Economic And Benefit Reform Essential To Replace UKs Stagnation With Rising And Shared Prosperity

4th July 2023

Stronger economic growth is fundamental to restarting rising living standards in the UK, but must be accompanied by reform to our economy and benefits system if the rewards are to be widely shared, according to new Resolution Foundation analysis published today (Tuesday 4 July 2023).

Sharing the benefits - the 40th report from The Economy 2030 Inquiry, funded by the Nuffield Foundation - examines what a plausible path to rising shared prosperity for the UK would look like, after 15 years of stagnation.

While some argue that growth isn't desirable and doesn't feed through to rising wages for normal workers, the authors show that productivity growth is the essential prerequisite for rising wages. Its absence is the key driver of the UK's current wage stagnation: productivity and wages grew 29 and 30 per cent in the decade to 2005, before falling to just 8 and 4 per cent respectively in the decade to 2020.

But the Foundation's analysis shows that rising wages alone will not deliver shared prosperity. If wages grew in line with the OBR's forecast over the next decade, then low-income households would see income growth of just 2 per cent, compared to 12 per cent for typical households and 14 per cent for those on high incomes. This would mean 1.8 million more people, including 1 million children, falling into relative poverty.

This is because far from all households receive the majority of their income from employment, including pensioners and many of those with disabilities or children. In total, around 11 million people get less than half their income as earnings from employment, including almost half (47 per cent - equivalent to 5.4 million people) of the poorest fifth of households.

The authors show that ensuring growth raises living standards but not inequality requires productivity growth to be accompanied by reform of our economy (so higher employment and pay raise the incomes of poorer households) and welfare system (so the gap between wages and benefit levels does not get ever larger).

First, higher employment rates should disproportionately benefit poorer households. This approach has been successful in the past, with all of the increase in employment since 2009-10 located in the bottom half of the distribution. Repeating this success with a further 3 percentage point (equivalent to 1.2 million people) rise in employment over ten years would bring 500,000 people out of poverty.

Second, policy makers should build on the success of the minimum wage, targeting faster pay growth for lower and middle, than higher, earners. Significant progress on both these economic fronts would make income growth middle heavy, but still see poorer households (who would not benefit from wage gains but would see their housing costs rising with average incomes) left behind. Over a decade, the poorest fifth's incomes would grow by around 10 per cent versus 18 per cent for middle-income households and 14 per cent for the richest fifth.

The authors say that any plausible route to shared prosperity will therefore also need reform of the benefits system, directly connecting the level of working-age benefits to wage growth, just as Britain does for pensioners, and housing support to the actual level of rents.

Combining growth with action on employment, pay, and benefits offers a route to shared prosperity and the most significant fall in inequality since the 1970s. The Foundation's modelling shows that over a decade the poorest households incomes would rise by 19 per cent, compared to 17 per cent for typical households, and 13 per cent at the top.

The authors note that while this shared growth strategy is ambitious, policy change to connect groups at risk of being left behind by growth has been achieved before. Between 1983 and 1989, pensioner poverty soared from 14 to 41 per cent as rapid economic growth boosted workers' wages while pensioners were left behind. A major policy drive - including guaranteeing to increase pensioner benefits at least as fast as earnings - then brought pensioner poverty down to 14 per cent in 2010-11, lifting 2.3 million pensioners out of poverty.

Finally, the Foundation notes that while linking working age benefits to wages would increase costs, total spending on working-age benefits as a proportion of GDP would still be 0.4 percentage points lower in 2041-42 than in 2026-27 (due to the UK's ageing population). Furthermore, half of the cost of the policy could be offset by treating working-age and pensioner benefits the same, and uprating both via a smoothed earnings link.

Mike Brewer, Chief Economist at the Resolution Foundation, said, "Economic growth - the essential precondition for rising wages - is sorely needed after 15 years of stagnation. But it’s equally important that this rising prosperity is widely shared.

"A strategy that delivers productivity growth alongside reforms to employment, pay, benefits and housing costs is ambitious. But it can draw on past policy successes, including the reduction in pensioner poverty, rise in employment and faster earnings growth for lower earners seen over recent decades.

"All political parties say they want to see a return to rising, and shared, prosperity. But only combining an end to Britain’s productivity stagnation with major reforms to our economy and benefits system can make that a reality - getting incomes up and inequality down."

Sharing the benefits
Can Britain secure broadly shared prosperity?
The UK has been living through a period of relative decline that has proved toxic for those on low-to-middle incomes. Against that backdrop, this report examines whether there is still a plausible path to steadily rising shared prosperity and, if so, what does it look like. It does this as part of the Economy 2030 Inquiry, which is developing an economic strategy for the UK to underpin higher growth and lower inequality.

