Low pay and the deficit

As ever with the Office for Budget Responsibility’s reports, there is some fascinating stuff in its recently published Welfare Trends paper. The OBR expects the cost of social security to rise as a percentage of GDP after 2018, due mostly to the ageing population

Our long-term projections show total welfare spending rising by 2.5 per cent of GDP between 2018-19 – the end of our medium-term forecast – and 2063-64, with almost all of the rise accounted for by benefits paid to the elderly. This is largely driven by demographic trends, which are partly offset by further expected increases in the state pension age.

If the OBR is right, unless pension entitlements are reduced even further, the next five years will be the last time we see a reduction in the cost of benefits as a percentage of GDP. After that, the cost will gradually inch up every year.

Even the predicted fall over the rest of this decade isn’t looking as good at we might once have assumed though. Working age benefits should come down once the economy picks up, right? As economic growth produces more jobs with higher wages, there’s a double bonus for the public finances. Taxes go up and spending on benefits falls.

At least, that’s what’s supposed to happen but, as we have already seen, the tax take has been anaemic so far because of the number of people in low paid work. For the same reason, the benefits bill is staying stubbornly high. People may be coming off unemployment benefits but if they go into low wage work, they are likely to continue claiming some form of welfare.

Last month’s House of Commons briefing on social security expenditure showed very slight fall in forecast benefit costs between now and 2018, followed by an increase, taking real-terms spending almost back to where it was at its peak in 2012/13.

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Some of this is due to rising pensions but the figures for HMRC tax credits show a rise towards the end of the decade too. This suggests that there will still be lots of people needing some form of state support for their low wages.

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Instead of getting a double bonus, then, the government is getting a double whammy. Not only do low paid people not pay much tax, they keep on claiming benefits too.

The shift to private rented housing hasn’t helped either. As the OBR shows, the proportion of housing benefit claimants in the private rented sector has increased.

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At the same time, rents have risen faster than incomes but markedly so in the private sector.

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As a result, the OBR has to keep revising up its forecast for housing benefit spending.

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None of this helps a government which wants to reduce borrowing without increasing taxes. If the cost of benefits stays high and the tax take stays low, the only thing to be done is to cut public services even further.

All public sector and publicly funded organisations are therefore under pressure to cut costs and to become more efficient. One way to achieve this is to do what lots of other organisations have been doing: automate things. Of course, this means employing a small number of highly paid people to make this happen and to run it afterwards, while getting rid of many middling and lower paid employees.

The civil service, it seems, has been doing some of this. This chart from Jamie Jenkins at the ONS shows the change in civil service employment over the last year, with fewer people at the junior levels and more people in the higher paying grades.

Civil Service employment; entrants and leavers in year to 31 March, 2014

Civil ServiceThe data from previous years indicate that this has been going on for some time. The civil service, then, is hollowing out just like the rest of the workforce. It may be the smallest it has been since the Second World War but it is still taking on the highly skilled and highly paid. I haven’t seen any data for the rest of the public sector (and I’d be interested to hear from anyone who has) but I know some local authorities have been going the same way. Given what we know about the rest of the labour market, I’d be surprised if something similar wasn’t happening in other local councils and the NHS.

The hollowing out process seems set to continue in the large private sector organisations too. Lloyds Bank chairman Lord Blackwell recently told staff that the industry faces more change in the next 10 years than there has been in the past 200. That means more technology and more job losses.

But what makes sense for an individual organisation may make the wider problem worse. A recent report from the CIPD and one from the Resolution Foundation due out this week show that low paid employment is becoming sticky. People made redundant from mid-level jobs rarely re-skill and move up the pay scale. Instead, they tend to accept lower skilled jobs, then find it difficult to get out of low paid work. The middling level jobs in large public and private sector organisations that used to provide skill development and pay progression are disappearing so it is becoming much harder to escape from low pay. As austerity bears down on the public sector, still more of these jobs will go.

At a Resolution Foundation event I went to last week, the LSE’s John Van Reenen said that we shouldn’t be too pessimistic on pay and employment. Eventually, he believes, the recovery will deliver more full-time jobs and improved pay. He may well be right but he also warned that this won’t happen quickly and that the next five years will be difficult for whoever wins the next election. How much of the persistently low pay is due to the recession and how much is due to longer-term structural factors is anybody’s guess. What does seem clear, though, is that, barring an unexpected (and unlikely) leap in economic growth, we are stuck with it for the next few years.

All of which makes the deficit reduction claims of all the main political parties look even less likely. A labour market that can’t produce higher tax revenues and that still has a lot of people dependent on state support is unlikely to do much for a chancellor aiming at an absolute surplus by 2019.

The OBR has said that it will take a long hard look at the labour market before making its budget forecasts in December. So it should. The UK’s fiscal position and its labour market are functions of each other. The figures on pay, employment and social security spending suggest that the deficit reduction plans may be even further into La La Land than we thought.

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7 Responses to Low pay and the deficit

  1. Means test State pensions? Political dynamite, obviously – but start with the uber-rich (not such a hard sell) and once the principle has been accepted gradually expand its incidence?

  2. P Hearn says:

    In summary, we’re screwed!

  3. NeilW says:

    An absolute surplus is impossible in the UK without generating a credit bubble or using an accounting trick.

    And that’s because the size of The Deficit is not under the control of the government. It is entirely caused by the system fulfilling the savings desire of the private sector. If you then also allow the system to fulfil the spending desires of the poor up to the living wage, then everything will work out just fine.

    Pages and pages written worrying over nothing – when we should be worrying over continuing levels of poverty, poor productivity and lack of business investment.

    • Metatone says:

      Another part of this same story is that if you want a large financial sector hub in your country, then this will also affect the level of private savings – and hence the deficit.

  4. SK says:

    The government has to chase tax revenue from the people who benefit from all this. Time for an additional tax on BTL landlords.

  5. Pingback: It’s the economy stupid. - OverThePeak.com

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