The economy’s British summer

The spring equinox was at 4.30 this morning, heralding lighter evenings and, we hope, much warmer days. Last week’s economic forecast by the Office for Budget Responsibility felt distinctly autumnal though.

This, the important story from the budget, barely made it onto the front pages. Most of the headlines were about the sugar tax. Only the Guardian mentioned the forecast £56 billion deterioration in the public finances. It is the cause of that black hole that was the real story  on Wednesday.

Some spotted it early. In this great video, recorded just after the chancellor had finished speaking, the FT’s Chris Giles said that the OBR had forecast lower growth, like, forevuuuh!

OK, he didn’t actually mean forever but for the period over which it is possible to make any reasonable judgement, the OBR has effectively told us that growth will bump along at just over 2 percent. We described a period of similar growth as a mini-downturn in 2002, a sign of how far our expectations have shifted. In other words, then, the OBR has decided we’ve had all the post recession bounce we are going to get.


Chart by Resolution Foundation

The chancellor got his excuses in early a couple of months ago, blaming global economic headwinds and a cocktail of risks from the rest of the world. The OBR was having none of it though:

Real economy indicators around the world have not been as weak as financial markets, so we have made only relatively small downward revisions to our forecasts for world GDP and world trade growth, with knock-on implications for the UK’s export markets.

No, what really blew a hole in the public finances was a home-grown problem. Low productivity:

The most significant change we have made to our domestic forecast since November has been to revise down our estimate of potential productivity growth, which in turn reduces the sustainable level of GDP and our forecast for GDP growth over the next five years.

[P]roductivity growth in mid-2015 seemed consistent with our long-held assumption that the post-crisis drag on productivity growth would ease as the financial system returned to full health and that it would be back at its pre-crisis historic average rate of 2.2 per cent by the end of the forecast period. That pick-up appears to have been another false dawn.

The productivity plummet at the end of last year killed all that optimism stone dead.


Chart by Office for Budget Responsibility

The upshot of this is that the OBR’s productivity forecasts have been revised down every year, as this chart from the Resolution Foundation’s excellent budget briefing shows.

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Chart by Resolution Foundation

The report comments:

This change reflects the OBR’s assumption that more of the weak productivity growth post-crisis represents a permanent shift in the UK’s potential to grow, with the pick-up in productivity growth in mid-2015 now being described as a ‘false dawn’.[1] This goes further than the concern that has dominated the productivity discussion to date – namely the scale of the productivity hit endured after the crisis. Instead, it implies that trend productivity growth has fallen.

Productivity is already around 17 per cent below where it might have been in the absence of the post-crisis stagnation. If the trend rate of productivity growth has fallen, then this gap will widen – rising to 24 per cent by the end of the forecast horizon.

In other words, the OBR has given up on productivity growth returning to normal, at least for the rest of this decade.

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Chart by Resolution Foundation

This, says the Resolution Foundation, will have an impact on pay growth. Based on these forecasts, it doesn’t expect real-terms median employee pay to get back to its pre recession level until sometime after the next election.

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Chart by Resolution Foundation

The result of this is much lower tax revenue than the chancellor was hoping for. Some of this shortfall is due to the raising of tax allowances but most of it is simply due to weaker pay growth.

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Chart by Resolution Foundation

So there you have it. Stubbornly low productivity eventually feeds through to a £56 billion black hole in the public finances.

Most people, including me, thought that, as the economy improved, the labour market would start getting back to normal. We assumed that some of the features of the recession, like low investment, low productivity, wage stagnation and high self-employment, would start to unwind. They did, for a while, then over the past few months things seemed to go into reverse again.

This wasn’t what was supposed to happen. Past recessions have always been followed by booms which have made up for lost growth. This time we have had a much more severe downturn but the post recession recovery never really got going.

GDP growth March 2016

Source: ONS, OBR


It reminds me of one of those classic British summers. After a long cold winter, everybody is waiting for the warm and sunny days to arrive but they never quite do. We get the odd hot spell but none of them seem to last very long. The abiding image of the summer is pouring rain at Wimbledon and overcast days at Headingley. Before you know it, there is that first whiff of autumn in the air and everyone is asking where the summer went.

