Sunday, November 07, 2021
The big squeeze on incomes is not just for Christmas
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on www.thetimes.co.uk This is an excerpt. Not to be reproduced without permission.

There are some questions that are bigger and more important to most people than whether the Bank of England nudges interest rates up a little. As it happens, the dog did not bark on Thursday and the Bank left interest rates unchanged, as I suspected it might. The 0.1 per cent rate lives to fight another day.

The bigger issue is that, as a nation, we have stopped getting better off. Prosperity, which at one time we got used to being on a rising trend, has stalled. The cost of living crisis and subdued or falling real income growth are not just for Christmas. They are, as a flurry of analyses in recent days shows, the new reality. I shall come on a little later to what we might do about it.

The Resolution Foundation think tank came up with the striking finding that we are heading for the weakest growth in real household incomes in this Parliament than in any since the data became available in 1955. Compared with a long-run average of 2 per cent a year real income growth, though less than 1 per cent a year since 2010, the prospect is for a mere 0.1 per cent a year over the 2019-2024 Parliament. This is a close to stagnation as you can get.

The strongest growth in real incomes, incidentally, an annual rate of 3.8 per cent, was in Harold Wilson’s truncated first term, from 1964 to 1966, although income growth slowed sharply after he was returned to power in 1966 until his defeat in 1970, just 0.9 per cent a year.

Margaret Thatcher’s last period as prime minister, though she was forced to step down in favour of John Major just over halfway through produced surprisingly strong real income growth, 3.7 per cent a year over the 1987-92 period, though much of that occurred in the late 1980s’ boom. That reading may help explain why, against expectations, Major won the 1992 general election.

There are three reasons why the outlook now is so poor, according to the Resolution Foundation. For all the talk of a high-wage economy, prospects for real earnings growth – after allowing for inflation – are poor. Taxes, including next April’s national insurance hike and the freezing of income tax allowances and thresholds, will take a big bite. The employment rate is also expected to remain lower than before the pandemic.

It is more than a week since we had a flurry of analyses, official and unofficial, on the economy as part of the information overload that accompanies the budget. Quite a lot has stayed with me from the flurry, but one thing has really stuck in the mind. This is that, as far as most people are concerned, the economic good times came to an end 13 years ago, and they show no sign of returning.

This was the consistent story from the Office for Budget Responsibility (OBR) and the Institute for Fiscal Studies, as well as the Resolution Foundation. Three shocks to the system; the global financial crisis, Brexit (the self-inflicted one) and the pandemic have left us poorer than we could have reasonably expected to be, and it is only when you stand back and look at it that you realise the extent.

As Xiaowei Xu of the IFS pointed out in her analysis, real household disposable incomes rose by 2.3 per cent a year, on average, over the period 1989-2008. Incomes in real terms at the end of the period, in other words what people could afford to buy, were strongly higher. Given that the period included one significant recession and took us to the brink of another, it was quite an achievement.

Now consider the period since 2008, up to the end of the OBR’s forecast period in 2026. Real income growth is expected to average just 0.8 per cent annually, a third of its previous rate. On another measure, real average earnings, they would be 42 per cent higher than they are if the trend prevailing before the financial crisis had continued.

What is the impact of this very slow growth in incomes? As you might expect if people have not got the money they cannot spend it. In the 13 years leading up to the crisis consumer spending rose by 52 per cent in real terms. In the 13 years since it has grown by a shade under 10 per cent. That may be a slightly unfair comparison because spending has not yet recovered to the pre-pandemic level but, compared with that level, it rose by 17 per cent. Income growth slowed to a third of its previous level, and so did spending growth. Consumer-facing businesses have been finding it tougher.

Can we hope for anything better than income stagnation in coming years, or is the die cast? The financial crisis and the pandemic cannot be undone and, judging by the state of relations between the UK and France, there is not a lot of entente cordiale around at the moment.

The key to rising prosperity is, of course, rising productivity. On the output per hour measure, it rose by 26 per cent in the 13 years leading up the crisis and has increased by just 6 per cent since, somewhat less than a third of its previous performance.

The Productivity Institute, based at Manchester University, has some good ideas for raising productivity, which I shall discuss soon. So did the Industrial Strategy Council, set up under Theresa May, but abolished by this government. I have not seen many good productivity ideas coming out of the government, including in the budget.

Business investment, a key to raising productivity, was flattened by the Brexit vote and, while it may undergo a short period of growth to take advantage of the chancellor’s “super deduction” incentive, will be held back by rising business taxes. The official approach to raising skills is a piecemeal one. It is not clear whether the green obligations on business flagged at the Cop26 summit will boost or limit productivity growth.

Maybe technology will come to the rescue and lift us out of our productivity and prosperity malaise. Rishi Sunak suggested in his Tory conference speech that artificial intelligence (AI) could provide a £200 billion annual boost to the UK economy, though he did not show his workings.

Something is needed. The living standards’ malaise has already been around for a long time, taking on an air of permanence, and it appears to be getting worse, not better.