Making the country work again

February 23, 2013

Even Margaret Thatcher didn’t manage to dismantle Britain’s disastrous welfare system. Judging by the policy plans of the Lib-Con coalition, there is little reason to be optimistic that today’s leaders will be any more successful.The timid proposals on welfare are little more than an expansion of existing failed programmes.

It is unsurprising that welfare reform has presented such a problem for successive governments. The six million working-age adults who now receive out-of-work benefits – plus millions more over 60s receiving generous pension credits – comprise a large voting bloc. Labour would have risked losing its core support had it attacked benefit dependency.

Within the new administration, the rebranded, centrist Conservative Party will be wary of implementing policies perceived (wrongly) as an attack on the poor, while any major changes could face strong opposition from the Liberal Democrats’ hard-socialist left.

Nevertheless, the dire state of the public finances means the new government will have little choice but to make substantial cuts in welfare expenditure. Benefit payments now account for almost one in three pounds the government spends. Balancing the budget will be next to impossible unless welfare plays a proportionate role in the programme of cuts. In reality, the new adminstration may be forced to implement radical reform.

This represents a huge opportunity – not just to save money, but also to address many of the social problems associated with welfare dependency. Life on benefits not only encourages crime and anti-social behaviour; a growing body of research suggests that long-term claimants are more likely to suffer from poor physical health, low self-confidence, anxiety and depression. Studies have also linked worklessness to lower life expectancy. While one should be cautious about such findings, a convincing case can certainly be made that the benefits of employment are not just financial.

The negative effects of welfare dependency are amplified by its concentration in certain areas and among particular groups. On many social housing estates the majority of residents are reliant on benefits. Any sense of shame for relying on handouts has long since disappeared, replaced by an aggressive sense of entitlement. Worse still, the behavioural norms needed to hold down a job – honesty, reliability, good manners and so on – have been undermined. This catastrophic decline in standards will take generations to reverse. Eliminating the poisonous impact of the benefits system is, however, a necessary first step.

The key to reducing welfare dependency is removing the ‘poverty trap’. The current system means that for many claimants it is simply not worth doing low-paid work – at least not in the ‘formal sector’. Once additional work-related costs such as clothing, train tickets or petrol are factored in, someone working full time on the minimum wage will typically be just a few pounds a week better off. Because benefits are withdrawn as income increases, the effective pay rate can be less than £1 an hour.

Working may also mean losing the other perks given to those on welfare, including priority access to low-rent social housing. As a result of massive government subsidies, social properties are generally of superior quality to privately rented homes. Indeed, a high proportion have recently been refurbished with new kitchens, bathrooms and heating under the multi-billion-pound ‘Decent Homes Initiative’. It is almost as if claimants are being rewarded for their dependence on the state.

This approach has to change. Benefits, tax credits and other subsidies have produced close to a communist distribution for families earning less than the median wage. Yet welfare dependency will only be reduced when there is a big gap in living standards between those who work and those who do not.

A series of specific policy measures would push the system in the right direction. Child tax credits, for example, should be paid at a much lower rate to workless households to better reflect the additional costs of working. More can also be done to reduce the income tax burden on low-paid employees – the new government’s plan to increase personal allowances is a good start, though it would be far more effective if it were funded by benefit cuts rather than higher taxes on investment.

The poverty trap is a particular problem for those stuck on incapacity benefits. The incentives to move on to them are too strong and there are powerful reasons for claimants to hang on to these entitlements. But incapacity is a privately insurable risk. The government should not provide special benefits for those no longer able to work as a result of chronic health problems.

Perhaps most importantly, the perverse incentives associated with housing policy must be addressed. Social housing should be very basic – a last resort for the genuinely homeless rather than an aspiration for people trying to get accommodation on the cheap. This means paring down the £7 billion-a-year public housing subsidies and also reforming the £20 billion-a-year Housing Benefit system.

The latter is absolutely essential if work incentives are to be increased. Withdrawn at 65p for every pound earned, Housing Benefit is often the major reason why it is not worth working. Part of the solution is to ensure that a significant proportion of rent is paid from basic benefits such as Jobseeker’s Allowance and Income Support. In this way, tenants are encouraged to find low-cost accommodation and the negative impact of the subsidies is reduced. Moreover, the barmy rules that allow claimants to live in expensive areas such as Kensington and Chelsea should be phased out.

