Productivity stuck on auto-creep

Tim Scott’s piece on productivity earlier this week led me to this ACAS report on the subject. As you might expect, they focus on what has been happening in the workplace:

A range of macro solutions have been offered by Government and others, including capital and financial investment in infrastructure. But it is now understood that these can only yield lasting improvements if workplaces are operating at their best. The way workplaces are organised, the part played by managers and leaders, and the role and involvement of employees can help deliver better outcomes for individuals, organisations and the economy.

In an ACAS paper published in February, Ian Brinkley remarked:

The macro-economists have tortured just about every dataset they can get their hands on in just about every way possible.
It is always possible that a new insight will provide the missing part of the explanation, but so far we are coming up short.

In other words, lots of very clever people have looked everywhere and still can’t work out what’s wrong.

He continues:

There is a growing consensus that the bit of the productivity puzzle we cannot easily explain is based on what is going on in the workplace – in other words, there is a significant part of the fall in productivity shortfall that is attributable to employment relations in its widest context.

Or, as Tim says,“It’s the workplace, stupid!”

A recent paper by the National Institute of Economic & Social Research (NIESR) suggests they might be right. The productivity fall, say the report’s authors, has happened across the board.

The most striking feature is the widespread weakness in total factor productivity within firms, pointing to the importance of a common factor in explaining productivity weakness.

Commenting on the paper in the FT, Matthew Klein says:

Adding to our confusion is a fascinating new paper from the National Institute of Economic and Social Research, which shows the UK productivity problems aren’t concentrated in any particular sector and (mostly) can’t be blamed on the inability of good firms to grow at the expense of bad ones. Moreover, there is no noticeable difference in the performance of companies that relied heavily on bank lending before 2008 and those that didn’t, nor is there a significant difference between big and small companies.

Rather, all businesses experienced a big drop in underlying productivity since 2008.

So the collapse in productivity isn’t because of dependence on bank lending nor zombie firms taking resources that should go to better ones. The productivity problem can’t be blamed on the skill level of the workforce either. What we seem to be seeing is a general and sharp decline in productivity across UK organisations.

So what has happened? What has been going on in Britain’s workplaces?

The NIESR report makes a suggestion, though, tantalisingly, it leaves the discussion for another day.

[We conclude that other common factors, which we do not explore in this article, for example general demand weakness coupled with flexible wages, are likely to have been central in explaining the stagnation in UK productivity growth.

This goes back to the hand car wash argument, where cheap labour means that firms don’t need to invest in equipment. Instead, new and existing firms just find ways of profiting from the ready supply of cheap labour.

Some might argue that the labour market needs to be more flexible so that managers can push workers harder and sack those who don’t perform but recent IMF paper concluded that labour market deregulation does nothing to improve productivity and might even make it worse.

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Research in the US and in the UK, France and Germany has shown that unfair dismissal laws encourage firm level innovation. by providing protection for employees to take risks and by encouraging firm to take risks on new projects.

A flexible labour market and stagnant wages, therefore, might have the opposite effect. When managers have more power, employees keep their heads down and their bosses get lazy.

As Gary Miles of Roffey Park said when the Beecroft proposals were announced, removing employment protection lets poor managers off the hook. It absolves them from tackling performance issues. If it gets easier to sack people without explaining why, you don’t need to spend time trying to understand the source of the problem, you just blame the worker, sack him and get someone else. Of course, Beecroft’s proposals were not enacted but the raising of the unfair dismissal threshold and the introduction of tribunal fees has had a similar effect. An employer’s risk of being taken to a tribunal is much reduced.

All this is circumstantial, of course but so far, every attempt to explain the productivity puzzle has drawn a blank. The UK’s stagnating productivity has come at a time when employment protection has been eroded, training investment has been in decline and non-regular employment, such as zero hours contracts, self-employment, temporary employment and part-time work, has increased. As I said earlier this year, the productivity puzzle leaves Britain’s managers with some serious questions to answer. With one of the largest graduate workforces in the EU and one of the largest shares of high-skilled jobs our productivity should be higher than it is.

Like ACAS, the UK Commission for Employment and Skills has been calling for improvements to management practices for some time. Yesterday, Sara Mosavi said that management needs to shift up a gear if Britain’s productivity is to be improved. She’s right but when cheap and flexible labour allows you to coast along on auto creep and still make money, why would you bother?

