For years we have been told that a billion or so people in the world have to live on “less than a dollar a day.” That originally meant that poverty was defined as a money income of $1.08 a day in terms of the US dollar at its 1993 level.
The value of the dollar was set at so-called purchasing-power parity, meaning what it would have cost an American to buy a defined selection of goods. (PPP, as it is known, is used in making international comparisons to avoid the distortions caused by fluctuations in exchange rates).
But the “dollar a day” standard has always seemed an unrealistic way of defining poverty, mainly because the poor countries of the world are not primarily money-based economies. Much of daily life, particularly in rural areas, is based on exchanges that do not involve money changing hands. Housing, food and sometimes clothing may be offered in return for labour, and food is also grown for direct consumption instead of having to be bought.
The World Bank has published two papers on which it is consulting with proposals to change the yardstick - partly to reflect some progress in reducing relative poverty levels since 1993, particularly in China.
But the prospective outcome is odd. $1.08 at 1993 prices would become $1.45 at 2005 PPP rates. But the new standard looks like being set at only $1.25 - a drop of 14 per cent in real terms. This, of course, has the effect of reducing the numbers of people below the threshold, and the World Bank has in fact decided to do just this. Having collected information from 75 of the poorer countries, it restricted its analysis to the 15 poorest among these – including 13 in sub-Saharan Africa.
So the new poverty standard is, in effect, $0.93 a day in the original 1993 dollars, and reflects almost entirely conditions in the worst-off parts of Africa.
While living conditions and levels of poverty remain appallingly low in much more of the world than covered by the new calculations, at the same time it would be quite wrong to assume that “living on a dollar a day,” or close to it, can be compared in any realistic way with the daily expenditure of advanced countries. Look at all the things the real poor do not need to bother with – not least all our “defensive” or negative expenditure: from insurance to gambling and from the disposal of refuse to countering pollution.
The Economist and Financial Times have been pondering the new poverty guideline. Two comments. First, what would a purchasing-power parity collection of goods worth $1.25 a day look like in London or New York? Secondly, the poverty line for a family of three could be just over $26 a week. Just enough to buy the Financial Times and the Economist for a week – and nothing else.
Author Archive for Harvey Cole
Soaring food prices have been hitting the headlines. Wheat recently reached new records, but in real terms (after adjusting for general inflation) it has only recently recovered to the levels it traded at in the early 1970s. Indeed, between 1973 and 2000 the price of wheat dropped by 80 per cent. This time around it has already lost more than a third from its peak.
In a few dramatic days in April, the price of rice almost doubled, but it remains over a third below its all-time highs in 1971-72.
While remaining volatile, food prices can be expected to maintain high levels more consistently this time around. Emerging countries have much more spending power and are using it to consume more food. Between 1985 and 2007, China’s population trebled the amount of meat they ate, to 65m tonnes. That absorbed much of last year’s world increase in grain production to 2.1bn tonnes. 40 per cent of that was fed to animals rather than humans.
Biofuels took another 5 per cent, neatly offsetting the growth in output. Ironically, the rush to supplant petrol is itself putting pressure on oil prices: agriculture is one of the largest consumers of oil through fuel and power, transport and, particularly, oil-based fertilisers.
So we can look forward to high food prices over the coming years—although the price of a loaf of bread has already risen by far more than the cost of the wheat it contains.
How good are the forecasters? 45 leading banks and other financial institutions ended 2007 having all failed to make an accurate guess at the 3.1 per cent by which GDP rose during the year. (The nearest was the treasury—thanks to its bracket figure of 2.75 to 3 per cent). All the others were too low. Similarly, not a single one forecast that the bank rate would end the year at 5.5 per cent. Although in mid-year many were predicting 5.75 or even 6 per cent, only one pencilled in a rate of more than 5.25 per cent back in January.
Only two got within 10 per cent of the current account deficit of £60bn—the great majority guessing more than 30 per cent too low, while every single forecaster overestimated the level of unemployment. The only relative success was on inflation: three quarters guessed to within a tenth of the actual 2.1 per cent.
Does it matter? Maybe not. But it may be a good idea to ask your experts what unforeseen events they have taken into account when examining the entrails.
It is often said that the shortage of housing in Britain is confined to what is called the affordable sector. That is just another way of saying that an increasing number of people are unable to buy homes at current prices. Is an end to the housing shortage possible?
With households forming at the rate of over 220,000 a year, and the number of new dwellings built each year numbering around 150,000 since 2000, it is obvious that the shortfall must be increasing by around 70,000 annually, before taking account of the loss of existing homes and the fact that many properties are in places where the population is decreasing for economic and other reasons.
The housebuilding industry would therefore need to increase its output by at least 50 per cent for ten years to eliminate the shortage—and to concentrate its efforts in the lower end of the market. The industry regularly blames planning delays and restrictions for the situation but this is simply not true. Planning permissions are valid for three years after being granted, and enough are outstanding to support rates of building well in excess of actual completions: the nine leading companies had, in 2006, almost 225,000 full permissions, but built between them only 83,400 homes.
Not only does the housebuilding industry react apprehensively to any hint that the market may be softening, by reducing output and sitting on its (continually appreciating) landbanks, but it is doubtful that it has the capacity to produce a sustained increase in homes built even if it wanted to. There is a severe shortage of virtually every skilled and semi-skilled trade in the industry, with unfilled places for 90,000 trainees and apprentices. (Short-term recruitment from East European countries cannot fill the gap over the longer term.)
