Economic and benefit reform essential to replace UK’s stagnation with rising and shared prosperity

Stronger economic growth is fundamental to restarting rising living standards in the UK, but must be accompanied by reform to our economy and benefits system if the rewards are to be widely shared, according to new Resolution Foundation analysis published today (Tuesday).

Sharing the benefits – the 40^th report from The Economy 2030 Inquiry, funded by the Nuffield Foundation – examines what a plausible path to rising shared prosperity for the UK would look like, after 15 years of stagnation.

While some argue that growth isn’t desirable and doesn’t feed through to rising wages for normal workers, the authors show that productivity growth is the essential prerequisite for rising wages. Its absence is the key driver of the UK’s current wage stagnation: productivity and wages grew 29 and 30 per cent in the decade to 2005, before falling to just 8 and 4 per cent respectively in the decade to 2020.

But the Foundation’s analysis shows that rising wages alone will not deliver shared prosperity. If wages grew in line with the OBR’s forecast over the next decade, then low-income households would see income growth of just 2 per cent, compared to 12 per cent for typical households and 14 per cent for those on high incomes. This would mean 1.8 million more people, including 1 million children, falling into relative poverty.

This is because far from all households receive the majority of their income from employment, including pensioners and many of those with disabilities or children. In total, around 11 million people get less than half their income as earnings from employment, including almost half (47 per cent – equivalent to 5.4 million people) of the poorest fifth of households.

The authors show that ensuring growth raises living standards but not inequality requires productivity growth to be accompanied by reform of our economy (so higher employment and pay raise the incomes of poorer households) and welfare system (so the gap between wages and benefit levels does not get ever larger).

First, higher employment rates should disproportionately benefit poorer households. This approach has been successful in the past, with all of the increase in employment since 2009-10 located in the bottom half of the distribution. Repeating this success with a further 3 percentage point (equivalent to 1.2 million people) rise in employment over ten years would bring 500,000 people out of poverty.

Second, policy makers should build on the success of the minimum wage, targeting faster pay growth for lower and middle, than higher, earners. Significant progress on both these economic fronts would make income growth middle heavy, but still see poorer households (who would not benefit from wage gains but would see their housing costs rising with average incomes) left behind. Over a decade, the poorest fifth’s incomes would grow by around 10 per cent versus 18 per cent for middle-income households and 14 per cent for the richest fifth.

The authors say that any plausible route to shared prosperity will therefore also need reform of the benefits system, directly connecting the level of working-age benefits to wage growth, just as Britain does for pensioners, and housing support to the actual level of rents.

Combining growth with action on employment, pay, and benefits offers a route to shared prosperity and the most significant fall in inequality since the 1970s. The Foundation’s modelling shows that over a decade the poorest households incomes would rise by 19 per cent, compared to 17 per cent for typical households, and 13 per cent at the top.

The authors note that while this shared growth strategy is ambitious, policy change to connect groups at risk of being left behind by growth has been achieved before. Between 1983 and 1989, pensioner poverty soared from 14 to 41 per cent as rapid economic growth boosted workers’ wages while pensioners were left behind. A major policy drive – including guaranteeing to increase pensioner benefits at least as fast as earnings – then brought pensioner poverty down to 14 per cent in 2010-11, lifting 2.3 million pensioners out of poverty.

Finally, the Foundation notes that while linking working age benefits to wages would increase costs, total spending on working-age benefits as a proportion of GDP would still be 0.4 percentage points lower in 2041-42 than in 2026-27 (due to the UK’s ageing population). Furthermore, half of the cost of the policy could be offset by treating working-age and pensioner benefits the same, and uprating both via a smoothed earnings link.

Mike Brewer, Chief Economist at the Resolution Foundation, said:

“Economic growth – the essential precondition for rising wages – is sorely needed after 15 years of stagnation. But it’s equally important that this rising prosperity is widely shared.

“A strategy that delivers productivity growth alongside reforms to employment, pay, benefits and housing costs is ambitious. But it can draw on past policy successes, including the reduction in pensioner poverty, rise in employment and faster earnings growth for lower earners seen over recent decades.

“All political parties say they want to see a return to rising, and shared, prosperity. But only combining an end to Britain’s productivity stagnation with major reforms to our economy and benefits system can make that a reality – getting incomes up and inequality down.”