Like the weather forecaster in late August, telling us that we have probably seen the last of the hot days, the OBR told us last week that the best of the recovery is behind us. The economic nights are drawing in and we are now into a period of low growth for the rest of the decade.

Of course, the OBR could be wrong. As Chris Giles says, “this one of the most sudden and nastiest changes of view it has offered to date.” Some people think it is being way too downbeat and its chairman Robert Chote said productivity forecasts are some of the “least certain judgements that any medium term forecaster has to make”.

It could be that the  last few months was the blip, not the previous year. We may still see another spurt of growth. Perhaps the recovery is not quite over yet. Perhaps, but then again, you know what those British summers can be like….

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OBR repossesses the sofa

At first sight, the cuts to public service spending outlined in yesterday’s budget don’t look that much bigger than those in the autumn statement. As these charts from the OBR’s Economic and fiscal outlook show, day-to-day spending on public services is set to fall by £11.6 billion, £1.2 billion more than the chancellor forecast in December. There is also no end-of-parliament boost, of which more later.

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This sounds like a lot and public service providers will find the cuts difficult to make but the reduction in spending is nowhere near what we were talking about this time last year and a very long way from the sheer lunacy of the previous autumn.

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An extra year to meet the target, some optimistic revenue forecasts and shifting more of the deficit reduction burden onto welfare helped to ease the pressure on public service spending.

Since the autumn, though, things have gotten that bit worse. The OBR has downgraded its productivity forecast and its growth forecast for the rest of the decade.



Charts by Resolution Foundation

This, says Chris Giles, is “unremittingly bad”:

There are two big judgments the OBR has made in this Budget: lowering the outlook for productivity growth, and reducing the expectation for the rise in the overall size of the economy.

The first matters for growth with the OBR now thinking the UK can sustain an expansion of only 2.1 per cent a year. When Gordon Brown was chancellor, he thought a “cautious” estimate was 2.75 per cent a year and this lowers income and revenues without lowering public spending.

The second matters for tax revenues, which are levied on incomes, spending and profits, all of which are affected by inflation. Cut nominal GDP forecasts and tax revenues come down even if the exchequer makes some savings from lower forecasts for interest payments on government debt.
In the Autumn Statement, the OBR gave the chancellor an unexpected £27bn windfall to spend between 2015 and 2020. On the same basis, it has taken away £52bn today.

£27 billion to £52 billion? Looks like the OBR has repossessed the sofa and charged interest.

The upshot of this is that, by 2019, annual tax revenues are set to fall some £16 billion short of the November 2015 forecast. To get back to his surplus target by 2019-20, the chancellor will therefore need to find more money from somewhere. As this OBR chart shows, he is helped by the UK’s record low borrowing costs and he has made the rest up from tax increases and cuts to spending on public services and welfare.

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The sharp-eyed among you will have spotted an item labelled “Public service pensions measure”. This is a plan to increase public sector employers’ pension contributions. The OBR explains:

[T]he Government has also placed an additional £2.0 billion a year squeeze on departments in that year by raising planned public service pension contributions, in line with a lower discount rate, but not compensating them for the additional costs they will face. This reduces borrowing by displacing other departmental spending within existing expenditure limits, while reducing net spending on public service pensions.

People who know a lot more about this than I do were somewhat baffled:

But in my simple head, if you make public service providers pay an extra £2 billion into their pension schemes, that is money that has to come off the budget for day-to-day services. In effect, then, this amounts to an extra £2 billion stealth RDEL cut. So the £11.9 billion cut to day-to-day public service spending shown in chart 4.5 is actually £13.9 billion.

You will also notice an extra £2.5 billion of welfare cuts on the chart. Now I am still extremely sceptical about the government’s ability to achieve the welfare cuts it has already outlined, so I’m far from convinced about the additional saving. Without further tax increases, any shortfall in welfare savings will fall back on public services. That would bring us to cuts of £16.4 billion, not far short of where we were last summer.