The report argues that a return to productivity growth is the central precondition for a return to rising wages in the UK, the main motor of increasing living standards. But it also explains why growth is a necessary but far from sufficient condition for success. It goes on to show that growth combined with a significant, but achievable, policy agenda covering both predistribution (including ensuring the rewards from the labour market are widely shared) and redistribution (including benefits system reform) offers a plausible path to rising and shared prosperity.

Key findings
The link between productivity growth and typical in wages isn’t perfect at all times, such as when growth in wages is skewed towards the top, when higher productivity is seen in non-wage compensation, or when rising import prices reduce the buying power of workers’ wages. But these do not fundamentally break the link between higher productivity and higher living standards. In the decade before 2005, GDP per capita and average wages grew by 29 and 30 per cent in real terms in the UK; in the decade before 2020, growth in both plummeted to just 8 and 4 per cent respectively.

But relying on the labour market to deliver rising prosperity is flawed, as not all household income comes from today’s labour market. As well as pensioners, there are 11 million individuals in working-age households - nearly 5 million of which are in working households – where employment income makes up less than half of household income. Of the 6.1 million in households in which no-one works, the majority (3.6 million) are in households with someone who is long-term sick or disabled, and 1.2 million are in households with dependent children. Only 0.9 million are traditionally unemployed. Those in the bottom fifth of the income distribution get just over half their income from the labour market, compared to almost 94 per cent among the richest fifth.

Using microsimulation modelling, we assessed how incomes might change were the UK to return to a more normal period of productivity growth. After a decade, real wages could be 16 per cent higher but. If we assume no change in earnings inequality, typical household income would rise by 12 per cent, and by slightly more (14 per cent) in the top income quintile, but incomes at the bottom of the income distribution would see average growth of just 2 per cent, reflecting the smaller contribution of earnings to household income. This would mean relative poverty rising by 1.8 million (1 million children) and the income gap between a typical and poorer (bottom fifth of household income distribution) household rising from £18,000 to £21,000.

This ‘prosperity gap’ is the result of the UK’s approach to the benefit system, where amounts rise by (at best) prices rather than wages. As a result, basic benefit support is today at the same level in real terms as it was in 1992, despite a 51 per cent growth in GDP per capita. Continuing with this approach would see the Universal Credit (UC) standard allowance fall from 14 per cent of earnings in 2025-26 to 12 per cent in 2035-36 and 10 per cent in 2045-46, down from 17 per cent in 2000-01.

These modelling results have a similar pattern to the experience of the 1980s, when pensioner poverty soared (from 14 to 41 per cent from 1983 to 1989) as pensions (then rising in line with prices, rather than earnings) lagged behind rapidly growing earnings. But, with broad political support, subsequent UK governments deliberately linked pensioners’ incomes to broader economic growth by using earnings-indexation, first for the means-tested support for pensioners, and then for the basic state pension, ensuring future growth wouldn’t leave pensioners behind.

Growth will also push up essential costs, notably housing. If housing costs continue to broadly track income growth, then households in the bottom quintile would see a living standards decline of 4 percentage points over 10 years. This is because of our approach to Local Housing Allowance (LHA) rates. These are currently frozen in nominal terms – which is clearly unsustainable – but even if governments index them to inflation, then long-term increases in housing costs will eat up all the gains from growth at the bottom of the income distribution.

Taken together, productivity growth, higher employment and progressive wage growth would ensure higher incomes for all parts of the income distribution. But poorer households would still see the slowest income gains (10 per cent). Ensuring that those parts of society who do not receive the majority of their income from the labour market share in growth can only be achieved by social security benefits growing in line with wages rather than prices, and LHA rates keeping up with growth in housing costs. This would be a big shift, but not unprecedented: New Zealand has recently joined Germany, Belgium, and the Netherlands in uprating benefits with reference to changes in earnings (or GDP), and in the UK we moved towards this approach to benefits for the over-65s around two decades ago.

Linking working-age benefits to wages would involve governments spending more than if they permanently linked them to prices, but total spending on working-age benefits as a proportion of GDP would still be 0.4 percentage points lower in 2041-42 than in 2026-27 even with earnings-indexation (due to favourable demographic trends). Furthermore, half of the cost compared with price-indexation could be offset by treating working-age and pensioner benefits the same, and uprating both via a smoothed earnings link.

Read the full report HERE
Pdf 56 Pages.