Living standards: what happens next?

Going into next year’s election – the ‘living standards election’ – party political strategists are likely to fret about the length of voters’ memories. When asked whether the government has made them better off, will they compare their position with last year or with five years ago? The depth of the decline in incomes associated with the downturn and the gradual pace of recovery means that the distinction will be an important one.

As today’s annual state of play report from the IFS shows, the good news for David Cameron as he puts the finishing touches to the team he hopes will sweep his party to victory is that household incomes have started to stabilise. True, median net household income remains nearly 6 per cent lower in real terms than the 2009-10 peak and the mean is down 8.5 per cent, but the latest data – which, let’s not forget, is from 2012-13 and therefore already behind the curve of a recovering economy – points to an end of the decline.

Inequality has fallen over the course of the parliament too. Incomes at the top have fallen further than those in the middle, while those at the bottom have tended to increase slightly. As a corollary, the headline relative poverty measure has also been falling. Some 1.3 million fewer adults now live in ‘poor’ households (with net incomes less than 60 per cent of the median) than was the case in 2007-08.

And the reduction in inequality has not happened by accident. It’s been well-documented that the earnings of those at the very top of the distribution were hit particularly hard at the start of the downturn but, taking all private income – from weekly earnings and investments – over the entire period since 2007-08, we find that the distribution has become more skewed, not less. The narrowing of inequality in net incomes instead rests on a combination of the kicking-in of automatic stabilisers alongside deliberate policy choices in the early post-crisis years to increase taxes at the top and support at the bottom.

Yet there is much to give the Prime Minister cause for concern too. Absolute poverty has increased, particularly once housing costs are accounted for. Relative poverty is only down because the median has fallen further than the bottom. We might not be getting more unequal, but only because we’re all getting poorer. Inequality is lower than it was before the crisis, but it hasn’t improved in any statistically significant way in each of the last three years. And the IFS highlights the extent to which the young have borne the brunt of the downturn. Workers in their 20s have faced particularly sharp increases in unemployment and under-employment, along with dramatic cuts in pay. The distinction in labour market performance between younger and older workers goes beyond what we’d normally expect to see during a downturn.

Prospects for the coming years look equally mixed. Economic growth has picked-up since 2013 and employment has continued to rise strongly. But pay growth – of employees at least, we have no way of capturing self-employment earnings – is still lagging inflation. While we can expect a return to real wage growth over the course of 2014, the recovery is likely to be very gradual. And if the uneven distribution of private income growth recorded during the downturn persists, then we might find that improvement in the official Average Weekly Earnings measure of pay continues to overstate the recovery for many workers. Our projection is that median weekly pay (adjusted using RPIJ – it looks a little better using CPI and a little worse using RPI) will remain broadly flat through to 2018.

Layer on top more cuts in state support for those of working-age – for the out-of-work and lower income workers alike – and we might expect recent improvements in poverty and inequality to go rapidly into reverse. As the IFS points out, welfare cuts were accelerated from April 2013, with the introduction of a three-year 1 per cent uprating for all working-age benefits alongside Housing Benefit and Council Tax Support reductions. More cuts are planned – if not yet ear-marked – for the next Parliament. The parties may disagree about the precise pace and balance of austerity, but they are all committed to spending cuts that will inevitably fall in a significant way on working-age households.

Prior to the release of the 2012-13 numbers, our projection was that median net income among working-age households would remain broadly flat through to 2015 before picking up relatively slowly through to the end of the decade, as the chart shows.

By May 2015 many of our economic measures will point to an apparently positive outlook. Recovery in economic output is likely to be well entrenched. Average wages will remain below their pre-crisis peak, but should be heading in the right direction. Similarly average income growth should at least have turned positive again. Yet the dissonance between these measures and the realities faced by households has the potential to be great. Low and modest income families with children might fail to recognise the rosy economic picture painted by the data, while pensioners and higher income households might have cause to wonder what all the living standards fuss is about.

Whatever conclusion we draw about what today’s report says about the state of living standards in the UK in 2013, the more important consideration is what it says – or at least hints at – about what comes next. After all, the true question voters will ask themselves next May is which party will make them better off over the next five years.