Sunday, July 22, 2007
Our real poverty is in a lack of skills
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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It made for a neat juxtaposition. Levels of inequality in Britain are at their highest for 40 years, according to a new study published by the Joseph Rowntree Foundation. Meanwhile, Sir Tom Hunter, the entrepreneur, plans to give away £1 billion over the next few years in an act that recalls the great philanthropists like old Joseph Rowntree himself.

In Rowntree’s day, the state was a lot smaller. Hunter’s act of generosity is a giant step for a man, though it will be as galling for him as anybody to know that £1 billion is what the government spends roughly every 15 hours.

Is Britain really at its most unequal for 40 years? The new “masters of the universe” operating from expensive addresses in Mayfair – the hedge-fund and private-equity stars who rub shoulders with nondomiciled billionaires – give that impression.

But the Joseph Rowntree research, while interesting, is a long way from proving that inequality is at its highest since the 1960s or, as Danny Dorling, one of its authors suggests, since 1937.

What it does, using census data, is look at how poverty and wealth have shifted between geographical areas, and between rural and urban areas. Its strength is that it allows the researchers to drill down to local level. Whether it is appropriate to use this to make claims about national inequality is disputed by other researchers.

Another weakness is that, because the study uses census data, it can only tell us what is happening every 10 years. We won’t know what has happened since 2001, for example, for another five years or so, when 2011 data are available.

What we do know about inequality is provided by other, more mainstream measures. So, for example, data from the Office for National Statistics show the “marketable” wealth – that which can be sold – owned by the top 1% and 5% of the population. In 1923 the top 1% owned 61% of wealth and this halved to 30% by 1970. The latest figure, for 2003, is 21%. The corresponding figures for the top 5% of the population are 82%, 54% and 40%, respectively.

The picture may have changed a bit since 2003, the trough of the stock market, but the trend is unmistakable. Indeed, one feature of recent years has been the democratisation of unearned wealth. About half of personal wealth is in housing and the boom in house prices has spread that wealth far and wide. There are plenty of people in London and southeast England who have modest incomes but own houses worth more than £1m.

The conventional measure of income inequality is the Gini coefficient. It is time to let it out of the bottle. A Gini of zero would be perfect equality. A Gini of 1 would be perfect inequality – one household would have all the income. The Institute for Fiscal Studies’ (IFS) database shows the Gini was 0.261 in 1961, fell to 0.239 in 1976, before rising during the 1980s to 0.339 by 1990. It remains roughly at that level – the figure for 2005-6 was 0.346 – below the high of 0.353 in 2000-1.

Another useful measure of inequality is the 90:10 ratio, the incomes of the 90th percentile of the income distribution (people 10% from the top), compared with the 10th percentile, those 10% from the bottom. This has the virtue of excluding those at the very top and bottom of the income distributions from the comparison, a virtue because in neither case are the statistics entirely reliable.

In 1961 the 90:10 ratio was 3.207, falling to 2.947 by 1978. It, too, rose in the 1980s, reaching a high of 4.44 in 1991. In 1996-7 it was 4.130, slipping to 4.055 in 2005-6. On this measure, inequality is still historically high, but has fallen by roughly 10% since the early 1990s.

The central point is that when claims of record levels of inequality are bandied around, people will often reach for the knee-jerk response; that the rich need to be taxed a lot more and the poor given more direct financial support from the government.

In fact, as the IFS points out in its latest report on the subject, Poverty and Inequality in the UK: 2007, the government has done quite a lot. Under the Tories from 1979 to 1997, the poorest fifth of the population saw the weakest income growth; less than 1% a year in real terms, with progressively faster growth up to the near-3% of the richest fifth.

Under Labour, income growth has been more evenly spread between different groups, helped by benefits and tax credits, with the strongest growth enjoyed by the bottom two-fifths of the population, Inequality may be historically high but would have been a lot higher without Labour’s redistributive changes, about 0.378 on the Gini, according to the IFS.

The real solution to inequality lies elsewhere. The gaps that have emerged in recent decades are between those who have the skills to prosper in a globalised world and those who do not.

In the old days, manufacturing apprenticeships provided skills for young people who had no academic qualifications. As manufacturing jobs migrated to services, apprenticeships did not shift with them. The result, as a report from the House of Lords economic affairs committee on Friday pointed out, is “millions of young people have missed vital chances to improve their skills and earnings, representing a serious loss to the country”.

Too many children leave school without the basic functional literacy and numeracy even to start an apprenticeship, where they exist. Apprenticeship programmes themselves are often poorly run by training providers.

