The price of old age

Lawyers are supposed to be adept at confusing the layman. Economists are sometimes far worse. Henry George said: “For the study of political economy you need no special knowledge, no extensive library, no costly laboratory. You do not even need textbooks nor teachers, if you will but think for yourselves.”

It sounds so easy…

Recent research by the Alliance Trusts into the relationship between age and inflation makes interesting reading. It suggests that while consumer price inflation for the under 30s may be hovering around one per cent per year, the inflation applicable in practice to those aged over 75, was 67 per cent higher than that in January this year. This is quite a difference when the nibbling away of the real value of pensions and fixed income is factored in for older people as compared to the ability of most younger people to keep up by way of regular pay rises. We should not forget that just one per cent compounded over 30 years, for example, between the ages of 60 and 90, can make a 35 per cent difference in spending power. With larger inflation digits, the effect is astronomical.

So what exactly is a price index intended to achieve?

“The purpose of a consumer price index is to measure changes over time in the general level of prices of goods and services that a reference population acquire, use or pay for consumption. A consumer price index is estimated as a series of summary measures of the period-to-period proportional change in the prices of a fixed set of consumer goods and services of constant quantity and characteristics, acquired, used and paid for by the reference population. Each summary is constructed as a weighted average of a large number of elementary aggregate indices...” International Conference of Labour Statistics – Geneva 1987.

There is the rub precisely. The aim of a consumer price index, be that CPI, RPI, RPIX or otherwise, is simply to measure aggregate price changes. It is also often used to create a realistic cost-of-living index. A true cost-of-living index assumes that rational consumers seek the route with least cost to achieve a certain level of specified/desired economic well-being. It then seeks to assess the impact upon the rational consumer of attaining that specified/desired level of economic well-being when prices change. But it does not look at the apparent ‘irrationalities’ of different age groups within the ‘average’. The impact of inflation upon one group might, as revealed in the Alliance Trusts research, be quite different from the impact upon another group.

Research notes by The Alliance Trusts state: “In every single month [over 2004 and 2005] inflation rose in line with the age of the person running the home.” The difference ranged from 28 per cent to 136 per cent. They added that the current approach “is operating to the disadvantage of our older citizens”. In short, I interpret this as meaning that increasing age-related benefits in accordance with a price index based on the whole population’s average spending habits rips off pensioners.

Why the difference? Older households spend relatively more on food and non-alcoholic drinks, more on health products, notably medicines and utilities (as a result of being at home) the prices of which are rising faster than average. They spend less on the clothes and electrical goods that younger people buy relatively more of, which are falling in price. They don’t really like pizza, but love fish and chips.

So what? Apart from the big difference it makes to older people right now it means to me (though as an economics duffer I am open to other arguments) that those scary figures presented about how much we need to save for our pensions are depressingly inaccurate. Actually we need to save much more income-generative capital than we thought we did in our worst nightmares. Perhaps twice as much. The problem also applies to long-term trustee investment for vulnerable people. Inflation is probably not as dead as it seems to those of us who endured the price spirals of the 1970s, despite it nowadays appearing to be something that only happens to balloons. It has simply become more insidious and less obvious in its effects. Dare we forget it?

David Coldrick
Editor
david.coldrick@wrigleys.co.uk

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