An Ending Stagnation special

Afternoon all,

Did I mention we’ve been conducting an Inquiry into the UK economy – the Economy 2030 Inquiry?

Thought not. Well we have, and this week we published its Final Report. Ending Stagnation: A New Economic Strategy for Britain is out, single handily solving all your hardest “what to get your mum/brother/lover/small child for Christmas” conundrums.

The book is the product of nearly three years of research and tears graft from the Resolution Foundation and LSE teams, so obviously you’re getting a TOTCs special on it. I’ll briefly cover the stagnation part, but it’s good to focus on the ‘ending it’ bit at more length. After all, the central argument of the book is that while we’re in a hole there’s no excuse for fatalism. Britain has a lot of strengths – it’s just time we got serious about building on them. In fact, more generally it’s time we started being a serious country once again.

Have a lovely, and not too serious, weekend.

Torsten

Chief Executive

Resolution Foundation

What is this stagnation we’re trying to end? 

Countries can survive a year or two of poor productivity growth and flatlining wages. But we’ve managed a decade and a half of both. Workers heading into this festive season are still taking home smaller pay packets than workers were on average in 2008. Merry Christmas. If real pay growth had continued to follow its pre-recession trend, British workers would be £10,700 a year better off. This unprecedented squeeze has gone on so long there are now almost nine million younger Brits who have never worked in an economy that has sustained rising average wages – and I can’t help worrying that we’re starting to think this is normal.

The fundamental driver of this disaster is low productivity growth – the UK has seen half the growth experienced across advanced economies since the financial crisis. The ‘de-growthers’ out there have got exactly what they wanted – and working Britain is paying a very high price.

Crucially that recent slow growth has come together with our longer lasting high levels of inequality: the UK is Europe’s most unequal large economy. This combination has proved toxic for those on middle and low incomes. We think we’re similar to the likes of France or Germany, but our poorer families are now a staggering 27 per cent worse off than their French and German counterparts.

This is not what success looks like. Stagnation is not going to be ended by wishful thinking about silver bullets (cut taxes! green jobs for all!) or nostalgia. We need to move on from thinking that “world-beating” rhetoric automatically translates into world-beating reality. It’s time for a new economic strategy built on our actual strengths, alongside honesty about the constraints and trade-offs involved.

Getting serious. We’re a services superpower.

We should start by understanding the nature of the British economy. We are the second biggest services exporter in the world. Only the US sells more. Our services strengths are not limited to financial services, whose role in our economy is actually shrinking. Our universities, architects, cultural services, technology companies and many others are world leading.

This should be the starting point because it is not going to change anytime soon (of the top 10 products the UK was most specialised in back in 1989, seven were in our top 10 in 2019) but also because it provides a plausible route to prosperity: global trade in the services we are good at is growing twice as fast as goods trade. Our trade strategy needs to reflect that, while also doing more to protect the role of our high-value manufacturing (where we have important if narrower strengths) in European supply chains. It is the impact of Brexit on the likes of our car and chemical industries that should worry us most.

The services-led nature of our economy also tells us how to release the brake on its growth: our great second cities, such as Birmingham and Greater Manchester, currently have below average productivity (see chart) but are natural locations for cutting-edge services exactly because they are so large. They are too big to fail, but also big enough to be far more productive than they are today. This will require change on a scale not currently imagined, but it is what an industrial strategy in a service dominated economy looks like.

Investing in our future, rather than living off our past. 

The UK has been the weakest investor in the G7 over the past four decades. There is no route out of our relative decline – or to net zero – unless we turn this around. Britain has to start investing in its future, rather than living off its past.

Firms that do invest in Britain make money, but they too rarely do so, with managers facing very unusually weak pressure from owners or workers to invest for the long term. Less bonkers politics and sensible taxes will help on this front, but real change will require more pressure on management from above (with a smaller number of far larger pension funds behaving as active owners) and below (with workers on boards of companies – something that has raised investment levels in several European countries).

Public investment has also consistently been too low – and we’re cutting it again today. We can see the results everywhere – from struggling hospitals, to shaky public transport, and too little housing. Not only is our public sector investment low, it’s highly volatile, with long-term planning decisions stunted by the short-term nature of twice-yearly fiscal events, and the need to meeting rolling fiscal rules. We need to take a new approach – raising public investment of 3 per cent of GDP, and keeping it there.

In time, higher investment will create higher living standards (and a greener economy). But only in time. In the short term it has to be paid for, either from higher savings (lower consumption) at home, or more borrowing from abroad. We already do too much of the latter and there is nothing resilient about an economy where over two fifths of families had savings of less than one month’s income when the pandemic hit. So we need a 50 per cent increase in minimum auto-enrolment pension savings rates, and the state should be saving more (by running a slightly tighter fiscal policy). Countries that save more, invest more.

What growth will achieve… 

A few people asked me this week whether growth delivered by creating more capacity for high value-added service activity would only benefit a handful of highly educated graduates. I wanted to dwell a bit on why this is too simplistic. First, the easier to understand reason: workers of all education levels earn a very significant premium if they work in higher productivity sectors.

