Cost of Living?
April 2013
There’s a perception among many Australians that they are doing it tough, that they are being squeezed by cost of living pressures and that their financial position is fragile.
A recent poll from Essential Vision found that of those who thought the economy was “poor”, 27 percent of respondents judged that “increasing cost of living” was the main reason for that assessment. In similar surveys, a significant proportion of the respondents highlight cost of living issues as reasons for their voting intention or degree of (dis)satisfaction with the government.
Cost of living also features prominently in the rhetoric of politicians of all colours as they tap into the insecurities of voters ahead of the September 14 election. It is a high profile issue.
While no doubt there are some people who are genuinely confronting financial difficulties, for the country as a whole there is scant macroeconomic evidence to even vaguely justify this assessment.
For there to be legitimate cost of living pressures, general prices need to be rising more than incomes. This would be the case in the following stylised example where someone starting on an income of $100 a day spends $100 a day on a range of goods and services.
If over the next two years, for example, their incomes rise by 5 percent to $105 but the basket of goods and services they buy rises 10 percent to $110, there are genuine cost of living pressures. In this example, the person will have to cut consumption to move back to break even on their finances, or dip into their savings or borrow money if they want to maintain their consumption levels.
It is that simple.
The data on income growth and price increases over the past decade show something vastly different to the example above. The facts completely sink the notion that the general population is being dogged by increasing cost of living pressures. Whether a five or 10 year time frame is used, wages growth has exceeded the rate of consumer price inflation by a wide margin.
In the last five years, average earnings have increased by 23.6 percent, a figure that has been boosted, in part, by the mining industry boom and solid wages gains for mine workers and in related sectors. Over the past five years, the consumer price index, which measures the price change for the basket of goods and services purchased by the average household, has risen by 14.5 percent. In other words, the purchasing power of someone on average weekly earnings has increased by close to 10 percent over that time.
In this example, a person on an income of $100 five years ago is now earning $123.60, while the cost of their basket of goods and services has risen to $114.50. They are clearly better off, having $9.10 more to buy extra or better things, with the cost of living easing quite markedly.
Over the past 10 years, the gains are more marked. Average earnings have risen by 54.2 percent while the consumer price index has risen by 31.4 percent, which means that the purchasing power for someone on average earnings has risen by over 20 percent in that time.
Over the past decade, household finances have also been boosted, quite massively, with some of the largest income tax cuts ever seen. These income tax cuts were delivered by both the Howard and Rudd governments and have injected tens of billions of dollars per annum into the pockets of householders.
Reinforcing the case that shows that the cost of living has been falling has been a rise in household savings rates at the same time growth in household consumption expenditure has been growing solidly. Furthermore, the growth in household credit has slowed to a 35 year low, so borrowers are improving their balance sheets with lower debt and lower leverage.
These indicators do not fit with tough financial times for consumers.
The perception of the cost of living pressures appears to be more of a problem of the cost of consumption, which is a bias of consumers to spend money on what could be termed luxury items, indulgencies and non-necessities. If people become used to having an overseas holiday every year, or upgrading to a $50,000 car every few years, or decide that private schooling for their children is preferable to public education and then find they are having cash flow issues, they might feel times are tough and have cost of living pressures.
This is also the case if you voluntarily go to a bank and borrow an excessive amount to buy a house that is big, well appointed and geographically desirable. Any cost of living pressures from servicing a large mortgage is self-inflected pressure when a smaller, less fancy and geographically inferior house would lower your debt burden.
All of which suggests that the cost of living issue is a big furphy. There is no widespread financial pressure on consumers from weak wages growth or high inflation or a poorly performing economy. This, unfortunately, won’t stop the issue dominating the discussion in the upcoming election campaign.
Stephen Koukoulas is Managing Director of Market Economics. He writes a daily column for Business Spectator.
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