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There’s a bit about Fastow’s hero-to-zero story I still don’t get

I was at the FT’s Camp Alphaville yesterday. It was an excellent event but it was on Britain’s hottest July day on record and the whole thing was in tents. As I don’t much like the heat, I stayed in the main tent, which had big cooling units in it, for much of the day.

I’m glad I did because it was there that I saw the fascinating presentation by Andrew Fastow, the former CFO of Enron. He started off by confessing his guilt, admitting his part in ruining thousands of people’s lives and saying that he deserved to go to prison. Then he began to tell the story of his fall.

First he held up his CFO of the Year award from 2001. Then he held up his prison ID card. Both, he said, he had been given to him for doing the same things. Describing himself as the Chief Loophole Officer, he explained how he had exploited the grey areas of the law to conceal a lot of Enron’s borrowing, thereby presenting a misleading picture of the company’s finances.

Here is an example:


(Picture by Neil Hume)

Instead of Enron borrowing $970 million for a pipeline, the bank set up a company which acquires the pipeline. It then allowed Enron to use it for a fee and a guarantee to cover its maintenance, any risks associated with it and its de-commissioning or re-sale afterwards. The bank put up the money and Enron paid it for doing so but legally the transaction was not a loan so didn’t have to be declared as such. It looked and sounded like a loan but, as far as the accounts were concerned, it wasn’t.

“There may be a fundamental difference between a company following the rules and a company presenting a true picture of its financial position,” he said. To illustrate this, Fastow told us the touching story of how he explained his conviction for fraud to his 15-year-old son, during a prison visit.

Let’s say your rule is that you will not drink any alcohol when you go to parties. Other kids try to persuade you to have a drink but you refuse and stick to your rule. Then a friend tells you he has this alcoholic beer-flavoured sweet. If you chewed that, you wouldn’t actually be drinking alcohol so you wouldn’t have broken your rule. Would this be OK? “Of course not,” his son replied. That, explained Fastow to his son, is the difference between breaking the principle and the rule. “I’m the guy who chewed the beer pill.”

The trouble is, in corporate America, lots of people were chewing beer pills. The creative accounting for which Andrew Fastow won his award was accepted practice in may organisations, including Enron’s competitors. If you weren’t doing it, your company would be at a disadvantage. Everything he did, he insisted, was signed off by Enron’s auditors, its lawyers and the board. At one point, Fastow calculated the amount of debt that the company was hiding and took the spreadsheet to the board. Instead of being concerned by the level of debt, the board congratulated Fastow on the great job he was doing keeping it off the books. That, he said, showed the mindset that they were in. No-one thought they were doing anything wrong. Furthermore, he said, a lot of people in large companies still don’t and similar things are still going on.

These days Andrew Fastow lectures on business ethics and he told a great story about a task he set for a group of students. He gave them some company accounts and asked them to work out the debt-to-asset ratio. He then asked them to go through the accounts, find the footnotes, work out how much debt was off-balance sheet and do the calculation again. This time, the debt-to-asset ratio was more than twice that of their original figure.

Asked for their views on the company, the students were clear. There is no way they would invest in it or work for it. They wouldn’t go anywhere near such an unethical organisation. Fastow then told them these were their own university’s accounts. The students were outraged. They would complain to the university authorities and demand that they come clean about the debt. But then Fastow explained that, if they did that, fees would have to go up by 10 percent. At this point, the students’ indignation evaporated and they unanimously decided to take no further action. “It took them 4 minutes to sell out,” he said.

And that’s why so much off-balance-sheet accounting still goes on. The rewards for sticking to the rules while ignoring the principles are too great and if all your competitors are doing it we, you’d be daft not to, wouldn’t you?

It was an interesting and entertaining talk. Andrew Fastow held our attention for well over an hour. He ran over but nobody minded. The FT has a write up of the session here.

I was still left with some nagging questions though.

Maybe I missed it but it wasn’t clear at what point his activities crossed the line from unethical to illegal. Perhaps that was the point he was trying to make – that he isn’t sure either. After all, lots of other people were doing it and Enron’s gatekeepers approved all of it. In which case, either there is something he is not telling us or lots of other people who should have gone to prison never got caught. What is more, if similar deals are still going on, are lots of other CFOs risking prison if their companies collapse and they get found out?

Or is it that Andrew Fastow was the example, the sacrifice, after which people learned to cover themselves more effectively so that they could carry on exploiting loopholes without the risk of prosecution?