There is something else about this that doesn’t ring true though. As Chart 4.5 above shows, most of the cuts come in the last year of this parliament. The government will, apparently, go from a £21.4 billion deficit to a £10.4 billion surplus in one year.


Chart by Resolution Foundation

This isn’t what governments usually do in an election year. Accepted practice is to do all the nasty stuff early in the parliament and then give a bit away at the end.

Will any of this really happen, wonders Chris Giles:

Who knows? 2019-20 is just before the next election, so politics suggests it is not the optimal time to be imposing huge tax increases and spending cuts. There is still plenty of time for Mr Osborne to hope something good turns up and he can change his plans.

I’ve long thought that David Cameron and George Osborne are more Micawber than Machiavelli. The sofa has been repossessed but, who knows, another one might turn up before the end of the decade.

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Graduates and the finishing school effect

“Kiss that graduate pay rise goodbye,” says the Times’s financial editor Patrick Hosking. He was commenting on a recent Bank of England report on the composition of the UK workforce which noted that, while the proportion of graduates has gone up over the last two decades, their pay premium has gone down.

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The Bank comments:

There are a number of possible explanations which would be consistent with this finding. For example, if demand for highly skilled workers has not kept pace with an increase in supply, an increasing number of graduates would also lead to a decrease in the wage premium for those with degrees. Alternatively it is possible that the large increase in individuals studying for a degree in the United Kingdom has led to a fall in its signalling value (the ability of degrees to correctly identify more talented individuals) and thus the amount of pay which those with degrees can command.

There is something in both of these explanations. As the number of graduates has risen, a lot more of them have gone into occupations that, at one time, we would not have described as graduate jobs. CIPD research published last summer found that the percentage of graduates had increased in all occupational groups since the early 1990s.

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We would expect the graduate share of professional and managerial jobs to increase but their colonisation of the administrative, skilled and personal service occupations is perhaps more surprising.

At a Resolution Foundation event last year, Andrea Salvatori presented some findings from his work on job polarisation. He found that here are more graduates doing middle skill jobs now than there were 30 years ago while “non-graduates have also seen a major shift in the distribution of their employment from middling to bottom occupations.” Not only are there fewer mid-level jobs but a lot of those that used to be done by non-graduates are now filled by people with degrees.


The CIPD research found that the growth in the number of graduates had outpaced the growth in the number of high-skill jobs in most European countries but that this trend was particularly marked in the UK. This left the UK with a relatively high number of graduates overqualified for their jobs.

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Does this mean that the UK has produced too many graduates? Perhaps, although there are other good reasons for getting degree aside from landing a higher paying job. I wonder, though, whether some of this is due to the number of graduates from elsewhere in the EU coming to the UK and doing non-graduate jobs.

Some of this is due to the difference in pay levels. Graduates can earn more in the UK doing a middle skill job than they can get at home doing a graduate job. But there is also something going on that I call the finishing school effect.

My data for this is largely anecdotal but bear with me. A number of European graduates I have spoken to recently explained that having worked in London means they get better jobs when they return home. One even told me that employers are now looking askance at people who haven’t left the country for a stint abroad. Graduates will, she told me, take any job in London. They are not bothered whether it is a graduate level job and, for the most part, neither are their employers. If you take a job on reception, in finance support or course administration for a big firm it might lead to bigger things but, even if it doesn’t, the mere fact of having worked in the City, West End or Canary Wharf adds cache to your CV.

McKinsey’s recent globalisation report concluded that the world only has eight truly global cities. Only one of them is in Europe and that city is London. It’s no surprise that young people are drawn to it from elsewhere in Europe.

A UCL CReAM report found that the UK has become a magnet for well educated EU migrants.

Even more remarkable is the immigrant population’s educational achievement, which has been consistently higher than that of the native population since 1995, with an increasing gap ever since. Whereas in 1995, about 13% of the UK born and 14% of the EEA immigrant population (excluding those still in full-time education) held a university degree, such was the case for 15% of the non-EEA population. By 2011, the percentage of natives with a degree had nearly doubled, to 24%, while the percentage of EEA and non-EEA immigrants had increased even further, to 35% and 41% respectively.

