What’s in store for 2025

Morning all,

I hope that Santa gave you all the presents you asked for. But if you didn’t find the five charts you put on your list under the Christmas tree then fear not! The Foundation’s New Year Outlook for 2025 has you covered. A fuller version will be published on 7 January (alongside our event with Gus O’Donnell and Stephanie Flanders), but here are a few highlights to whet the appetite of TOTC readers…

All the best,

Mike

Interim Chief Executive
Resolution Foundation

Government takes centre stage in 2025

2024 was the year that parliament took centre stage, as a record 335 new MPs were elected this summer. But 2025 looks set to be the year where government enters stage-left, following the big pivot in the Autumn Budget (lost somewhat in the various tax rows) towards the public sector. This is a striking change of direction – the first we’ve seen in Britain in the past quarter century outside of an economic or public health crisis. In this edition of Top of the Charts, we’ll take you through how we consider this shift towards the public sector might affect the economy and – more importantly – living standards over the coming year.

In the Autumn Budget, the Chancellor told us she would tax more and borrow more so as to spend more (on day-to-day public services) and invest more (in infrastructure). But we must not forget that all of those changes were building off what was an unrealistic baseline for taxes and spending set down by her predecessor, Jeremy Hunt.

The result, as the chart shows, is that the government’s share of overall consumption (i.e. how much stuff in the UK’s economy is being used by the government) will rise next year, but then remain steady for the rest of the decade. Similarly, the government’s share of investment is set to rise to 20 per cent in 2026-27, far higher than the low of 14 per cent in 2016-17. But even after the additional £100 billion of public investment announced in October, the government share of investment is still set to fall slightly by the end of the decade.

Public sector employment is set to increase 

This ramping up of government consumption and investment will lead to a growing public service workforce. Despite the anti-civil service rhetoric we’ve sometimes heard from the Conservative Party, the number of full-time equivalent civil service employees rose by almost a third between 2015 and 2024 (up from 392,000 to 513,000). And the share of the workforce that is in the public sector is set to carry on growing over the rest of the decade, reaching levels last seen at the start of the Osborne-Cameron years (18.3 per cent in 2029-30 – just below the 18.8 per cent experienced in 2011-12).

But it’s not just the size of the government workforce that is changing – it’s what they do too. In 2000, the majority (54 per cent) of public sector staff worked in and around local government, a figure that has since shrunk to just one-in-three (34 per cent). Going in the other direction are employees in health and social work, who now constitute 37 per cent of government employment (up from 29 per cent in 2000).

A greater share of employees in the public sector means that public sector pay has more impact on household living standards. As the chart below shows, private sector pay has risen gradually over the past year, but the real change in the public sector happened in October, when NHS pay settlements took effect. As a result, average pay for public sector workers ended up 6 per cent higher than private sector workers in the three months to November 2024, having started 2024 at just 2 per cent higher. Looking ahead, with a growing share of employees having their pay decided by the state, the Government’s approach to these negotiations will become all the more important. So far, departments have recommended a 2.8 per cent pay rise next year, marginally above the predicted average rate of inflation (2.6 per cent), but lower than unions might have been expecting.

Of course, the majority of workers in the UK get their income from the private sector, and private sector pay is expected to have risen by around 5 per cent across 2024 as a whole – very robust, especially in the context of inflation slowly returning to around its 2 per cent target. If the private sector labour market remains this tight, then the growth in the size of the public sector might bid up wages by taking scarce workers out of private-sector jobs. But the Bank of England’s latest forecasts are for private sector wage inflation to fall back sharply to a familiar (low) rate of 3.3 per cent next year, as vacancy rates fall. In this world, rising public employment will be a welcome shock absorber.

The outlook for public services – and public investment – matters for living standards 

What, then, does this pivot towards the public sector mean for living standards? To answer this question, the RF brains have created a measure of ‘real living standards’ that includes both disposable income (post-tax wages + investment income + social security benefits, deducting housing costs) and the ‘benefits-in-kind’ that households get when they use public services (such as the value of education or healthcare), similar to what the ONS do. The value of these varies across the income distribution, and benefits-in-kind from public services in general make up a greater proportion of the real living standards of poorer households than richer households.

Of course, the highlight (or lowlight, depending on your point of view) of the Autumn Budget was the rise in employer National Insurance, in part offsetting some of the two rounds of cuts to National Insurance under the previous government. This and other tax rises (in total, the Chancellor announced £24 billion of tax rises for 2025-26) lie behind the fall in disposable incomes expected next year. This Budget tax-rise gamble from the Chancellor is that, while people may not be better off in purely financial terms, they will feel better off if we can have better less dysfunctional public services.  As the next chart shows, this looks like it will be the case for those in low-to-middle income families, whose ‘real living standards’ tend to benefit most from improvements to public services. On average, we estimate that non-pensioners in the bottom half of the income distribution will see their real living standards rise very slightly – by 0.2 per cent between 2024-25 and 2025-26 – while those in the top half will see their real living standards fall, by 0.4 per cent. These changes to real living standards are equivalent to an annual gain of £28 for individuals in the bottom half of the distribution, and a loss of £140 for those in the top half.

Two other things stand out from the chart. First, for the poorest households (those in the bottom income decile), the investment in public services does not do as much to compensate for the dire outlook for disposable income: these households are hit hard by rising housing costs, as well as tax rises (including Council Tax, which is set to rise by up to 5 per cent). They are also affected by the lack of government action to rein back ongoing real-terms cuts to social security, such as the two-child limit, the benefit cap and Local Housing Allowance (LHA) freeze. The upcoming Child Poverty Strategy could of course radically change this picture: scrapping the two-child limit and the benefit cap, as well as unfreezing the LHA, could immediately lift around one million people, including 600,000 children, out of relative poverty.

Second, at the other end of the income distribution, higher-income households also face a gloomy outlook. These households benefit less from better public services (since they are less reliant than poorer households on services like education and childcare); will not benefit as much as poorer households from the bottom-heavy wage growth fueled by minimum wage rises announced in the Autumn Budget; and will see their income from savings reduce as interest rates fall. If we put a cash figure on the benefits-in-kinds from public services, then the 0.6 per cent real living standards fall for the richest tenth of households is equivalent to a cash hit of £356 per person next year.

Things can only could possibly get better 

So, despite the Government’s new targets for rising disposable incomes in its Plan for Change, the living standards outlook for 2025 is hardly a cause for celebration: disposable income is likely to fall, and if households are to feel better off, then it will only be if they see the benefits from spending more on public services.

But, there are some reasons for optimism and, this being TOTC, we’re taking some very nerdy solace from a particularly obscure part of the OBR forecast. Very specifically, the OBR expects that the additional government spending (the inputs into public services) will pass through to direct measures of output more efficiently than in the past: in the chart below, the pink line (reflecting the OBR forecast) is steeper than the red line (based on the past quarter-century of outturn data).

So, the outlook for living standards in 2025 – or indeed the Parliament – isn’t great, but can be improved – either through better economic performance (private sector wage growth is currently looking very resilient), efficient use of public services (see nerdy chart above), or new policy (see the upcoming Spending Review and Child Poverty Strategy).

And you can count on Top of the Charts to talk you through all this and whatever else 2025 throws at us. We are having next week off, but we’ll be back on 10 January for my penultimate TOTC, as we at RF have a brand new Chief Executive, Ruth Curtice, taking over the helm in just over three weeks.

Until then, enjoy Tuesday night’s celebrations in whatever way suits you, and see you in 2025.