He has done similar speeches around the world and I’ve looked at some of the write ups but I’m still none the wiser. I’m also no expert in US corporate law and I have only a superficial knowledge of the Enron case, so there may well be something I’ve missed.

Nevertheless, I’m still left with the question. Could it really be that the very same deals that won Andrew Fastow an award in 2001 got him jailed in 2006? If everything he did was within the rules, if lawyers and accountants approved it, and if lots of other people were (and still are) doing it too, how come he went to prison and very few others did?

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The rise or fall of management

Chris Dillow wonders whether managerial control has stifled innovation:

Could it be that the spread of managerialism and the pursuit of “efficiency” in the static sense of trying to maximize output for given inputs has squeezed out innovation?

Two things suggest an affirmative answer. One is casual empiricism: the growth of managerialism has been followed by a decline in trend labour productivity growth. The other is a paper from David Audretsch and colleagues, which shows that since the late 70s innovation has tended to come less from incumbent firms and more from new ventures.

I will leave the second bit of this, productivity and innovation, for another day. For now, though, I’m not convinced that we have seen a growth in managerialism, if we define that as hierarchy, control and the close management of people.

For at least the past 100 years, firms have employed professional managers with the aim of making their organisations more efficient, productive and profitable. This development is often associated with the godfather of scientific management, FW Taylor. Since the 1970s, there has been a shift away from Taylor’s ideas or, at least, there has been in management theory. Ever since I joined the corporate world in the late 80s, most of the talk has been of empowering employees and getting rid of layers of management.

Evidence for the benefits of management delayering is patchy, to say the least, and, despite the vogue for it in the 1990s, it doesn’t seem to have reduced the number of managers in the UK. According to UKCES, managers, directors and senior officials accounted for about 8 percent of the workforce in 1992. The ONS figure for May 2015 is around 9 percent. Allowing for the growth in the workforce, then, the number of managers hasn’t changed much. If the proportion of managers is anything to go by, we are no more or less managed than we were at the end of the 1980s.

How far the day-to-day supervision and control of employees has changed over the past three decades or so is also difficult to assess. The experience is probably different depending on the sort of work people do. There has been a big expansion in the number of professional and technical roles. It is this, rather than managerial employment, that has created the cocktail glass effect. I couldn’t find much evidence of this but, anecdotally, I would say that close supervision of these employees has diminished over the past decade. For example, I know of a number of employers who no longer require people to clock in and out. Many of those in technical and professional roles are given more freedom to work away from the office and the emphasis on presenteeism is no longer as strong.

Certainly most of the offices I see these days don’t feel as regimented as they did when I started work. Then again, these days my relationship with the hierarchy is different. I’m usually there as an advisor to someone senior so I’m not experiencing the power and status differences as acutely as someone who works there all the time. As ever, I suspect that the more layers there are above you on the organisation chart, the more heavy the hierarchy feels.

None of this is to say that close supervision is a thing of the past. In some occupations it is as prevalent as it ever was and there are examples of places more tightly controlled than ever they used to be. Briefly, in the 1980s, I worked in a warehouse and it was nothing like this. In some call centres there is a war of attrition between Big Brother managers and slacking employees. But many of the routine jobs that used to be subject to strict time management have been automated or offshored.

To look at the articles that appear in my Twitter timeline, the future of work is all about technology driven collaboration, Teal organisations, self-managed teams and working from anywhere. Management is a busted flush and bureaucracy must die. Oh and, of course, there’s holacracy.

Yet there is also a lot of talk about software that will predict who is likely to leave the organisation and companies using wearables to monitor not only their workers’ whereabouts but also their health. There are even systems which claim to be able to spot rogue employees by analysing emails, texts and social media activity.

Arguments about the need for supervision versus the benefits of worker autonomy have been going on for centuries. They probably had them when they were building the pyramids. This is from Roman landowner Lucius Junius Moderatus Columella in the first century:

Nowadays I make it a practice to call them into consultation on any new work and to discover by this means what sort of ability is possessed by each of them. Furthermore, I observe that they are more willing to set about a piece of work on which they think that their opinions have been asked and their advice followed.

The history of work, though, is mostly one of compulsion. Some sort of vassalage and work obligation existed in almost all agrarian societies. In Britain, as soon as people began to break the chains of feudalism, new laws were brought in to keep them in line. The desire to control people and make them work runs deep.

I don’t think that this will change. The zeitgeist among management theorists may advocate worker autonomy but technology offers so much scope for monitoring and controlling people that the temptation to do so will be too great for some. Forms of control may change with technology and social norms but I doubt that we will see the death of management that some predict.