So the proportion of migrants with degrees is higher than that of the UK born population. As the CIPD found, in a 2014 study, a lot of those EU graduates are working in low- to middle-skill jobs. Screen Shot 2015-07-07 at 10.05.07

The report also found that EU migrants are concentrated in mid-twenties to early thirties age band. In other words, most come to the UK when they already have some work experience. A job in London can then be a stepping stone to a future career here or a gold star on the CV making a graduate more marketable back home or anywhere else.

OK, my data for this is anecdotal and circumstantial but surely some of the UK’s relatively high graduate over-qualification must be due to the attraction it holds for foreign graduates who are prepared to do all sorts of jobs. It is true that some UK born graduates are also finding themselves having to take lower-skilled and lower-paid jobs but that isn’t the only reason for the graduate colonisation of lower skill occupations. It’s yet another symptom of the UK’s, and especially London’s, idiosyncratic labour market.

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The sovereignty thing

Sovereignty is a word we will hear a lot over the next few months. Brexit supporters say we need to leave the EU because it’s a threat to Britain’s sovereignty. According to the Mayor of London (yes, he is still that) parliament lost its sovereignty in 1972 and the only way get it back is to leave the EU. At least, I think that’s what he said but even Carl Gardner (who knows a lot about all this) wasn’t entirely sure what he meant.

Fortunately, for those of us who would like to understand the idea of sovereignty in a bit more detail, there are plenty of people writing more clearly on the subject. There are two important points.

Firstly, on parliamentary sovereignty; parliament can make any law it likes. As Carl explains:

When we say Parliament can make any law whatever, we really mean it. It’s a radical idea, that many law students find hard to believe at first.

While in some countries it is possible to challenge legislation in constitutional courts, there are no such constraints on the UK’s parliament. As Mark Elliot says:

A law directing the killing of all blue-eyed babies would be valid. The fact that such laws remain unenacted is thanks to “political constitutionalism” as opposed to “legal constitutionalism”: it is political, not legal, factors — including, one hopes, legislators’ own sense of morality — that operate as the restraining force.

Let’s take a recent example. Donald Trump has said that he would ban all Muslims from entering the US. If he were elected, though, he might find that promise difficult to keep. It would certainly be challenged in the courts and would probably be declared unconstitutional. A British prime minister faces no such constraints, apart from those that parliament has chosen to impose on itself. And these can always be repealed.

This piece in the FT by Philip Stevens explains the position clearly:

[E]even as authority is delegated, the sovereignty of parliament remains unfettered. What Westminister devolves it can reclaim. International treaties and commitments bind Britain only in so far and for so long as a majority of parliamentarians so decide. Each and every one could be abrogated by a simple legislative act. Britain is free to leave the UN, quit Nato and renounce its human rights commitments whenever it so chooses.

The same is true of the EU. Membership of the union represents the most extensive and complex exercise in the delegation of authority to a supranational organisation. The European Court of Justice adds a dynamic legislative interpretation mostly absent elsewhere. The basic principle remains, however: the accession treaty can be revoked at the whim of parliament.

So all those horrid EU laws, including the dreaded European Communities Act 1972 that Boris Johnson was complaining about, can be repealed. EU law only has primacy over UK law in certain areas because Parliament says it has. And Parliament can change its mind about that whenever it likes.

Here’s Mark Elliot again:

If EU law is supreme, can Parliament be sovereign? The answer is ‘yes’. This follows because the default primacy enjoyed by EU law in the UK is itself attributable to an Act of Parliament—that is, the 1972 Act—and Parliament remains capable of amending, overriding or even repealing that Act.

The second point is that there is always a tension between national sovereignty and matters of geopolitics and global trade. George Magnus explained this in Prospect a couple of weeks ago:

There is a trade-off to be made, then. In light of this, you cannot have an abstract discussion about sovereignty without saying what you are going to surrender in terms of economic integration and benefit. Brexiteers are free to discuss “taking back control,” but they are then under an obligation to discuss the potential economic disadvantages of doing so.

