NATIONAL INFLATION MEASURES FAIL TO CAPTURE THE REAL COST OF
LIVING IN LONDON AND THE SOUTH EAST
The Retail Price Index (RPI) fails to take account of substantial regional variations in
the cost of living in the UK, underestimating the cost for people living in regions with
more expensive housing, such as London and the South East, and overestimating the
cost in less expensive regions, such as Northern Ireland and Scotland.
These are among the findings of new research by Cinzia Rienzo, to be presented at
the Royal Economic Society’s 2011 annual conference. The research suggests the
need for a region-specific cost of living index and related policy to address differences
in the labour market and standard of living across the UK regions.
The RPI is a measure of inflation widely used by the UK government, for example, to
calculate appropriate wage levels for public sector workers and tax allowances. This
study examines how the national RPI changes when accounting for regional differences
in the cost of housing in the UK. Among the findings:

In 2008, the regional RPI in London and the South East was higher than the
national RPI by 9% and 6% respectively. In the same year, the regional RPI for
Scotland was 6% lower than the national RPI.

Due to the higher cost of living in the south, an hourly wage of £10 can buy
between 8% and 11% less in London and the South East than elsewhere. In the
least expensive regions, the same £10 can buy 9% more.
More...
The national Retail Price Index (RPI) fails in being fully representative of regional
variations in the cost of living in the UK and this inevitably has some implications for the
level of regional real wages.
The RPI provided by the Office for National Statistics (ONS) measures the proportional
change in the cost of buying a fixed bundle of goods as prices change. It is one of the
most common inflation measures in the UK. But the ONS does not calculate regional
price indices though the regional variation in the inflation rate is an issue of importance
because of the crucial role of the RPI for policy decisions.
Specifically the RPI does not account for the differences in regional housing costs,
despite the fact that expenditure on housing represents the largest component of total
household expenditure and varies considerably across regions. As such, differences in
regional housing costs might be expected to play an important part in determining cost
of living differences among regions in the UK.
This implies that deflating the nominal wages by a regional RPI might lead to different
levels of the observed real wage deflated using the national inflation index.
The study examines how the national RPI changes when accounting for regional
differences in the cost of housing in the UK and its implications when using the RPI to
deflate the hourly wages.
To derive the regional RPI, the national RPI calculated by the ONS is partially updated
with a regional specific housing index that allows the RPI to vary across regions.
The analysis reveals that:

The national RPI underestimates the cost of living of workers living in regions
with more expensive housing (London and the South East) and overestimates
the cost of living for ‘cheaper’ regions (such as Northern Ireland and Scotland).

In 2008, the regional RPI in London and the South East was higher than the
national RPI by respectively 9% and 6%; in the same year, the regional RPI for
Scotland was 6% lower than the national RPI.

When deflating hourly wages by the regional RPI, the average level of wages is
lower by 8-11% an hour for workers in London and the South East, while it is
higher by 2-9% in the remaining regions.

In 2008, 38% of the UK graduate labour force was concentrated in London and
the South East. This implies that many graduates are increasingly exposed to a
higher cost of living and that the relative increase in their real wage may be
smaller than the relative increase in their nominal wage.
The research uses data from Living Costs and Food Survey (formerly the Family
Expenditure Survey) and the Family Resources Survey from 1997 to 2008 to construct
the regional RPI, and the Labour Force Survey as the primary source for individual
earnings data analysis.
The finding that the national RPI does not reflect any regional variations in the cost of
living in the UK is remarkable. The use of inflation measures and the way we measure
them are crucial in terms of policy decisions, since the RPI is used by the government
for a number of reasons: to set up and uprate the level of wages and tax allowances,
and to regulate train fares as well as index-linked government bonds.
The findings of this research suggest the need for a region-specific cost of living index
and regional-related policy to address the existing regional differences in the labour
market and standard of living across the UK regions.
ENDS
‘Real Wages, Wage Inequality and the Regional Cost-of-living in the UK’ by Cinzia
Rienzo
Contact:
Cinzia Rienzo
Email: c.rienzo@rhul.ac.uk