The government has provided “poor leadership” on the issue, something it needs to address.

Inequality of income and wealth may not be quite at the level suggested by the Joseph Rowntree Foundation, but it is high. And it can only get worse, driven by inequality of skills. Efforts to redistribute income provide only a sticking plaster. Unless people are properly equipped with skills, there will be no place for them in the workforce of the future, as Lord Leitch’s review for the Treasury made clear. And if we’re not careful, it will soon be too late.

PS: What’s the connection between DFS – “think sofas, think DFS” – and overexcited money markets? Last month DFS and its competitors put up prices by an average of 7.2%, which added 0.1% to the inflation rate. Consumer price inflation, instead of falling from 2.5% to 2.3%, fell to only 2.4%, provoking a panic reaction.

This month the DFS sale is on: “It’s big; It’s on everything; And it’s on right now.” It is a fair bet prices will be down by 7.2%, or more. This is the oldest retailing trick in the book – bump up prices before knocking them down in the sales. June’s rise in furniture prices was the biggest for the month on record. But it was no reason to panic.

When the Bank of England’s monetary policy committee (MPC) raised its interest rate from 5.5% to 5.75% this month, both its deputy governor responsible for monetary policy, Rachel Lomax, and its chief economist, Charlie Bean, were in the minority of three against. That should tell us something. Even among the six for the hike there were varying degrees of enthusiasm and no presumption this was a staging post on the way to further increases.

The MPC is divided between new and old members; between gradualists and shock troops; and between “neo-mons” – those who have discovered the money supply (M4 slowed last month from 13.9% to 13%) – and those who think it is as misleading now as ever. There is the Greek chorus urging the MPC to go further and faster in raising rates. It will be the first to criticise if the Bank is found to have gone too far.

There is a lot of noise around the interest-rate debate. Will oil hit $100 a barrel; will the floods push up food prices? In fact, the MPC’s choice is a simple one. If it thinks it has done enough to secure a significant slowdown in household spending and therefore the pressures for higher prices, it can relax. If not, it will have to do more. Last month’s retail sales figures, showing a rise of just 0.2%, were not conclusive but I believe the Bank is at or very close to the point where it can stop hiking.

From The Sunday Times, July 22 2007

Comments

David, good article today. Just thought I'd make a couple of additional points.

First, you don't really go into the source of rising income inequality. I think it's striking that it's not just in the UK where the debate about income inequality is raging. There are similar discussions happening in the US, continental Europe and even in many developing countries, like India. In my mind, this isn't all that surprising. The last ten years have seen some of the fastest rates of growth in the global economy in decades, spurred by a wave of increased integration across the global economy. The evidence about whether growth is good for income inequality or not is mixed. But I reckon most economists would agree that when it's driven by rising openness to trade and increased specialisation, it tends to increase the returns to skills at the expense of the unskilled.

I think I'm with you from here on. Rising income inequality can't be good for the health of the nation. It's detrimental to growth and democracy. As you suggest, the policy response is far from clear. Should we provide a bigger social safety net for the unskilled? This might be part of the solution, but the primary objective should be to provide the opportunity to everyone to gain these skills in the first place. Apprenticeships might help, though I think the government needs to take a harder look at the education system.

Posted by: Sell Everything at July 22, 2007 10:10 AM

A similar upswing in furniture prices happened back in March of this year as retailers raised prices prior to Easter "sales". Prices did, as predicted, fall in April, though not back to levels in April 2006, or even February 2007. When averaged out over the first six months of the year to avoid the effect of "sales", the inflation rate of furniture and furnishings in the CPI has averaged about 3.5% over the first 6 months on this year. Last year, it average 0.75% over the same period. Core inflation hasn't been this high since 1997, when the base rate headed up to 7.25%.

Posted by: RichB at July 22, 2007 10:28 AM

Good article and good points. But let's just mention immigration again. If we hadn't had so much of it we wouldn't have had such low wage inflation. Without which we wouldn't have had such low interest rates or such high house price inflation. Home owners wouldn't have been sitting on such large assets. We would have had less inequality.

Posted by: bears all at July 22, 2007 11:05 AM

Here's an interesting resource on the increasing wealth of the super-rich in the USA.
http://elsa.berkeley.edu/~saez/pikettyqje.pdf

Posted by: Mr Naresh Radson at July 22, 2007 04:16 PM

Thanks for comments. As I say, I believe skills are the key explanation for rising inequality, and it is the case that immigration has helped undercut the unskilled, further undermining their labour market position. Mind you, we've also had plenty of immigration at the top end; look at the City and Canary Wharf.

