Today saw the biggest teachers strike in 20 years as the Government tried to force teachers to accept a pay deal of 2.45% linked to the Consumer Price index (CPI) (2.5%) instead of the more recognised Retail Price Index (RPI) (4.1%). The CPI is the internationally standardised inflation measure that is designed so as to under report inflation and thus make the jobs of politicians and finance ministers easier when it comes to public sector pay deals.

The impact of pay linked to the CPI manipulated inflation statistic is that year on year workers salaries fall in real terms. The consequences of this is that ordinary people need to increase their debt to pay for the shortfall in living expenses. Whilst the property market was booming many workers enjoyed the wealth effect which they capitalised upon through equity withdrawal which given the Credit Crisis is now no longer an option.

The most resent surge in worker discontent is as a result of the surge in food prices, peoples shopping basket prices are not increasing by the CPI rate of 2.5%, the actual year on year increase in food costs that many experience is more like 50%.

The Retail Price Index (RPI) whilst far from perfect, has long been recognised as a reliable measure of inflation and therefore accepted by both public and private sector workers in pay negotiations. The above graph illustrates the accumulative spread between the CPI and RPI over the last 5 years and clearly shows the degree to which the CPI under reported real inflation by 7%. The British government in 2006 instructed the public sector to link pay deals to the CPI index instead of the RPI index, during which time public sector workers would have seen a loss of 3% in purchasing power.

What is the real rate of inflation ?
Whilst inflation is dependant upon individual choices and circumstances the real rate of UK inflation is probably at least 1% above the RPI index therefore at above 5% against the RPI of 4.1%, thus resulting in a far greater loss of purchasing power.

Another U-Turn Coming?
The striking teachers must be buoyed by this weeks U-turn on Tax, and are looking towards another similar U-turn which will see their pay linked to the RPI Index. However, many other public sector workers are watching the situation with the teachers closely as any concession towards the teachers would have to be applied across all public sector works. Otherwise the government would be in for a "Summer of Discontent".

However the teachers have enjoyed a significant real terms pay rise of as much as 20% as New Labour sought to boost the relatively unproductive public sector which has seen public sector debt mushroom under New Labour and is headed for 40% of GDP up from 29% in 2000. The December 07 article Public Sector Pay to Cripple the UK Economy During 2008 warned of the consequences for UK economy.

The implications of another U-turn will be inflationary and would be expected to push the already weakening UK economy into a stagflationary recession during 2009. The Market Oracle forecast for GDP growth for 2008 is 1.3% as of December 2007. The consensus forecasts have been repeatedly revised lower from 2.5% in December 07 to the current 1.7% and will likely converge with the Market Oracle forecast by the end of 2008. However the Governments forecast for 2009 growth of 2.5% seems ridiculously over optimistic as Britain will be lucky to avoid a technical recession of 2 quarters of GDP contraction.

By Nadeem Walayat

Nadeem Walayat has over 20 years experience of trading, analysing and forecasting the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 120 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors before engaging in any trading activities.

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