Even outside the EU, as this week’s Bagehot column in The Economist points out, the UK would still be subject to 700 international treaties, a member of the UN, WTO, NATO, IMF and World Bank, and subscribe to a swathe of nuclear test ban, energy, water, maritime law and air traffic treaties. The idea that leaving the EU would lead to a golden era of UK sovereignty and self-determination, is, it is fair to say, far-fetched at least.

North Korea is an example of sovereignty taken to its extreme. The government there does whatever it wants to but the trade-off is that no other country in the world wants anything to do with it. Any government can exercise as much sovereignty as it likes but it has to decide how much its people are prepared to sacrifice as a result. Iran, for example, could have chosen to continue its nuclear programme but it would have therefore had to continue to endure the trade embargo.

Such de facto limits on sovereignty are inevitably a function of power. Burma became a pariah state after its violent suppression of popular protests. The US, EU and others imposed sanctions. China, on the other hand, can shoot protesters in the streets and still be awarded the Olympics. Having a growing economy and a fifth of the world’s population means that you don’t have to worry quite as much about what other people think.

The EU is an attempt to resolve some of this tension by creating institutions to govern a series of trade agreements. With the European Parliament it has even tried to subject them to some democratic accountability. In the interests of trading with each other, EU countries give up some of their day-to-day sovereignty and agree to be subject to EU law. Even so, any one of those countries can leave the EU at any time. This is a fact which seems to get lost in the noise about sovereignty. Even if the UK votes to stay in three months from now, that still wouldn’t stop it from leaving in the future.

The same is true of all the international treaties to which the UK has signed up. If the British voters decide that the risk of adhering to these treaties is worse than the consequences of withdrawing from them, then there is nothing to stop us from doing so. The Atlantic reported last week that Barak Obama had pointedly reminded David Cameron of his NATO obligation to spend at least 2 percent of GDP on defence, after which the defence budget was ring-fenced. Is that another constraint on our sovereignty? Only because we want to be members of NATO. We can always decide to leave.

The UK is a sovereign state and, within it, its parliament is sovereign. Like most other countries, it chooses to be bound by international treaties and trading agreements. None of these are irreversible. If we are prepared to deal with the consequences, we can repudiate any treaties we don’t like. None of that will change whether we vote to stay or go on 23 June.


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Red tape: Another Brexit red herring

As soon as the EU referendum was called, it was inevitable that someone would start banging on about red tape. It costs £8.6 billion, no, £18 billion, no, £33 billion, no, £80 billion. Oh well, it’s loads and loads anyway. Getting rid of it would, apparently, free Britain up to become a super-competitive world-beating economy.

The trouble with all this, though, is that the UK is already one of the least regulated countries in the world. The OECD’s product market regulation index rates the UK as the second least regulated economy in the developed world (or perhaps the third least as the US didn’t participate in the most recent study).

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When it comes to employment legislation, the picture is very similar, for both permanent and temporary workers.

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Charts via OECD Employment Outlook 2013

Even this isn’t the whole story, though, as it has become much more difficult in the UK for workers to enforce any employment law. The introduction of employment tribunal fees has seen a sharp drop in the number of cases being brought. As an employer in the UK there isn’t much employment law to fall foul of but, even if you do, the chances of being prosecuted for it are pretty remote.


Chart via Wonky

Whatever measure you use, compared to most other countries the UK is lightly regulated. As the Economist pointed out last week, the UK is 6th on the World Bank’s ease of doing business index, 10th on the World Economic Forum’s competitiveness index and 10th on the Wall Street Journal & Heritage Foundation index of economic freedom. In all three cases, some of those countries ahead of the UK are EU members and therefore bound by the same rules.

As BlackRock said last week, in its assessment of the risks of Brexit:

Optimistic Brexit scenarios also assume the UK abolishes swathes of EU regulations – and emerges as a Hong Kong-style provider of valued-added goods and services to the rest of the world. Again, we are sceptical. The UK already ranks among the world’s least regulated economies. And its overall export  to China and India lags that of supposedly overregulated Germany.