Are we more closely managed at work now than we were twenty of thirty years ago? I’d say no more but probably not a lot less, it’s just that the ways of controlling people have changed. Technological developments will offer new possibilities for both autonomy and control. Expect the battle between Theory X and Theory Y to go on for some time yet.

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Cutting in-work benefits: right-wingers think it’s a bad idea too

It now seems to have dawned on just about everyone that, if the government really does cut £12 billion from the social security budget, most of the pain will be felt by those in work. There have been some interesting reactions to this from right-of-centre think-tanks. The Institute of Economic Affairs said the cuts would be “extremely unfair on the working-age population” while the Adam Smith Institute warned that cutting tax credits would remove incentives to work and make the working poor worse off. The Centre for Policy Studies argued for an increase in the minimum wage to reduce the cost of tax credits.

It’s not just those on the left who think cutting in-work benefits is a really bad idea. In fact, it’s quite difficult to find anyone outside the government and its media cheerleaders who thinks this will do anything other than cause a lot of misery for a lot of people.

As Michael O’Connor pointed out earlier this week, close to half the UK’s families with children are receiving welfare support in addition to child benefit.



A combination of a chronically low-wage labour market and rising housing costs means that people with jobs and children, the archetypal hardworking families the government keeps telling us about, can’t make ends meet without support from the state. People are already looking for better paying jobs and more hours. Cutting benefits isn’t going to magic up any more of them.

Compared to most European countries, the UK’s benefits system does a lot of heavy lifting, especially for those in work, reducing poverty levels from well above to just below EU and OECD averages. Unless there is a significant rise in pay over the next few years, cutting in-work benefits will see this country rising up the international poverty league tables.

Our labour market still isn’t creating jobs that enable people to look after their children and pay for their housing costs without help from the state. Both lefties and righties can see that cutting people’s tax credits isn’t going to change any of that. As one of my lecturers used to say, you can stop a dog from scratching by cutting its leg off but afterwards the dog will still have fleas.

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Work-shy dole scroungers – so last century

The Resolution Foundation published two reports on work, poverty and benefits either side of the weekend. Last week’s An Ocean Apart contrasted the developments in employment and welfare in the UK and USA over the last 20 years. This week’s report on Universal Credit recommended a redesign of the in-work benefits system.

In his commentaries on both reports, Gavin Kelly points out that the political rhetoric on poverty and work is two decades out of date. As he says:

[T]he UK’s longstanding problem of workless families has been transformed since the late 1990s: once viewed as the biggest social ill facing the country, the rate of worklessness in households in which there are no disabled adults has plummeted.

There are big structural problems in the UK jobs market: low pay, low labour productivity, insecure work for the young, and next to no incentive to earn more for those on tax credits (or indeed Universal Credit). These should all be near the top of our problem list. Falling levels of worklessness needn’t be. Welfare policy – and ministerial rhetoric – are yet to catch up with this.

And on Universal Credit:

The real problem with UC stems not from this understandable desire to integrate benefits, but from its narrow view of the social problem that benefit integration could be used to fix. At root, UC is a policy shaped by the view that the towering problem facing the UK today is mass worklessness; it has fragments of ‘Broken Britain’ in its DNA. Yet, as RF research showed last week, worklessness among non-disabled couples with children has plummeted over the last fifteen years. As things stand UC will end up being a missed opportunity to make in-roads into one of the real social-ills of our time: in-work poverty and the low pay trap.

We see the same theme in comments about cutting the welfare bill. The high cost of social security is still framed as a worklessness problem.

Yet the proportion of people claiming out-of-work benefits has been falling steadily for the last 20 years. The worst recession in living memory caused a slight rise but even this didn’t take it back to its 1990s level.

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Source: Resolution Foundation, An Ocean Apart

Of those without work, only a minority have been without it for long. Many go through what the Joseph Rowntree Foundation describes as the low-pay no-pay cycle, moving between periods of unemployment and low wage work. This seems to have continued during the downturn. Even the worst recession in living memory didn’t have that much effect on labour force participation. In the UK, most people kept looking for work and employment bounced back reasonably quickly. If ever the British were work-shy, we’re certainly not now.

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Source: Resolution Foundation, An Ocean Apart

The flip side of this rise in employment, though, has been the rise in in-work poverty. A lot of these jobs don’t pay very much and have to be supported by benefit payments. Alongside the fall in the proportion of people on out of work benefits, there has been a rise in spending on tax credits and housing benefit.

