Energy and Environment

A real agenda to reduce the cost of living

Earlier this week, I outlined the red herrings that distort the debate about low pay and the cost of living. These create an environment for politicians to advocate economically damaging interventions in product and labour markets. Furthermore, they mean politicians ignore the effect of current government interventions which drive up living costs.

The high cost of essentials is a big problem, particularly for those on low and modest incomes. But if only politicians were willing to countenance stripping back existing policies, living standards could be improved dramatically. In my new paper, Low Pay and the Cost of Living: A Supply-Side Approach, I outline in detail the causes of high prices for housing, energy, childcare and food – and use the example of an imaginary illustrative family to outline how supply-side reform in these product markets and cuts to highly regressive sin taxes could reduce living costs for the household by up to £7,800 per year.

Thinking through an illustrative example helps to bring home the extent of the negative impact of current policies. Imagine a family of four – 2 adults, 2 children – renting two-bedroom accommodation in a medium-sized English city like Bristol or Milton Keynes. Both parents work, but on modest incomes whereby they are both basic-rate taxpayers. One child is aged 3, the other aged 8. One of the parents is a moderate smoker, they drink moderate amounts and they drive roughly the same amount as an average low-income household with a car. The combined cost of housing, energy, childcare, food and sin taxes for this family could be as much as £25,860 per year at the moment.

Almost all evidence suggests that house prices in the UK are high because of planning constraints which have become binding as demand has increased. Traditionally, both here and in many other parts of the English-speaking world, the  long-term median multiple for house prices (the median house price divided by median income) has been just under 3. In the UK it has accelerated to 4.9. Academic analysis of the effects of planning policy suggests that planning constraints have increased prices by as much as 41 per cent. Moving to a sensible planning system could therefore reduce house prices and rents by the same margin over time, saving our family £3,120 per year.

Childcare in the UK is also very expensive compared with other developed countries. We have high out-of-pocket costs and high levels of taxpayer subsidy. The reasons include strict planning laws and policies which encourage formalised care, imposing heavy regulation on childminders. Our childcare could be substantially cheaper under a policy of deregulation, which would include planning reform and a shift away from the idea that pre-primary childcare is about education. Even reducing the cost of childcare in line with other EU countries with similar enrolment rates would reduce costs by 40 per cent – saving our family £3,376 per year.

Though energy price rises in the past decade can to a large extent be explained by rising wholesale costs – Britain’s current environmental policies go way beyond the economically efficient means of seeking to reduce carbon, pushing up bills further than need be the case. Eliminating the worst of these schemes, and allowing the market to find the most efficient ways of reducing carbon emissions could reduce gas prices by 4 per cent and electricity prices by 22 per cent – saving our family £144 per year. This is a very conservative estimate – it completely ignores the effects on prices of the reduction in production costs brought about by cheaper energy, and the long-term benefits of a dynamic energy market.

At an international level, food prices in the UK are higher than they need be due to the Common Agricultural Policy and biofuels mandates at EU level. Abolishing the CAP and instigating reform of our planning system away from Town Centre First policies which reduce supermarket productivity could reduce food prices by at least 10 per cent as a very conservative estimate. This, alongside reductions in highly regressive duties on tobacco, fuel and alcohol (currently way above an amount justified by the external financial costs of the activity), would save our family a further £1,140 per year.

Overall then, the consequences of supply-side reform could be huge in reducing living costs. Of course, those in receipt of benefits may see their benefit entitlement fall as housing and childcare becomes cheaper. But the reductions in government spending on these benefits would allow taxes to be reduced, bringing dynamic benefits through economic growth and allowing cuts to some of the most regressive taxes.

The lower cost of living would furthermore mean that working households would not be as dependent on government to top up their incomes. The aspirations of the ‘living wage’ campaign – that those working full time should be able to earn enough to live comfortably – would be much more likely to be achieved, but without the need to cajole or legislate for higher wages, with all the potential negative consequences for those with weak labour market attachment that this would bring.

Given the potential prize on offer from this sort of agenda, why do anti-poverty campaigners remain obsessed with redistributive welfare and the living wage campaign?

Click here to download Low Pay and the Cost of Living: A Supply-Side Approach.

Head of Public Policy and Director, Paragon Initiative

Ryan Bourne is Head of Public Policy at the IEA and Director of The Paragon Initiative. Ryan was educated at Magdalene College, Cambridge where he achieved a double-first in Economics at undergraduate level and later an MPhil qualification. Prior to joining the IEA, Ryan worked for a year at the economic consultancy firm Frontier Economics on competition and public policy issues. After leaving Frontier in 2010, Ryan joined the Centre for Policy Studies think tank in Westminster, first as an Economics Researcher and subsequently as Head of Economic Research. There, he was responsible for writing, editing and commissioning economic reports across a broad range of areas, as well as organisation of economic-themed events and roundtables. Ryan appears regularly in the national media, including writing for The Times, the Daily Telegraph, ConservativeHome and Spectator Coffee House, and appearing on broadcast, including BBC News, Newsnight, Sky News, Jeff Randall Live, Reuters and LBC radio. He is currently a weekly columnist for CityAM.