Yet reforming the benefit system is only part of the equation. The next government must also tackle other barriers to work. Key steps include abolishing the minimum wage, reining back employment law, and making it easier for the unemployed to relocate by liberalising the planning system. Indeed, by lowering the cost of housing and basic goods, a programme of deregulation across the economy would enable benefit rates to be cut without increasing poverty, giving a further boost to work incentives.

A policy of radical reform will clearly face stiff opposition from entrenched interests, including the bureaucrats that depend on bloated budgets within government. Small, incremental measures risk being obstructed and diluted, and the political will to push them through could easily dissipate. A more effective approach may be to undertake a fundamental rethink of the scale and scope of the benefits system. Certainly, only major changes will achieve a big reduction in welfare dependency within one parliament. A degree of consensus may even be possible. Many from the left are now joining the right in openly acknowledging the harmful effects of state handouts on the prospects of the poor.

The long-term aim should be to make work much more rewarding than life on benefits so that only a relatively small number of people in genuine need require assistance. At this stage, responsibility for their support could be returned to families, charities and community groups. Britain’s counterproductive experiment in state welfare could finally be wound up.

19 May 2010, a different version of this article was published in the Daily Telegraph

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Darling must cut UK’s huge welfare bill

February 17, 2013

Alistair Darling is staring into the abyss. Unless he makes severe cuts to government spending there is a real risk he will plunge the UK into another economic crisis.

Without a credible commitment to bring public expenditure down to sustainable levels, the bond investors funding Britain’s near £200 billion annual borrowing may demand a risk premium in the form of higher interest rates. A big rise in rates would in turn increase the cost of the government’s debt repayments, threatening a debt spiral which could jeopardise economic recovery.

Growth is already threatened by the well-known crowding out effect of public borrowing, which diverts resources from the productive parts of the economy. This may mean official growth forecasts are too optimistic, making cuts in spending even more necessary.

In the context of these grim economic realities, Darling cannot make savings of sufficient scale without tackling the major areas of government spending – health, education and, most importantly, welfare. Including state pensions, welfare benefits cost about £170 billion per year, around one in four pounds the government spends. This emphasises the magnitude of the problem. Even a highly contentious 10% across-the-board cut would save just £17 billion – worthwhile, but a fraction of what is needed.

Yet many welfare benefits are more about favouring particular groups of voters than providing a safety net to cover basic needs. For example, a whole host of payments have been introduced that favour the over-60s, including pension credits, winter fuel payments and free travel. These special benefits add up to at least £12 billion per year and often go to relatively well off households. They also reduce incentives to work and save.

A combination of phasing out special payments for the over-60s and reducing benefit rates by a relatively small percentage across the board would help ensure welfare played a proportionate role in rescuing the public finances. A failure to address Britain’s huge welfare bill in today’s PBR will augur very badly for the country’s economic future.

9 December 2009, IEA Blog

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North to pay heavy price for dependence on public spending

February 17, 2013

Public spending dominates the economy of the North of England. In the North-East region, for example, it accounts for close to 70% of GDP.

Many northern cities seemed to prosper in recent years. The luxury apartments and office blocks that sprang up in Newcastle, Liverpool, Manchester and Leeds were one visible sign. But it was largely a bogus boom based on Gordon Brown’s public-sector spending spree, which included substantial regeneration subsidies.

Times have changed and very severe reductions in government expenditure are now necessary. This suggests that those areas that are heavily dependent on public spending face a particularly painful adjustment process. These regions include not only the North of England, but also Scotland, Wales and Northern Ireland.

In the long-term, however, the cuts should bring benefits. Undoubtedly the bloated public sector has crowded out private sector activity in these areas, partly because it has artificially inflated wages.

Yet it may be over-optimistic to expect the private sector to become the economic dynamo it was during the 18th and 19th centuries and pull the North out of stagnation. Businesses now face barriers that would have been unknown to the great entrepreneurs of that era. Environmental legislation will make life very difficult for manufacturers, while the welfare state has blighted much of the North with endemic worklessness and poor skill levels.

Britain’s stagnating regions are therefore likely to be a major problem for the next government. But it should resist the temptation to repeat the mistakes of the past. Public subsidies to failing areas undermine the adjustment process needed for their economies to recover. Policymakers should instead focus on removing the barriers to entrepreneurship and self-help. This means deregulation to help businesses and improve labour mobility, and welfare reform to end the curse of long-term worklessness.