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Source: House of Commons Library, Social security expenditure

Screen Shot 2015-06-10 at 12.48.21Source: Resolution Foundation, Making the most of UC 

In 2012, the number of working families in poverty overtook the number without work. (See previous post.) Among those households below the official poverty line, the working poor now outnumber the unemployed, retired and sick put together. Not only do the in-work poor outnumber the workless, nearly half of them are in families where all the adults have jobs.

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Source: Joseph Rowntree Foundation, Monitoring Poverty and Social Exclusion

Despite all this, MPs still talk about the “something for nothing” welfare state and the Conservative Party issues press releases saying that this is why the welfare bill is out of control, reinforced by a poster campaign featuring a man with his feet up. The Prime Minister has just appointed as Employment Minister someone who said that the British are “among the worst idlers in the world“.

Like its view of industrial relations, the government’s image of poverty and welfare is stuck in the 1980s. Strikes and powerful unions are, for the most part, long gone but that doesn’t stop Conservative politicians making blood-curdling speeches about the dangers of industrial action. Likewise, the association of poverty with idleness and unemployment shows a lack of understanding about how the nature of work has changed.

As the Resolution Foundation’s Adam Corlett said, the debate about work and welfare “sometimes feels like it’s stuck in a time-warp”. Assumptions about the link between poverty and lack of work no longer hold true. These days, those claiming benefits are more likely to be cleaning offices, making sandwiches, picking vegetables and looking after the elderly. If the UK’s social security costs really are out of control it’s not because lots of people are sitting around with their feet up. It’s because lots of people are in jobs that just don’t pay enough.



Today’s Welfare Trends report from the Office for Budget Responsibility compares the UK’s benefit spending to that of other European and OECD countries.

The UK has one of the lowest levels of spending on unemployment benefits:

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When it comes to support for low-income families, though, it’s a different story. The OBR notes:

On the SOCX definition, public spending on support for families amounted to 4.3 per cent of GDP in the UK in 2011, significantly above the OECD average of 2.6 per cent. (In Chart 3.20, we have combined the cash benefits and tax expenditures figures for the UK, to be more consistent with the presentation of tax credits under ESA10 in our forecasts.)

Tax credits are the largest component of spending on families in the UK. Spending on them has doubled as a proportion of national income since 2002-03.

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Then there’s housing benefit:

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Some of the UK’s relatively high figure is because other countries support housing costs through other benefits, so in some places what we class as housing benefit would come under, say, unemployment benefit. Even so, our spending is way ahead of the average. I’m guessing that rents in London and the South-East must push the figure up.


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How big a problem is the UK’s public debt?

How much of a problem is high public debt? The government claims it is a serious problem and we need to reduce it, urgently. Others maintain that it isn’t really much of an issue. We’ve had higher debt-to-GDP ratios in the past so what’s the problem?

The reaction of some on the left to the row about Reinhart and Rogoff a couple of years ago struck me as a mirror image of the right-wing fuss about estimates of glacial melting. In massive leaps of logic, a few errors and over-claims here and there were taken as ‘proof’ that climate change isn’t happening or that government debt doesn’t matter.

It meant nothing of the sort, of course, as Diane Coyle said:

[W]e ‘know’ there might be a threshold for sovereign debt, but it varies over time and across countries, it’s a correlation whose causal direction and mechanism is unclear, and there isn’t enough data for any estimates to be robust (because history only runs once). All of which only goes to underline how little is known about the macroeconomy, not to mention how hard any macroeconomists and their camp followers find it to resist claiming certainty where there is none.

No doubt Reinhardt and Rogoff were tempted into over-claiming for their work by the politicisation of the debt threshold issue. But the underlying message of their big 2009 book, This Time is Different, is unscathed: unlike the later paper, it makes it absolutely clear that debt ‘thresholds’ above which increasing borrowing is correlated with lower growth vary widely in different countries and at different times (no magic 90% here); and that the historical record indicates it generally takes a long time for growth to recover after banking crises involving debt overhangs.

In short, there comes a point at which public debt damages the economy but that point will be different for different countries, depending on their circumstances at the time.

It’s difficult to work out where that point might be but economists from the IMF published a report earlier this week which attempts to do just that. They have estimated the amount of fiscal space each country has, that is, the amount in percentage points of GDP by which a country can safely increase its debt.

