How to get family incomes growing again

Lots of things matter for family incomes – but for British households as a whole nothing matters as much as the labour market. Questions of who has a job and what they get paid for doing it might not be the only determinant of our living standards – but they are certainly the first. So what would it take for Britain’s labour market to do a better job of driving up our living standards?

Let’s start with the lessons of recent years of what has worked – and what has been a disaster. On the positive side, over the last two decades Britain has been following a labour market policy with twin objectives: higher employment levels and higher pay for the lowest earners. On both counts, with ups and down, it has seen big successes. Employment levels and our minimum wage now stand at record highs – 75.2% of adults aged 16 to 64 are working (Q4 2017) and the wage floor is £7.83 per hour (from 1^st April 2018 for those 25 years or over).

In the second half of the 1990s, following the disaster of 3 million unemployed after the recessions of the 1980s and 1990s, there came a renewed focus on employment levels as a key objective of public policy. And a new policy approach was shaped to achieve it. This combined increased incentives to work (via tax credits) and expectations of work, alongside greater support to help make it happen (with childcare for example). In big picture terms this combination worked, in some cases dramatically so. Worklessness, which was a national disaster in the 1990s, has shrunk throughout the last two decades from being the experience of over 1 in 5 working-age households to just 1 in 7 in Q4 2017.

Employment rates matter so much for living standards not just because they drive how many people get paid but also who those people are. What matters is not just the overall level of employment income but the distribution of it. Degree educated, white, prime age (30-49) men are almost always in work wherever they live in the country and however good or badly the economy is doing. It is not these groups that benefit most from the tighter labour market that higher employment brings, but those nearer to the edge of the labour market – the employment rates of older workers, mothers, ethnic minorities and people with disabilities vary hugely across time and place. For instance the employment rate for people with disabilities is 49 per cent in the South East compared to 36 per cent on Tyneside, and while single parents in South Yorkshire and inner London now have similar rates of employment the pace of improvement has been very different. Lone parent employment increased by 20 percentage points in inner London over the past seven years compared to half that in South Yorkshire where the labour market has been weaker.

In general the rise in employment among single parents was an under-celebrated triumph of the pre-2010 Labour government. There was a transformational increases in employment from 43 per cent in 1996 to 54 per cent on the eve of the financial crisis. This was part of the reason why lone parent households’ income levels increased 1.6 times faster than working-age households as a whole between the mid-1990s and the financial crisis.

Further increases in employment levels in the last few years have disproportionately benefitted lower income families – almost all of the employment growth in Britain since the financial crisis has taken place amongst the poorest third of families. This is predistribution in action.

Figure 1: Employment rates by decile of the equivalised net household income distribution

Notes: Households are included in this analysis if they contain at least one adult aged 16-69.

Source: RF analysis of DWP, Family Resources Survey

Meanwhile, on the second pillar of labour market policy over the last two decades, the introduction and ramping up of the minimum wage has been perhaps the most high profile way in which government policy has directly increased family living standards via the labour market. And it has been a triumph, without the significant employment losses that its opponents predicted. The early years of the minimum wage from 1999 saw the abolition of extremes of low pay (in 1998 7 per cent of the workforce were earning below half of typical hourly pay, in 2002 it was 5 per cent and in 2005 2.5 per cent). The big hikes that have followed the introduction of the National Living Wage more recently lie behind the biggest single-year reduction in low pay in 40 years (5.1 million employees were low paid in 2016, down from 5.4 million in 2015). The lowest paid workers are currently receiving the highest wage increases in Britain – and that is likely to continue to be the case until the National Living Wage reaches its target level of 60 per cent of median earnings in 2020.

Figure 2: Growth in real hourly earnings (ex. overtime)

Source: RF analysis of ONS, Annual Survey of Hours and Earnings

It’s clear that the policy focus on full employment and low pay has brought rewards. But recent experience has more to teach us than that. We need to reflect on what has gone wrong, not just what has gone right. Britain’s households are after all in the middle of what is projected to be a full 17-year pay squeeze, with earnings not set to return to their pre-crisis levels until 2025. Recent years have also seen big increases in insecure work, with 900,000 workers now on zero-hour contracts.