The second reason is something people struggle with more: higher productivity is the route to raising wages across the economy, not just in the sector that productivity comes from. Think about hairdressing. This is the quintessential occupation with limited scope for productivity growth (there’s only so many barnets you can trim an hour, and the robots can’t manage a mullet yet). Yet hairdressers’ real wages have risen over the past three decades broadly in line with productivity/wages in the rest of the economy – otherwise no-one would be a hairdresser. What makes that possible is the rising relative cost of haircuts, rather than the productivity of hairdressers. While this effect is sometimes known as Baumol’s cost disease, it is actually a feature, not a bug or problem, of a successful capitalism.

…and what growth alone won’t achieve. 

But growth alone certainly won’t cut it. Indeed, just delivering faster growth would also deliver higher inequality, because market income (e.g wages/rent/dividends that generally rise with growth) is concentrated in the middle and top of the income distribution as our next chart (which considers the scale of income gains we might see over 15 years with and without our proposed economic strategy) shows.

The goal isn’t to become America – richer but far more unequal. So a new strategy needs to be as hard-headed about reducing inequality as raising growth. Lefties spend a lot of energy arguing about whether that is best delivered through predistribution (changing the distribution of market income) or redistribution. This debate is a waste of time – we need both.

Good work is the goal, not a happy by-product, of a new strategy. 

The bedrock of a fair economy is good work available in every town. We can learn from recent progress: the minimum wage has proved a resounding success and we should continue to raise it. But a good work agenda cannot continue to be a one trick pony when, even as the minimum wage has risen, lower earners’ job satisfaction has fallen. No wonder, when half of shift workers get less than a week’s notice of their hours and Statutory Sick Pay leaves some ill employees living on just £44 a week. So, we need to raise the floor of labour market minimum standards more generally, and ideally we’d actually start enforcing them (we currently have 0.29 labour market inspectors per 10,000 workers).

Many of the biggest problems are concentrated in specific parts of the economy – such as illegal underpayment in the social care sector. To address this, we propose pioneering new Good Work Agreements – bringing together unions, businesses and independent experts in the same vein as the Low Pay Commission – to agree higher sectoral standards. We should start on social care and its 1.7 million strong workforce.

We should be honest about the trade-offs here. Higher pay and better jobs for lower earners will raise prices in sectors most dependent on low paid labour (e.g hospitality). This is a feature of this lower inequality strategy: the gains to workers in those low earning sectors will fall disproportionately to families on low and middle incomes (see the blue bars in our next chart), while the higher prices most significantly affect those who do more consuming of those sectors services ie richer households (the red bars).

Combining redistribution and predistribution can bring inequality down

A predistribution agenda of this kind can shift income gains in a progressive direction – with middle income households (who benefit most from a higher minimum wage) seeing the fastest living standards improvements (see green bars in our next chart). But truly shared prosperity must include the 11 million working-age households who get less than half of their income from the labour market. A decent society doesn’t let poorer people fall ever further behind, but that is what we have done. Benefit cuts since 2010 have reduced the incomes of poorer households by almost £3,000 a year. The consequences are everywhere to see, as food banks expand and homelessness hits record highs. Shared prosperity requires benefits and the state pension to rise with growth and wages (working age benefits currently only rise in line with prices).

Sacrifices as well as rewards must be fairly shared. The tax take is set to hit an 80-year high this decade, and the need to raise investment, rescue public services and repair public finances means it is likely to stay elevated. But so far its quality has not risen with its quantity. Rather than the burden of tax falling disproportionately on wages, we need other sources of income and wealth to take more of the strain. Landlords can’t carry on paying lower taxes than their tenants.

If we put our benefit and tax proposals together with the predistribution agenda we can see (in purple bars above) rising living standards AND falling inequality, with the poorest households now seeing the biggest living standards boosts.

Economic and political fatalism is overdone.

We’re under no illusions about the ambition of this strategy, and there is nothing automatic about ending stagnation – just ask Italy. But fatalism is also misplaced because, having fallen so far behind, we now have one huge advantage: catch-up potential. We don’t need to become as rich as the US or as equal as Scandinavia. Closing our productivity and inequality gap with countries we’ve long considered ourselves similar to – Australia, Canada, France, Germany and the Netherlands – would mean British households being more than £8,000 better off. That is a huge prize, worth embracing a new economic strategy for.

The politics of change is always hard – there are some who benefit from the status quo. But it is increasingly clear there is a majority for change. Middle income Brits, not just the poorest, now find themselves behind their peers in similar countries. It is not only millennials facing disappointment; those in Generation X are entering their 50s wondering why their wages peaked in the 2000s. Older voters care about the lives of younger relatives, while the lack of growth threatens the funding of public services they rely on. Today six in 10 Britons think the country is heading in the wrong direction – just 16 per cent think it is on the right track. Britain is ready to do things differently because this stagnant chapter of British life has gone on long enough. It is time to turn the page.