indeed, union leaders in local government are relying on this to allow them to get away with one of the lowest pay claims ever seen - just £250 for every worker. But if the cost of living rises further, this could combine with concerns over both jobs and pensions to create the conditions in which widespread strikes will be on the cards.