Escaping Britain’s low-wage trap
Only sustained wage growth will restore trust in the economy
On Wednesday the Chancellor of the Exchequer will rise in the House of Commons to bring some early Christmas gifts. There will be few, if any, surprises as the key announcements will have been leaked over the weekend to test the waters. Whatever rabbits might be pulled out of Jeremy Hunt’s hat — or, rather, red box — they will perform an electoral trick in an attempt to change the political dial, whilst we hear endlessly about “tough decisions for the long-term good of the country”. With an election sometime in 2024, the government will likely keep its fiscal powder dry for a Big Bang budget around the Ides of March.
Away from the Westminster spectacle of spin and PR, the country’s economic woes are clear to see. True, wages are going up faster than prices for the first time in two years, and inflation has now dropped to 4.6 per cent. Whilst this is welcome relief to ten million working families that have seen their living standards decline since Covid, it shouldn’t obscure the fact that real incomes fell sharply for about half of the working population after the onset of the spike in inflation. This started in late 2021 and was amplified when Russia launched its attack on Ukraine in February 2022.
In its 2023 Autumn Outlook published last week, the National Institute of Economic and Social Research finds that for around 12 million households in the bottom half of the income distribution, real wages are on average about six per cent lower than in late 2019. We are talking about families with disposable income of £16,000 to £32,000 per year. Their living standards will not return to pre-pandemic levels until the end of 2026. That’s seven lost years, on top of real wage stagnation since the 2008 financial crash. It’s not so much the return of the “squeezed middle”, because they never went away after austerity. Rather, the decline of low-and middle-income Britain has been a part of the country’s chronic condition for 15 years and counting.
Neither tax cuts nor greater redistribution are the answer
Real income decline and deteriorating living standards reflect the United Kingdom’s broken model of low-wage precarity and high dependency on welfare support. Since work does not pay enough to feed yourself and your family, people depend on permanent benefits such as Universal Credit and other in-work benefits. This means that the state — and ultimately the taxpayer — is subsidising low wages, whilst many businesses boast high profit margins and consumers enjoy low prices (until the recent spike in inflation). The combination of low wages and high welfare dependency marks a model of capitalism that enriches a rentier class of people who own assets, whilst the “working poor” struggle to get by.
Neither tax cuts nor greater redistribution are the answer. Cutting income taxes costs billions, and it disproportionately benefits the top half of the income distribution. Wealth won’t trickle down from the top 20 per cent, just like capital doesn’t simply flow from the City of London down every provincial gulley. Raising current tax levels or introducing new wealth taxes will likely reduce consumption and further depress low economic growth and business investment. The country is in a vicious circle of low pay, low investment and low productivity that has trapped the economy for decades.
One part of the solution is to raise wages, starting with an increase in the national minimum and the national living wage. We know that this works because higher minimum and living wages feed into higher consumer spending and thereby higher investment and job creation. As NIESR has found, the 10 per cent increase in the national living wage — from £9.50 an hour to £10.42 an hour — which came into effect in April 2023 will likely boost the consumption of people who are in the bottom decile of the income distribution. The living wage increase will also boost labour market activity as people in the second decile will likely increase their hours worked as work pays more.
Critics will contend that higher wages will hit competitiveness and reduce business investment, but the National Institute’s research has also shown that the profit share in GDP has continued to increase. Profit margins can absorb real wage growth — and indeed have done so over the past months. Over time, better pay can also raise productivity through greater esteem of labour’s contribution to the economy, making workers more motivated and more creative. This goes not just for the private sector but also the public sector, where wage growth has lagged behind and so has productivity growth.
Shifting to a high wage model is all the more important since workers will face a growing tax burden and benefits cuts. The Chancellor has frozen the income tax personal allowance at £12,570 and the threshold for the higher income tax rate at £50,270, rather than uprating them in line with inflation — a phenomenon known as “fiscal drag” that gives the Treasury a shot in the arm whilst the rest go cold turkey. Despite cash increases, benefits are going up by less than inflation. The latest leaks suggest that in Wednesday’s Autumn Statement the government will announce benefits cuts for people with mobility and mental health problems.
All this, combined with council tax bills going up by as much as five per cent (or around £120 a year for an average home), suggests that the prospects for low-income families remain bleak. Only sustained wage growth, and a better balance between the return on capital and the return on labour, will restore public trust in the market economy on which support for our democratic model depends.
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