The real problem however is the inexorable law of supply and demand. Increasing supply will lower prices. A continuing need for more homes will not generate a greater supply. But sufficient new housing could be produced by the waving of some magic wand, either by enormous subsidies to so-called affordable dwellings—involving big rises in taxation—or by flooding the market. That would provoke such a fall in prices as to enable those now priced out of the market to pay their way in. The consequence would be for tens of thousands of pounds to be wiped off the market value of the 18 million or so existing owner-occupied homes. Any government that presided over such an event would have signed its own death warrant.
Disillusioned by their experience of other forms of investment, increasing numbers of people are putting money into houses—their own or those they buy to let to others—to provide a nest-egg for their retirement. Thousands are also helping their children to get a foot on to the rapidly receding first rung of the housing ladder by giving them all or part of the initial deposit. By 2006 the proportion of first-time buyers with such assistance had reached 40 per cent, against less than 10 per cent ten years earlier.
Of course, help with a deposit is a transfer of wealth from a generation which has benefited from soaring house prices at the expense of future generations. But if capital is passed on today, it cannot also be available to provide funding for retirement.
In any case, the extent to which the sale of a house can finance old age is limited. Suppose that, not having any children to assist (or deciding to let them fend for themselves) you are able to sell your home at the age of 65, for an imposing £600,000 or six times what you originally paid for it. You will still need somewhere to live, and that could well absorb half of your capital (or the equivalent in rental). £300,000 (or, more realistically, £250,000 after all the costs of selling and moving) will produce a retirement income of no more than about £14,000—a useful supplement to any other pension, but in 20 years’ time probably no more than 40 per cent of average incomes, and not necessarily any more than could have been built up by other ways of saving.
And what happens if there is in fact a crash in house prices some time between now and then? The closer that happens to your retirement date the more of a disaster it would be.
The great fear of homeowners is that a drop in prices will leave them in the state of negative equity—when you can only sell your home for less than you still owe on it—that afflicted so many at the end of the 1980s. But the joys of positive equity—being able to realise a net capital gain—are not unconfined. The current state of the housing market does not necessarily benefit homeowners to the extent we tend to assume.
Suppose, back in 1992, you had just managed to raise the resources to buy your first house, for £100,000 (or, more likely, £99,975). You had had your eye on an even more attractive place but, at £125,000, it was completely out of reach. You took out a 25-year mortgage of £90,000.
Now your house is worth £320,000. The apple of your eye is back on the market, however, it now costs £500,000. But, you say, there is a capital gain of £220,000 which will help make the whole thing possible. Not so fast.
By now you will have paid off around £40,000 of the original mortgage. But then, two years ago, you borrowed another £20,000, releasing part of your equity, to buy a car and have a well-deserved holiday. So you still owe £70,000. You will also have paid out perhaps £15,000 over 15 years on maintenance and repairs, so your real net capital gain is £235,000. Moving will involve (apart from removal costs) estate agents’ and solicitors’ fees, plus stamp duty of £15,000 and some inevitable spending on redecorating and improving the new home: you will be lucky if the total of these items is less than £35,000.
So you have around £200,000 in hand. Unless you have other capital to draw on, you will need a mortgage of £300,000 to complete your purchase. So you will end up with monthly payments of around four times the present level.
The first law of bubbles is that they burst. It may take much longer for them to do so than anyone expects, but in the end, they do.
It is a matter of simple arithmetic that house prices cannot continue increasing at the same rate—or anything like it—as in recent years. Since 1992 house prices have more than trebled. That is an average annual increase of 8.1 per cent. Over the same period incomes have not quite doubled.
The average house now costs approximately £200,000. Average earnings are around £25,000. That gives the much quoted statistic that a home costs eight times income, a historically high figure. It would in fact be more realistic to make the comparison with what is left out of those incomes after unavoidable outgoings have been paid: income tax, national insurance and council tax. That reduces net income to around £18,000 and means that average homes cost 11 times average incomes.
Now we are told, in a report by the National Housing Federation published yesterday, that average house prices are likely to reach £300,000 across the country by 2012. If post-tax incomes rise by a perhaps optimistic 3.25 per cent a year they will grow to £21,100 by then. The average house would then cost over 14 times the average net income. An 80 per cent interest-only mortgage at 5.75 per cent would then cost £13,500 a year, leaving only £7,600 for all other household expenditure—down from £8,900 today. In other words, living standards for new householders would show a dramatic decline, a situation hardly likely to prove sustainable.
Shorthand thinking means that inflation is now simply identified as an increase in prices. This is a dangerous misconception, as higher prices on their own are in fact deflationary. This point was recognised by some commentators when oil prices soared last year: the effect was correctly compared to a tax levied by the oil producers which depressed demand in general.
Higher prices are in fact a symptom of inflation, in the same way as a high temperature is a symptom of fever, not the fever itself. Inflation is fuelled by a rise in incomes and spending—not by higher prices, which are an attempt by the economic body to bring excessive demand back into balance with inadequate supply. Inflation is therefore appropriately tackled by letting prices rise without extra spending power. The weapon of choice—rising interest rates—is defective because it results in higher incomes as well as having some restraining impact on demand: many benefits, including pensions, are directly linked to inflation, as are many pay agreements. So relying on interest rates to squeeze inflation prolongs the process of regaining control and achieves eventual equilibrium only at the cost of pushing prices to higher levels than are necessary.
You don’t cure a fever by plunging the thermometer into cold water.
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