Screen Shot 2015-06-04 at 12.03.33For example, if we add these figures to the IMF’s debt estimates, the UK could increase its debt to around 220 percent of GDP, Germany to 240 percent and the US to 270 percent before they would run into problems. On the other hand, Japan at 246 percent, Italy at 132 percent and Greece at 177 percent, are already at their debt-to-GDP limits.

Debt sustainability, then, is not just about the debt relative to GDP. There are a lot of other factors which contribute to how much debt an economy can stand. It’s different for different countries at different times.

The report’s authors argue that those countries in the safe zone (the green area on the chart) don’t need to worry too much about reducing their debts because they have a lot of fiscal space to play with. Furthermore, attempting to pay off debt when they don’t need to could do more harm than good.

Where countries retain ample fiscal space, governments should not pursue policies aimed at paying down the debt, instead allowing the debt ratio to decline through growth and “opportunistic” revenues, living with the debt otherwise. The reason is that the deadweight loss associated with inherited public debt represents a sunk cost— so, abstracting from rollover risk, there is little purpose in paying it down by raising taxes or cutting productive government spending (of course if there is scope to cut unproductive spending this should be pursued). Distorting your economy to deliberately pay down the debt only adds to the burden of the debt, rather than reducing it.

[I]t does not follow that once the debt has been accumulated, it should be paid down to restore growth. On the contrary, where countries retain ample fiscal space, the cure would seem to be worse than the disease—the taxation needed to pay down the debt will be more harmful to growth than living with the debt, and the reduction in sovereign risk that would ensue is likely to be smaller than the distortive cost involved in paying down the debt.

In short, then, those countries in the green zone don’t need to panic about debt just yet.

Soumaya Keynes wrote a useful summary of the report in the Economist:

For those countries with no headroom (in the red or amber zone on the chart), the IMF’s paper is not much use: they need to take action to reduce their borrowing levels. But for countries well into the green zone (of which America is a star performer and Britain is a somewhat marginal case), the IMF’s analysis has a clear message: don’t worry about your debt.

For these countries, the wonks argue that the costs of raising taxes or cutting useful spending to reduce debt levels outweighs any benefits. For countries safely in the green zone, the authors present an example of a country reducing its debt from 120% to 100% of GDP. They calculate that the expected costs of the higher taxation (for instance, from the disincentives to work created by increased tax rates) are likely to outweigh the expected benefits (from the lower risk of a default in the event of a crisis) by a factor of ten.

What should such countries do instead? The best thing, the paper says, is simply to let economic growth take its course. In the long run, if the economy grows more quickly than debt, the burden of it will fall as a percentage of GDP.

For those that can afford to, then, it’s better to let economic growth do the job of reducing debt (as we have done in the past) than to subject ourselves to unnecessary austerity.

None of this is to say we should go on a spending spree. The UK is, after all, at the lower end of the IMF’s safe zone and these are only broad estimates. As Martin Sandbu says, the report’s methodology makes a lot of assumptions. Nevertheless, he concludes:

The simplifications do not mean that the IMF researchers’ conclusions are wrong. The biases go both ways. Acknowledging their circularity points towards paying down debt faster than they allow; including the demand side points towards even more caution against paying down debt. On balance, the advice is probably often right. And simply pointing out conditions under which paying down debt is more harmful than the damage caused the debt itself is a useful corrective to much of the debate.

Does government debt matter? Yes but the UK is still a long way from the point at which it becomes a serious problem. We are not, and never were, anywhere near to being like Greece (yes, people are still peddling that one) and it doesn’t make sense to act as though we are in some sort of crisis. Even the OECD has advised the government to ease off on its planned spending cuts on the grounds that they will damage growth. Is another round of austerity really necessary or is it just another vanity project?

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Is a £12bn welfare cut achievable? Only with a big pay rise!

The government made the Queen say “northern powerhouse” in her speech but, having decided one silly phrase was enough, stopped short of making her say “£12 billion welfare cuts”. Even so, the commitment to reform and cap social security was confirmed.

I still don’t think the £12 billion is doable for reasons I explained here and here. Richard Exell isn’t so sure though:

One way of looking at this is to say that this is incredible, that the Coalition gave up on a smaller scale of cuts in 2012, and it simply is not going to happen. The IFS repeatedly hint that this is their view and Flip Chart Rick has blogged about “12 billion flying pigs”.

