Even if the economy improves, living standards may notby Gavin Kelly / November 16, 2011 / Leave a comment
Published in December 2011 issue of Prospect Magazine
In the three months from July to September, Britain’s economy actually grew—by 0.5 per cent. That performance was less bad than many had feared, and some have seized on it as a source of hope. For Chancellor George Osborne it was a “positive step… laying the foundations for the future success of the country.” Even Bank of England Governor Mervyn King, hitherto the nation’s self-appointed prophet of economic doom, recently said that the squeeze “is now beginning to come to an end.” Whether or not such sparks of hope prove justified, they obscure a much bigger question: even if the economy recovers, will living standards improve?
For the 11m adults living on low-to-middle incomes, the answer is likely to be no. This broad section of the British population, defined as living on household incomes from around £12,000 to £48,000 per year (depending on the number of children they have), is overwhelmingly in work and not heavily reliant on benefits. To understand why people in this group may face continued stagnation even when growth returns, we need to appreciate the reasons why they continued to feel better off up until the middle of the last decade—and why these forces for prosperity are unlikely to play the same role in the decade ahead.
Take personal debt, for a start. Thanks to easier access to mortgages, loans, credit cards, as well as a housing boom, Britain’s ratio of household debt-to-income (what a household owes compared to what it earns) rose from around 100 per cent in 1988 to a peak of around 170 per cent in 2008.
Although interest rates have been close to zero for over two and a half years, those on low-to-middle incomes now have to spend a greater share of their income paying the interest on their debt than they did during the 1990s. That is because the total amount of debt rose so rapidly, and because banks and other lenders did not pass on these rock-bottom interest rates fully to borrowers.
Even if interest rates were to stay low, paying down this debt would still require households to spend a large part of their income on mortgages and loans for years to come. And interest rates must eventually rise. That will hit working families hard. The Bank of England estimates that if interest rates rise again to 5 per cent, it will mean a near doubling of the burden that households face from debt payments—and more still for the most heavily stretched.
If current trends continue, it will be roughly 2020 before household debt is back to its 2001 levels. Economists call this a “debt overhang.” Non-economists might call it a nasty—seemingly unending—hangover. Few politicians acknowledge how long the fallout might last.
Second, there is the threat to the future of tax credits. Created in Labour’s first term, these credits meant that millions of families struggling on low incomes receive top-ups to help with their household costs. They played a pivotal role in ensuring that growth raised living standards across the board.
Given cuts to spending, it’s clear that tax credits will not play this role on the same scale in the future. In the years before the recession began in 2008, spending on tax credits rose by around 5 per cent a year above inflation. Now it is set to fall annually by roughly 2 per cent in real terms. This shift from forward to reverse gear will cost more than 6m families across Britain an average of £1,600 per year by 2015, a grand total of £11bn. We have yet to appreciate what this is going to feel like, and there are few ideas about what will fill this gap. The notion that employers will decide to raise low wages is—to put it mildly—optimistic. Other tax and benefit changes, such as new rules on pension contributions, will also chip away at any growth in disposable income.
Third, the rise in women’s employment, which has long been a powerful force behind the rising prosperity of low-to-middle income households, has levelled off [see the charts, opposite]. The rise of women in the workforce since 1971—from 56 to 69 per cent of women of working age—has helped counter the decline in employment rates among men, whose employment rates fell from 92 to 75 per cent over the same period. But female employment appears to be reaching a plateau. Given the barriers to women working that remain in modern Britain—not least the eye-watering costs of childcare—there is little prospect that we’ll see much improvement in the near future. Indeed, without shifts in policy, there are reasons to fear the opposite. David Cameron may have embarked on a campaign to woo female voters, but there is little sign that his government has woken up to the long-term challenges facing women in the British jobs market.
Finally, there is the central question of what will happen to low-end wages. Only 12p of every pound our economy creates goes into the pay of those in the bottom half of the earnings distribution, a share that has fallen by 25 per cent over 30 years. This trend is likely to continue, partly because the minimum wage is not likely to play the role it previously did.
From 1999 to 2010 the minimum wage rose by 65 per cent in real terms—greatly outstripping inflation as well as outpacing average wages. This played a critical role in ensuring growth benefited not just the lowest paid, but those just above that level of earnings, too. But over the last few years the minimum wage level has fallen back compared to average pay. If we wanted the lowest paid in Britain to recover this lost ground—never mind advance their position—we’d need to see a steep climb in the minimum wage between 2012 and 2015.
In short, many of the key motors of progress for those on low-to-middle incomes have stalled. As yet, we have little idea what will replace them. We will have to cope with paying down debts while also grappling with the underlying problem of stagnant living standards, a problem that pre-dates the recession. Either challenge on its own would be a tall order.
Yet amid this gloom it is possible to discern new possibilities. The debate about growth often swings between fatalism on the one hand and airy generalisations about the sources of growth on the other (think of the rhetoric about “rebalancing” our economy). Instead, we must focus on gritty steps for improving household finances. This means working out where Britain could boost employment—particularly among women, older people, and those on low incomes—and how gains from future productivity could be more evenly shared. Far from being a distracting luxury in the midst of today’s turmoil, this will help us make more foresighted decisions.
A consistent principle of the Chancellor’s spending cuts has been to protect middle and higher income pensioners—for instance by keeping universal benefits like the winter fuel allowance—while letting working-age families, and the young, bear the brunt of the cuts. This can be seen in the reduced support for childcare—not just a blow to today’s working mothers, but also to female employment and household incomes for years to come. The government is making a big mistake here—not just in the way the short-term pain is allocated, but also by damaging the long-term prospects for working families.
True, the coalition has said it intends some of its major reforms to boost poorer working families’ incomes, such as raising personal tax allowances or introducing the universal credit [see Iain Duncan Smith, below]. But it is missing the opportunity to shape these measures so that they better address the underlying challenge to family living standards. For example, it has passed over fresh ideas ranging from child allowances, which would give bigger tax allowances to people raising a family, to extended childcare, to reforming tax credits and child benefit in order to target existing cash support towards young children.
The government could also boost employment and incomes by helping older workers. That’s one reason it was right to abolish the default retirement age, something Labour should have done years ago. But more positive reform is needed to unleash “grey” earning power. For all the attention on flexible working rights for parents with young children, little thought has been given to the value they could offer older workers. And if those in their fifties and sixties are to work longer, the government must also prioritise care for their parents’ generation.
Finally, there is the root problem: inequality of pay. A long-term view on the minimum wage would couple necessary caution now with a commitment to boldness later. If future increases kept up with average earnings, this would serve as a constant upward pressure on low wages.
Rhetoric on top pay continues to surge ahead of action, but practical new ideas do exist. Andy Haldane of the Bank of England has suggested linking bankers’ pay to the returns made from issuing loans, rather than their banks’ share prices. If this had been applied in the United States in recent decades, chief executives of banks would now earn not 500 times the typical household income but (only) 68 times.
The point is not that these policy directions are the only answer, but that simply hoping for the best won’t suffice. The recent past has shown that improvements in living standards for low-to-middle income Britain don’t arise by accident. They require concerted policy action. There are choices that the government could make which would mitigate the pain of cuts and a stalling economy, as well as open up new opportunities to raise living standards.
None of this diminishes the importance of securing a strong recovery. But it does warn us against the dangerous assumption that resumed growth on its own will be enough. The next election could well be framed by Westminster village excitement about renewed growth—matched by bewilderment that this good news is completely divorced from the dismal reality of millions of voters. If the political establishment fails to prepare for this, it will only have itself to blame.
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