Living standards & inequality

By historical standards, growth in household incomes over the past decade has been severely disappointing. In the long run, living standards as measured using real average incomes (i.e. adjusted for inflation) tend to improve over time, but the economic downturn in 2008 resulted in a prolonged period of weak earnings growth. Average incomes continued to increase for some groups, including pensioners, but for other groups average incomes slumped. This was particularly true of those in their 20s.

Increases in employment since 2013, combined with low inflation, mean average income has now climbed out of a trough and sits slightly above its 2009/10 peak. However, it remains well off its pre-recession path.

With benefit cuts likely to be felt more keenly in the new Parliament, the prospects for a shared revival in living standards look doubtful.

Wages are stuck in a rut

Median earnings for full-time employees fell by around £30 per week between 2008 and 2016, after adjusting for inflation – a decrease of 5.3%. Although average wages have grown more quickly than prices over the past two years, thanks in part to low inflation, OBR forecasts suggest real average earnings will not regain their 2008 level until after 2020. To find a period of similarly weak growth in average earnings, we have to look back to at least the 1920s.

The outlook for real wages has deteriorated since the EU referendum. In March 2016 the OBR forecast growth in real average wages of 8.5% between 2015/16 and 2020/21. That compares to the most recent March 2017 forecast of 4.6% growth. The gloomier outlook reflects the OBR’s expectations that inflation will be higher and productivity growth weaker as a result of Brexit. Of course, any such forecasts are subject to much uncertainty.

Lowest-paid employees can expect to see their earnings boosted by the National Living Wage, which is set to rise to 60% of median earnings by 2020 (expected to be just under £9 an hour). However, for many of the poorest households, the greatest impact on income in the new Parliament will arise from benefits changes.

Benefits changes will bite in the new Parliament

Real incomes for the poorest households increased between 2013/14 and 2015/16 thanks to strong employment growth and very low inflation. This was despite increases in most working-age benefits being limited to 1% over the period.

The period of very low inflation now appears to have drawn to a close and over the next few years, benefits changes are likely to see incomes of the poorest households decrease in real terms. The freeze in the value of working-age benefits for four years from 2016/17, along with the phased introduction of a two-child limit for tax credits and the roll-out of Universal Credit, will have the most impact on families with children.

Labour’s manifesto committed £2 billion to “reform and redesign” Universal Credit but commentators have pointed out this is relatively small compared to the total scale of cuts. Labour also said it would end the freeze in working-age benefits (although this was not included in the manifesto).
The Liberal Democrats planned to end the freeze as well as reversing most other planned benefit changes.

Better outcomes for some

Behind the headline trends, some groups have fared relatively well since 2008, notably pensioners and people who own their own home.

Although pensioner incomes have been supported by the ‘triple lock’ on the State Pension from 2011, they were already growing strongly in the years before the recession. To a large extent this is attributable to new cohorts of pensioners holding larger private pension pots and continuing to have some income from employment.

By contrast, median incomes for the working-age population have been flat since the recession, with particularly steep falls in average income of people in their 20s. (Note: we are not comparing the same groups of individuals over the period, since people will move in and out of age groups as they get older.)

Falls in mortgage rates since 2008 have benefited those who own their own home. At the same time, a larger share of people are living in the private rented sector, due to lack of supply in the social rented sector as well as high house prices for those seeking to buy a home.

What is to be done?

While the tax and benefit system can help support living standards for certain groups of families, or incentivise people to improve their living standards by taking up higher-paid employment, ultimately longer-term improvements in UK living standards will depend on delivering growth in earnings.

If that is to occur, the UK needs to escape the stagnant productivity that has been a feature of the economy since the 2008 recession. Put simply, we need to produce more for each unit of work we put in. Solving this problem will require the new Parliament to search for answers across policy areas more widely: from skills to infrastructure, from employment to trade, and beyond.