I don’t know if I agree with them. I certainly hope they’re right, but consider the damage failing to carry out these cuts would do to their case for austerity. The Chancellor has been talking £12 billion for two years now, it was in the Budget mood-music, not to mention the manifesto and the press will be hard on the government if they don’t deliver.

He’s right. It would be very embarrassing, having banged on about it for so long, for the Chancellor not to deliver the cuts. His boss has been making things difficult for him though. The Prime Minister promised to protect pensions and pensioner benefits, which accounts for around half of the welfare bill. Last week, the IFS produced this pie chart showing what’s left.

Screen Shot 2015-05-28 at 12.47.07

Oh but hang on, when put on the spot by angry parents before the election, David Cameron promised to ring-fence child benefit too.

The big lumps left after that are tax credits, housing benefit, disability benefits and incapacity benefits. There would therefore be no way of making £12 billion in cuts without hitting the working poor. As the IFS says:

Because of the protections outlined above, about 80% of entitlements to the benefits in the chart go to working-age families; and because the large majority of working-age benefits spending is means-tested, it would be very difficult to avoid hitting low-income households.

The assumption behind the rhetoric of tough welfare cuts is that there is a pool of unemployed who, if they could only be nudged and cajoled a bit, would go back to work. Cutting benefits is part of that nudge. The trouble with this argument is that employment, as the government keeps telling us, is now at a near record level. If ever there were any feckless unemployed, most of them have now gone back to work. Unemployment benefits account for a small and shrinking proportion of social security costs. It is unlikely that cutting benefits will incentivise the working poor to look for better pay or more hours. Most of them will be doing that anyway.

For some idea of the impact £12 billion of cuts might have, take a look at these three charts. The first, from last week’s OECD report on inequality, shows the extent to which the UK’s benefit system reduces poverty among households dependent on non-standard work (NSW), meaning that which is anything other than permanent and over 30 hours a week. The UK shows a 60 percent reduction on poverty for non-standard worker households, second only to Ireland.

Screen Shot 2015-05-27 at 09.55.51The OECD comments:

Screen Shot 2015-05-29 at 11.03.24

The second chart comes from a report by the Institute for Social & Economic Research for the Child Poverty Action Group. This shows that, but for redistribution through taxes and benefits, the UK would have one of the highest child poverty rates in Europe. Thanks to the benefits system, child poverty comes down from 40 percent to 15 percent, putting it below the EU average.

Screen Shot 2015-05-29 at 11.12.13

The UK’s welfare system, then, takes its poor from well above to just below EU and OECD poverty rates. Or, to put it another way, if the government starts reducing benefits, this country will shoot up the international poverty league tables. As the OECD says, the UK’s benefit policies are especially helpful to non-standard workers, such as those on part-time, temporary and zero hours contracts. The impact of reducing these benefits would be severe.

The third chart comes from a paper on poverty and inequality by LSE’s John Hills. He shows how the changes to income due to tax and benefit changes since 2010 affected people across the income distribution.

Screen Shot 2015-05-31 at 16.18.35He comments:

Overall, the poorest twentieth lost nearly 3 per cent of their incomes (before allowing for indirect taxes) and the next five-twentieths approaching 2 per cent. But, with the exception of the top twentieth, the income groups in the top half of the distribution were net gainers on average. From the bottom to four-fifths of the way up, the changes were clearly regressive, hitting those lower down hardest as a share of their incomes. This is because benefit reductions were greater for the bottom half than their gains from lower Income Tax.

This fall in income came about as a result of welfare cuts that, as the IFS said, were relatively modest and which fell well sort of their target.

Table 1. Changes in spending and announced cuts for some major working-age benefits


What, then, would be the effect of a further £12 billion cut?

As it is, the planned welfare cap, which the IFS says will save less than £2 billion,* is already causing alarm among civil servants and social landlords. The Guardian reports:

[A]n internal government assessment, seen by the Guardian, shows that if parents are unable to find extra work the policy will put 40,000 more children on or below the official poverty line, on top of the 50,000 already affected under the current rate.

The leak has emerged as housing associations forecast that, under the lower cap level, they will have to deal with a dramatic spike in rent arrears, evictions and homelessness, and will no longer be able to offer homes to jobless low-income families.

Modelling by the National Housing Federation (NHF) indicates that on top of the 59,000 households already affected, a further 90,000 households across private and social sectors in England will have their income reduced by the new cap.