Figure 3: Average annual employee earnings, CPI-adjusted: outturn and successive OBR projections (Q4 2016 prices)

Source: Resolution Foundation analysis, OBR

In particular anyone thinking about the future of labour market policy needs to ask why the financial crisis caused not only a huge pay squeeze, but a very swift one. It’s always been obvious that over the long term how much we produce for the work we do matters a lot for our pay, but one of the big lessons of the last decade is that some economic shocks can feed through very quickly indeed into our wages. In cases where Britain is either the only country affected by a shock (Brexit) or particularly hard hit (the financial crisis), the swift hit to living standards is driven by a falling exchange rate and the higher (import-driven) inflation that follows. In a flexible labour market, and in the absence of strong trade unions demanding that wages keep pace with fast-rising prices, big falls in real pay result. This is the dynamic behind pay declining by 5.3 per cent after the financial crisis and the return of shrinking pay packets in 2017. It was something no-one expected when the crisis hit in 2008 but which, now that we have experienced it twice in quick succession, should be front of mind for policy makers.

Another lesson from the financial crisis is the degree to which more insecure, atypical forms of work dominated post-crisis jobs growth. Self-employment has accounted for around 30 per cent of the employment growth since the crisis, while between 2011 and 2016 we saw an additional 130,000 agency workers. Importantly, though the growth in such work has now largely ceased (another benefit of a high employment and tightening labour market) the level remains too high. Yes, many enjoy the flexibility of non-traditional work, but collectively we should still be concerned about the pay penalties and lack of employment protection that too often come alongside such work.

Where do these labour market lessons of recent history leave us? Should a forward looking labour market agenda simply double down on what has worked in the past and avoid the things that have gone, so badly, wrong?

Well yes on the avoiding mistakes part – we could really do with a growing economy that avoids UK-specific policy driven economic shocks. And we should ignore some misplaced recent arguments that claim our individual pay packets have become entirely and permanently disconnected from the nation’s gross domestic product – productivity and growth really matter for our living standards. We also need to recognise that during any future economic shocks we should be paying more attention to the exchange rate, not because we are holiday makers but because we are workers.

And yes we should retain and build on progress on high employment and low pay. But crucially now is the time to update our approach, because a 21^st Century labour market policy should reflect the reality of the 21^st Century labour market not that of the 1990s.

On employment, we need to avoid going backwards on some big wins. That’s why elements of Universal Credit (as it is currently planned) that weaken work incentives for second earners and single parents  are unwise, not least because these are the groups most responsive to such incentives.

And while overall employment is at record highs, a new policy focus should recognise that there remain places and groups with far too low employment rates. Birmingham, for example, stands out for very low employment levels – 61 per cent, which is 15 percentage points lower than Bristol just 90 miles away. That is a disgrace from the perspective of economic output distribution. National policy alone can’t solve these huge regional differences, so we need a new focus where the role of geography and local economic leadership takes centre stage.

Our approach to those with a disability also needs a revolution. We need to prioritise supporting people to stay in work when they become ill rather than simply testing them for fitness for work once they have dropped out. Doing so would help close the disability employment gap which at 28 percentage points is far higher than the EU average of 20 points.

But, while targeting high employment remains key, policy needs to shift to confront new challenges. Worklessness is no longer the stand-out feature of our labour market as it was in the 1980s and 1990s. New challenges have emerged and just as we developed an active labour market policy agenda to confront the old challenges, we should do the same again today. People today are largely in work, but too many are insecure and too many are stuck.

The good news is that a time of high employment is exactly the right moment to strengthen the regulation of our labour market. There is no reason why it should be legal to leave people on a zero-hour contract when they are working regular hours. The law should explicitly protect anyone who choses not to accept extra hours from being disadvantaged. The tax system should not be offering firms big incentives to try to argue that their workforce are in fact self-employed. More radically we should be exploring ways to require firms that extensively rely on non-contracted hours to pay more for the privilege so that the benefits of flexibility go two ways. We used to call it overtime.