It’s interesting to look at the attitude to red tape in the few countries that are less regulated than the UK. What do business leaders in the US and New Zealand say about regulation? Why, they moan like hell about it, of course.

Everywhere has some regulation. Markets have been regulated almost from the moment they appeared. If Britain leaves the EU it would have to write a whole new set of regulations to replace the EU ones. Some of it will have to be kept if we want to export manufactured goods to the rest of the EU. Jon Worth gave a good example of this last year.  If we export construction vehicles to the EU then they will need to comply with EU regulations. There would be no point in making a separate version for the UK so, even after Brexit, these vehicles would still be manufactured subject to EU rules. Deciding what regulations we need to keep, what needs to be replaced and what rules can be dumped would be a colossal task. As Alex Barker said in the FT, the post Brexit To Do list would be daunting. It would certainly put a stop to the government’s planned staff reductions. Brexit would provide lots of work for civil servants well into the next decade.

No-one likes red tape. It’s annoying and gets in the way of day-to-day business. But in already lightly regulated economies like the UK, it is unlikely that taking away what little regulation there is will make much difference. Some people will complain about red-tape no matter how little of it there is. If the government repealed every employment law enacted since 1900 they still wouldn’t be satisfied. But just because people are a bit cross about something doesn’t mean that it’s the cause of the country’s economic problems. Compared to much of the world, regulation isn’t a big deal in the UK. Leaving the EU to avoid it would be like burning off an irritating spot with a blowtorch.

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Is pensioner spending keeping our small towns afloat?

The Joseph Rowntree Foundation had a report out last week on declining cities. Among other things, it noted the falling population of northern cities and the movement of young people from small towns to cities and, in England, from north to south.

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Figure 4 from the report shows the population change for the age cohort now in their late twenties to late thirties. Broadly, it shows that the bigger the city and the closer to London its location, the more of this age group moved there. City size and proximity to London are factors attracting younger workers.

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A report by the ONS a couple of years ago found something similar. It looked at migration to and from the northern regions. It found that school leavers tend to move away from the north but their numbers are offset by those of a similar age heading north to university. There is then a then a net migration from the north by those in their twenties, after graduation.

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The picture, then, is of a move from the small towns to the major cities and from north to south.

As the JRF report comments:

These specific population flows have cumulative effects on different cities. Champion et al. (2007) show that better qualified young people, such as graduates, are more likely to migrate. A city with strong net intra-UK inflows of young people gets a boost to its skill levels. Selective migration thus reinforces the uneven geography of job opportunities: young skilled people respond to the personal benefits of the regional ‘escalator’ while collectively they fuel the skills gaps between cities.

This cumulative difference in skill levels makes it far more likely that employers will set up in the bigger cities while ignoring the smaller towns. They might cut their costs by moving from London to Leeds or Newcastle but they are likely to avoid Hartlepool and Workington.

All this then starts to skew the population in the smaller towns towards the lower skilled and retired. Unfortunately the ONS seen to have archived all those interactive data maps and they no longer work. However, I still have some screen shots of a few of them. This one shows the percentage of retired people in each local authority area in England and Wales.

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On the whole, the further you get from London, the greater the proportion of retired people. The few light coloured pockets are cities like Newcastle, Manchester, Nottingham and Cardiff; university cities to which the young flock and which have enough opportunities to encourage some of them to stay. But, as the JRF report notes, just as London pulls the young and well-educated from the rest of the country, so these vibrant cities do the same to the regions that surround them.

What, then, of the towns left behind? Harry, my late father in law, had a hypothesis about the small towns in South Wales where he lived. The pensioners were spending all the money and the young people who hadn’t already left were employed in jobs running round after them. A trip to the local Wetherspoons seemed to bear this out. Lots of people in their late sixties and early seventies were enjoying pub lunches while being waited on by youngsters.

The share of spending by the over 50s has increased over the last decade or so, especially when it comes to food, drinking and entertainment.