Not sure how much a core CPI of 2% tells us about the appropriate level of interest rates. It was 1.8% in August 2005, when the MPC cut from 4.75% to 4.5%; and it was 1.7% in February 2003, when the Bank was on its way down to a Bank rate of 3.5%.

Posted by: David Smith at July 22, 2007 05:44 PM

RichB, not sure where you get your furniture index numbers from?

The CPI index number for "Furniture furnishings and carpets" on 31 December 2006 was 108.3. On the 30th June 2007 (6 months later) it was, er, exactly 108.3. That is a six monthly growth rate of zero %.

This is the problem with seasonal adjustment. You need to make sure that the two figures you are comparing are similar. If you take the figure for January 2007, the middle of the sales, and compare it with June 2007, just before the summer sales (5 months later), the index figures are 98.5 and 108.3 which is an increase of 9.95% in six months!

I do a lot of comparison numbers for CPI/RPI and retail sales for my work. About the only way of ironing out these differences is to compare the average of the last 3 months index numbers with the average of the same 3 months a year ago.

For funiture furnishings and carpets this figure is 3.75% (Apr-Jun 06 vs Apr-Jun 07) which ties in neatly with the increase in the general index. What is interesting is the fact that furniture prices rose much less in anticipation of the sales last year, about 3% between April and June, whereas this year they have risen 7.5% in the same period. A sure sign that the retailers are trying to force through price increases. How well they succeed we will see in the July retail sales figures which we will come out in late August. Of course we may find that the floods cause a major increase in the sales of 3 piece suites - but so far I have not perfected my "flood adjustment model" :-)

Month to month, and unadjusted year to year numbers, are next to useless.

Posted by: Matthew at July 23, 2007 11:05 AM

Matthew,

To clarify, the figures I cited are the average of the six Year-over-Year changes from Jan 07 to June 07 and the average of the six Year-over-Year changes for Jan 06 to June 06 for Furniture and furnishings, item 05.1.1 of the CPI hierarchy.

Posted by: RichB at July 23, 2007 07:37 PM

David - You said that you would respond to various comments made over the past couple of weeks about inflation adnt eh outlook for interest rates. You haven't yet. Have you gone quiet because you've realised that you have been wrong on inflation and consequently wrong on rates? It would be very interesting to know the rate at which you think this cycle will peak at now. Any references to NZ would be welcome (for context).

Posted by: Thomas Gumbrell at July 24, 2007 04:40 PM

Thomas, don't be so silly. The response to comments made at the end of last week was in Sunday's piece, as I promised, and it is always worth reading it, particularly before commenting. As I said, the reaction to the inflation figures was hysterical. I would add that the GDP numbers, while slightly stronger than the National Institute had expected, were in line with the Bank's forecast. You'll have seen evidence today from the CBI of an easing back of price expectations among businesses.

The New Zealand situation reminds me of the early days of Margaret Thatcher, when interest rates were raised over and over again, pushing the currency to new highs. New Zealand already has very high real interest rates and the central bank seems bent on hitting the economy hard, to the point where the government is considering force majeure intervention to stop it doing so.

Posted by: David Smith at July 24, 2007 05:39 PM

"Our real poverty is in a lack of skills"

Arse-about-face yet again, David.
You really are hopeless at this economics stuff, arent you?

The 3 or 4 best qualified and most able people I know are unemployed. Got a PhD? MSc? Then go somewhere else - the UK only wants people who push can buttons, flip burgers or pack shelves.

Know how to use Powerpoint? 38k pa.
Ability to sell dodgy financial products to vunerable pensioners? 100k. Take it.
Can you walk and chew gum? 25k pa.

Got a PhD in Comp.Sci and worked in Aerospace and advanced research? Sorry, no jobs here.

(Whats that you say Herr Deutschland, you've got a job paying €180k and you need my skills? I'll be right there.)

Posted by: contradictifier at July 28, 2007 01:41 AM

Well if they're as daft as you are, I'm not surprised they're out of work, and I'm not surprised you hide behind a ridiculous nom-de-plume. We don't have a problem in this country with a lack of tertiary-level skills - we produce an ample supply of graduates and postgraduates - as every survey ever conducted on this issue has shown. What we do have is not enough people with intermediate skills, and too many with no skills at all, hence the piece.

You really are hopeless, aren't you?

Posted by: David Smith at July 28, 2007 02:44 PM