Reducing insecurity in these ways is necessary anyway because some practices are simply not defensible. But it is also essential for living standards because for too many workers, and especially the young, a feeling of insecurity is holding them back from doing something too much of Britain has forgotten how to do: ask for a pay rise. Unions of course are also part of the answer to that challenge. The good news is public attitudes, especially amongst the young, are positive – only 8 per cent of millennials are opposed to unions in principle. The bad news is that young people outside the public sector generally have very little concept of what unions can do for them, beyond seeing membership as individual insurance against particularly bad treatment at work. Giving unions access to workplaces to overcome the awareness gap would be a good start. And the degree to which young voters have more positive attitudes towards unions should encourage politicians to look again at ludicrous bits of anti-union rules – like the ban on electronic balloting – and to institutionally build in more opportunities for workers voices to be heard. Well supported workers should be sitting on company boards, and at a sectoral level we should also be building on the tripartite success of the Low Pay Commission and the recent government decision to give the TUC and CBI strategic oversight of the National Retraining Scheme. We also need to celebrate the success of unions that are innovating and engaging with technologies that can help redefine collective action, while recognising that overall far too little of such innovation is taking place.

As with employment, on low pay we need to keep doing what has worked. We should press ahead with the rapid increases in the National Living Wage up to 2020, but the next step after that should be taking stock of what that huge rise between 2016 and 2020 has done to our labour market, for example what the side effects have been of moving from 7 per cent to 14 per cent of the workforce relying on the legal minimum. We may be able to go further; there is after all little strong evidence on where exactly the limit is for raising the minimum wage without significant side-effects. But there will be a limit, so any changes should be done in a steady and planned manner with our eyes open to the evidence. We should also look to reduce the number of age bands for the minimum wage, in the first instance by bringing down the age of entitlement to the National Living Wage below 25.

But our approach to low pay, upon which the UK economy has become far too reliant, also needs to broaden to recognise the nature of the challenges we face today.  An approach limited to simply pulling ever harder on one lever, the minimum wage, is insufficient. There are three new frontiers in the fight against low pay that should be explored. First, hours worked are as important as the hourly wage in determining low paid workers living standards, but never get talked about. Indeed falls in the hours worked by low paid men have exerted an upward pressure on inequality since the 1990s. Second, while the minimum wage has helped reduce the depth of low pay, it has (until recently) left the breadth of it far too high. That is to say it can narrow the gap between middle earners and the bottom, but not address the structural factors that leave more workers on low pay in the UK than in many other developed countries. To deal with that challenge we need to talk about progression routes out of low paid work and the productivity of low paid sectors of our economy. The challenge is big: Less than 1 in 20 people who were sales assistants back in 2011 for example had moved up to become retail managers or supervisors five years later. Third we need to explore in more detail whether in some parts of the country low paid workers have too little power in the labour market because they have no meaningful choice of employer. This so called monopsony problem has the potential to be a big drag on wages and is driving a big debate in the US that is sadly missing on this side of the Atlantic.

Along with the shifts in approach above, a full strategy to boost living standards through the labour market needs to recognise not just the need to raise productivity of the firms and workers we already have, but that we have slowed our pace of human capital improvement – that is to say we are not getting better qualified at the rate we once were. It would also note that the public sector pay restraint of recent years has reached the end of the road, and that much more needs to be done to close gender pay gaps that drag on women’s earnings.

So stepping back, a balanced reading of history tells us that labour market policy has seen big successes in recent decades but huge failures to. We need to recognise both – continuing with what worked, avoiding what didn’t – and update our approach for the new challenges that 21^st century Britain faces. That is the key to ensuring the labour market does what it in the end exists for: improving the living standards of the working people of Britain.

This article is a Chapter from the new Fabian Society essay collection Raising the Bar