Sunday 9 December 2012

Indexing benefits to inflation is not "unsustainable"

In the Autumn Statement the Chancellor decided to cut working age benefits and tax credits, thus reversing his previous (sensible) policy of allowing the "automatic stabilisers" to operate, and ignoring the advice of the IMF.  More on the macroeconomic issues here. He justified this change thus: 
But we have to acknowledge that over the last five years those on out of work benefits have seen their incomes rise twice as fast as those in work.  With pay restraint in businesses and government, average earnings have risen by around 10% since 2007.  Out of work benefits have gone up by around 20%.
That’s not fair to working people who pay the taxes that fund them.  Those working in the public services, who have seen their basic pay frozen, will now see it rise by an average of 1%.  A similar approach of a 1% rise should apply to those in receipt of benefits.  That’s fair and it will ensure that we have a welfare system that Britain can afford.
David Smith, writing in the Sunday Times, repeated the Chancellor's argument verbatim and stated that:
"In five years, out of work benefits have risen 20%, earnings 10%. That is unsustainable.."

The numbers are correct: but they are highly selective, and David's conclusion is simply wrong. The value of out of work benefits relative to average earnings (and more broadly the incomes of those in work) has fallen steadily over the past three decades, until the recent slight uptick resulting from the recession: 

In 1979, unemployment benefit (the predecessor to Jobseekers' Allowance) was about 22% of average weekly earnings; today it's about 15%, a relative decline of about a third.  What's going on?  Simple: JSA has been indexed to inflation.  In normal times, earnings rise faster than prices, as workers become more productive and the economy grows; this chart shows the cash value of both JSA and average weekly earnings:

So indexing benefits to prices has been far from unsustainable, or "unfair" to working people,  over the last 30 years.  Indeed it has resulted in a substantial reduction in spending on out of work benefits as a proportion of GDP, compared to the alternative of indexing benefits to earnings.  

As a result, we already have "a welfare system that Britain can afford", at least for  those of working age. Declan Gaffney et al note (table 3) that all out-of-work benefit spending only amounts to some 3 percent of GDP.   And even overall benefit spending, which has to accommodate the growing number of pensioners, has levelled off, as Chris Dillow has pointed out There is nothing remotely unsustainable about any of this.
In the last five years, however, earnings have risen much more slowly than prices, as the Chancellor points out. This is highly unlikely to persist, however, and it is certainly not what the official figures suggest: the Office of Budget Responsibility's forecast, which is not particularly optimistic about growth over the near term, suggests that earnings will rise about 5% faster than prices over the forecast period (table 1.1).   So unless we are stuck in permanent depression, even a modest recovery will in time lead to earnings rising significantly faster than prices, and the relative value of out of work benefits will decline again. No policy action is required to ensure this (although economic recovery would help!). 
So unless the OBR is completely wrong, and the economy flatlines for the foreseeable future, with no or negative growth in earnings relative to prices (and even at my most pessimistic I don't think that's likely) then the idea that benefits need to be cut in real terms in order to ensure either fairness to those in work or long-term sustainability is nonsense.

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