Low- and middle-income households are now more vulnerable to a recession than before the financial crisis

The income squeeze that followed the last financial crisis has left low and middle income households more vulnerable to the next economic shock than they were in 2008, according to new analysis published today (Monday) by the Resolution Foundation.

A problem shared? examines the distributional impact of recessions in the light of the financial crisis. It shows that a decade of weak income growth has left lower-income families in a more vulnerable position than when the crisis hit, as they have less scope to reduce their spending on non-essentials should their incomes fall, and a higher proportion of families have no savings to draw upon.

The analysis follows the Foundation’s previous warning that the risk of recession is at its highest level since 2007, and also comes ahead of Friday’s GDP figures for the second quarter of this year that could show the economy is already contracting. All this strengthens the case for the new Chancellor to make recession-preparedness a priority.

Before 2008, the received wisdom was that the poor bore the brunt of recessions. This was particularly true of the 1980s recession, in which unemployment increased by 1.9 million, and where the fall in employment towards the bottom of the distribution was six times larger than that towards the top.

In contrast, the pain of the 2008 recession – through rising unemployment and falling real pay – was more evenly distributed. Workers across the board experienced a deep pay squeeze that left average real earnings falling by £32 a week between 2008 and 2014.

The research finds that the social security safety net also played a key role during the financial crisis in protecting lower-income households from experiencing the recession more deeply. For those in the lowest income decile, the fall in employment income was more than offset by a boost from the tax and benefit system.

However, A problem shared? shows that the longer-term impact of the financial crisis has borne down most heavily on lower-income families. By analysing consumption patterns over the past decade, the report finds that lower income households were forced to retrench by more after the financial crisis, and are yet to shake the experience off. While the average decrease in spending between 2009 and 2014 was £20 per week, those in the bottom quarter of the income distribution cut back over three times more at £61 per week.

This consumption crunch has meant lower-income households spending a far greater share of their income on essentials. The rise in spending on essentials was three times larger for the average lower-income household than it was for those on high incomes between 2006 and 2012.

As well as reducing their spending to weather the economic storm, the research finds that low and middle income families also drew down on their limited savings. Despite some reduction in the debts of lower income households, nearly 60 per cent of this group now have nothing put aside, up by a quarter since the financial crisis.

The Foundation says that this lack of savings means that low- and middle-income families are more vulnerable than they were a decade ago, even if the downturn repeats the last in causing a general pay squeeze rather than the high unemployment associated with earlier recessions.

It adds that studying the financial resilience of the country today is crucial to understanding the distributional impact of a future crisis.

The Foundation is calling on the government to ensure that any policy response to prepare the country for the next recession takes households across the income distribution into account. It notes, for example, that a fiscal policy response focused on income tax cuts would overwhelmingly benefit higher-income households, even though lower-income households are likely to need the most support.

James Smith, Research Director at the Resolution Foundation, said:

“Britain is facing the highest risk of recession risk since 2007, and we know from previous downturns that it is lower income households that bear the brunt of economic downturns when it comes to their living standards.

“The deep income squeeze that followed the last financial crisis may have been more equally shared than previous recessions. But its depth and length has had a disproportionate impact on the resilience of lower income households, who now have less scope to reduce non-essential spending or draw down on savings to weather a further recession than they did after the 2008 crisis.

“The global slowdown and continued Brexit uncertainty are making recession preparedness even more urgent. In its response, the government should consider policies that limit and mitigate the effects of the recession, particularly for the most vulnerable in society.