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How far are the service economies in Britain’s small towns dependent on spending by the retired? Is pensioner spending all that is standing between them and economic collapse?

I couldn’t find anything that broke data on pensions down to local authority level but the regional data released earlier this month by HMRC is interesting. It shows pension income making up a greater proportion of total income in the regions more distant from London. This is partly because people move away from London to retire but also because the young are moving in the opposite direction.

Pension income

Source: Survey of Personal Incomes 2013-14, HMRC, 1 March 2016

As an aside, it’s also worth noting that total pensioner income is higher than total self-employment income in all regions except London.

Pensioners have done relatively well in recent decades, largely because they lived through a time when those on middle incomes enjoyed a greater share of income than at any time before or since and their assets, mostly their houses, appreciated faster than inflation. But with the decline of defined benefit pension schemes, the affluent pensioner is likely to be a historical blip. The next generations will not be anywhere near as rich.

Where will that leave the smaller towns? Much has been written about de-industrialisation but the legacy pensions of the big postwar industries are rarely mentioned. The factory that once dominated a town might be gone but its ghost is still there in the form of its final salary pension scheme. We have no miners and few steelworkers in the UK now but the miners’ and steelworkers’ pension schemes are still paying out, pumping money into areas where much of the economic activity has dried up. What happens when those who are entitled to these pensions die off and the schemes stop paying out?

The big corporate final salary pension schemes are the afterglow of the post-war industrial age. As they fade away, with nothing to replace them, life in the left-behind towns might get that bit darker.

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The National Living Wage and the productivity challenge

Research published earlier this week by the Social Market Foundation and Adecco Group concluded that many businesses will struggle to meet the cost of the National Living Wage (NLW). Without a significant productivity boost, many businesses will be forced to cut costs, which, almost inevitably, means cutting jobs.

The trouble is, the businesses likely to be most affected by the NLW are also the ones least likely to have the wherewithal to improve productivity. For example, the severely affected firms are already less likely to train people.

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Chart by Social Market Foundation

As Nida Broughton, the SMF’s chief economist says:

The low stock of skills amongst those affected by the new National Living Wage, and the relative lack of access to in-work training, means that businesses and the Government will have to act to make sure that workplace productivity rises alongside the new regulated wage.

If businesses can increase productivity there is less likely to be a risk of higher unemployment as a result of the introduction of the NLW, and workers will be more likely to benefit.

In its report report on the labour market last year, the UK Commission for Employment and Skills noted that Britain has too few high performance workplaces and a long tail of poorly managed firms. Its recent skills report found that, despite inflation and a larger workforce, training investment is more of less the same as it was two years ago.

That low pay and low training investment go together should come as no surprise. Research by NESTA and the Bank of England found that the UK economy is experiencing the opposite of creative destruction. The more productive firms have disappeared and been replaced by less productive ones. In other words, it looks as though some firms have been set up precisely because labour is cheap. It’s Mike Haynes’s Hand Car Wash Syndrome. There are firms whose entire business model depends on throwing a lot of low paid labour at a problem and not investing in skills or technology.

Figures released by the ONS this week suggest that the recent pick up in productivity has slowed down again.


Chart by Resolution Foundation

The gap between the UK’s productivity and the G7 average is the highest since records began in 1991.

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Chart from ONS International Comparisons of Productivity, 18 February 2016

Rapid productivity improvements across entire sectors are unusual and this is not a country showing any signs of making them.

What, then, might those businesses that are dependent on cheap labour do as the NLW starts to bite? A few might improve productivity, as the SMF urges them to, but many probably won’t. They will either go out of business or find other ways of taking on workers.  There is, after all, an army of poorly paid freelancers out there who are not covered by the minimum wage.

Talking of which, the employment figures were also out this week. After falling back from its peak in early 2014, the number of self employed people has risen again in the last few months.

Emp change 2008 to 2015

Source: ONS Labour Market Statistics, 17 February 2016

You can date the start of the recent rise in self-employment almost from the announcement of the NLW. Still to early to draw conclusions from this, of course. It could just be coincidence….


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