16 November 2009, IEA Blog

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Time preference, economic crisis and social decline

February 17, 2013

The last decade has been marked by a combination of low savings rates and high debt levels in both the USA and Britain. Indeed in 2005, the savings rate in the US reached zero, while 13 million adults in the UK – more than 1 in 4 – have no savings or investments.

The lack of savings, together with the readiness to take on debt, suggests that a high proportion of the population has a high time preference. In other words, the present is valued far more highly than the future.

Arguably the current financial crisis cannot be divorced from the short-term, “hand to mouth” culture that has come to dominate the USA and the UK. The widespread unwillingness to defer material gratification contributed to the debt bubble that precipitated the crash.

But the negative consequences do not end there. People with no savings are also more likely to have to rely on welfare-state safety nets when they lose their job or develop a health problem. They will also tend to be more reliant on state handouts in old age and may therefore vote for socialist political parties that promise to increase such benefits. There is also a strong association between high time preferences and criminality.

While it may be tempting to blame “cultural decline” for the phenomenon, the absence of saving in countries such as the UK may in reality be a rational response to artificial incentives created by government policy.

It is perhaps not that low saving causes welfare dependence but the prospect of welfare that causes low saving. Benefit claimants with more than £6,000 may face steep deductions in means-tested payments. If they have over £16,000 they may receive nothing. And when they reach old age, the availability of means-tested pension credits means low to middle income savers will be barely better off than their spendthrift contemporaries.

Another issue is long-term residential care for elderly. While savers will lose their assets, including their home, non-savers on state benefits will generally receive care free of charge – this is a tricky issue but, at the very least, those who do not save should not be able to expect a guarantee of the same standard of provision as those who pay for themselves.

All in all, the incentives for deferring gratification and saving are very weak. This problem should be addressed urgently through the reform of pensions and benefit systems in order to restore the social and economic benefits of a low time preference culture.

24 June 2009, IEA Blog

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Are large benefit increases wise in a recession?

February 17, 2013

Benefit rates are set to rise substantially next month. State pensions will rise by 5%, while means-tested payments, such as Jobseeker’s Allowance, will rise by 6.3%. The new rates, based on the Retail Prices Index (RPI), were determined in September 2008, when inflation peaked, but now represent significant increases in real terms.

Higher welfare spending will push the public finances even further into the red. The prospect of yet more government borrowing and tax rises in the future could undermine economic confidence and deter investment in the UK.

Moreover, at a time when many workers are being made redundant and others are facing pay cuts, higher out-of-work benefits will reduce the financial incentives for jobless people to take employment, particularly since in many cases they will also be entitled to Housing Benefit, which pays their rent. Combined with the minimum wage and restrictive employment regulation, this is likely to make the surge in unemployment even worse and condemn many more people to a life of welfare dependency.

It could be said that “rules are rules” and it is just an unfortunate coincidence that benefit levels were set in a “freak” month for RPI. However, imagine inflation had fallen to -5% last September before rising to become positive again in April 2009. Is it credible that the government would have imposed benefit cuts?

12 March 2009, IEA Blog

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Welfare reform needed to prevent long-term dependency

February 17, 2013

According to official figures, almost two million people are now unemployed in the UK. That number is rising rapidly as the economy shrinks.

This means extra expenditure on welfare benefits, putting further financial pressure on a government already deeply in debt.

More worrying still, hundreds of thousands of families will now be at risk of falling into long-term welfare dependency, with negative implications in terms of crime, family breakdown and ill-health.

Many of those made redundant, particularly the low-paid, will face strong disincentives to re-entering employment once they start receiving benefits. For every pound they earn above a certain level, they may lose 65p in housing benefit and 20p in council tax benefit. They must also pay significant income tax and national insurance – even at minimum wage rates.

There is therefore a real danger that the economic slowdown will lead to a structural rise in the number of long-term benefit claimants. Before the slump there were already around five million working-age individuals on various out-of-work benefits.

The depths of recession may seem like the worst possible time to reform radically Britain’s welfare system. Yet it is in periods of mass redundancy that change is most desperately needed to avoid growth in dependency. It is therefore essential that the government adjusts tax and benefit rates to improve the financial incentives for unemployed people to return to work. 

All the talk is about demand management. We must remember that how long unemployment continues rising for will depend, largely, on whether there is supply-side reform. Deregulation, lower and simpler taxes, benefit reform and a reconsideration of the level of the minimum wage must all be on the opposition and government’s agenda.

3 November 2008, IEA Blog

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