Detailed calculations by two housing associations, Moat and Sovereign, show that the lower cap level will make all three-bed affordable rented homes and some two-bed homes instantly unaffordable to capped tenants in a corridor stretching through Tory heartlands from Thanet and Basildon to Reading and Winchester.

The government says they are exaggerating but even if you halve these figures, the implications are frightening. These calculations are based on £2 billion of cuts*, around one sixth of what the government says is still to come. 

Another £10 billion will make a lot more people’s lives very miserable and many of them will be in Conservative constituencies. This will increase political pressure on the government. Hardworking families losing their homes, bailiffs removing furniture from the houses of two-job parents and footage on News at Ten of the deserving poor forced into debt by low wages and high rents won’t go down well with the voters. Getting tough with scroungers is all very well in the abstract but when you can put names, faces and jobs to the people being hurt even the hardliners may balk. (Something similar often happens with immigration too.)

I don’t believe David Cameron and George Osborne want to see scenes like this. As I said before the election, they are not ideologically driven state-shrinkers. The Prime Minister, in particular, tends to roll over whenever he is confronted by angry Middle-England, whether it’s over child benefit, trees or flood defences. Some of this has been blamed on the Liberal Democrats’ influence over the last government but I’m not so sure. I don’t think Dave likes aggro, especially not the sort he’d get from the widespread social distress that dismantling in-work benefits would entail. Bear in mind too that, at the same time as the welfare cuts, there will be a lot of other divisive stuff going on. Public spending cuts will be at their most severe in 2016-17, there will be an EU referendum, trade union legislation and the repeal or replacement of the Human Rights Act. All these things will increase the aggro factor.

Richard may be right. Perhaps the government will push through £12 billion of benefit cuts. I doubt it though. I still reckon they are hoping the economy will do the heavy lifting for them. A good spurt of productivity growth and wage increases could solve the problem. As Adam Corlett said, if productivity grew in line with the OBR’s more optimistic projection, the government could eliminate the deficit without needing any spending cuts at all.

Given the government’s other constraints, the only way to shrink the welfare bill by £12 billion is to reduce the amount spent on benefits to people in work. The only way for that to happen without considerable distress and social unrest is for a lot more people to start earning a lot more money. A pay rise is still the most effective way of taking working people out of welfare dependency. Unfortunately, last week’s GDP figures confirmed the slowdown in economic growth, productivity is still flat and pay growth is sluggish. In its latest inflation report, the Bank of England cut its forecast for wage growth. Wages will almost certainly rise over the next three years. The question is, will they do so quickly enough to reduce welfare costs and spare the Chancellor’s blushes?

Update 1: Declan Gaffney has a detailed explanation of what happened to social security under the Coalition.  In short, the government hammered claimants yet still ended up with welfare costs not that much lower than those planned by the Labour government’s last budget.

This chart shows where the main budget overruns occurred.


The major benefits that were lower than forecast by the end of the parliament were Jobseekers’ Allowance and Attendance Allowance. The others all came in higher.

As Declan says:

Higher than forecast expenditure on housing benefit and tax credits is explained by economic factors – most importantly, an unprecedented stagnation of nominal wages.

Given that housing costs are still rising and wages are only just starting to unstagnate, the chances of the £12 billion target being outrun by reality again look pretty high.

Update 2: Jonathan Portes reckons the benefit cap won’t even save £2 billion.

Update 3: *Clarification – The £2bn isn’t just the amount saved by the welfare cap. It’s the amount saved by all the measures announced so far.

Update 4: Some people have asked why the cost of incapacity benefits is so high. As Jonathan Portes explains, the government tried to reduce this but somehow ended up increasing it.

Update 5: David Cameron has confirmed that there will be no cuts to child benefit.

Update 6: Picking up on Michael O’Connor’s comment here, John Rentoul wonders if welfare cuts might yet be achievable.

So much unprotected welfare spending goes to families on above median incomes that it would be theoretically possible to cut £12bn and to leave the distribution of income more equal than before.

But that misses the second part of Michael’s comment:

This would of course ignore the fact that some families in the upper half of the household income distribution are people who would otherwise be rather poor on this measure, particularly in London where the average housing benefit award is over £7000 a year, or for low-earning families with children, where even with both parents working 30 hours at minimum wage a three-child family can be entitled to £20,000 a year in tax credits (including childcare costs). There is some irony in the fact that cutting these payments – and in some cases plunging people into at least relative poverty – would actually reduce household income inequality …

London is a city where even people earning above the national median wage rely on in-work benefits.


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