Living standards in the downturn and recovery: the backdrop to the election

After six long years, average pay is rising. The gains are currently modest, but momentum is expected to build in the coming months (thanks in no small part to falling inflation). And there’s evidence that household incomes have started to recover too. The best data on this is significantly out of date but, buoyed by both rising pay and strong employment growth, it’s reasonable to assume that a corner has been turned.

Yet this relatively sunny picture is not one that will be familiar to many Britons. Our new report on the state of living standards as we approach the election identifies a breadth of experience across households. Interestingly, the winners and losers of recent years cannot be distinguished along the traditional lines of where they sit in the income distribution alone (and the trends here may run counter to many people’s expectations): instead, we must consider age and location as well.

On pay, we find that average earnings fell by around 9 per cent in real-terms between 2009 and 2014, with wages at the bottom of the earnings distribution holding up slightly better (they fell by roughly 7 per cent) and those at the top recording the deepest reduction (10 per cent). But while the pattern is relatively uniform across the pay distribution, there are much clearer divides among other groups.

The squeeze among men approaches 11 per cent at the median, while for women it is just above 7 per cent. The gender pay gap has thus narrowed: though not in the way anyone would want to see. Perhaps starkest, is the split between younger and older workers. Among those in their 20s, typical pay has fallen by an eye-watering 12.5 per cent, taking the median back to a level last seen in 1998. In contrast, the squeeze on workers in their 50s amounts to 7 per cent and among those working beyond 60, it is below 4 per cent.

But earnings are just one part of the living standards equation. Household incomes are affected by the interaction of pay with the strong recovery in employment, and with government policy on tax and welfare.

We know from large-scale authoritative survey data that median income fell by around 2 per cent between 2007-08 and 2012-13. But that’s where the data ends. Timelier National Accounts data on income per head has been relatively flat since 2013 – though official projections from the OBR point to an expectation of a sharp pick-up in 2015. The problem is that this measure includes a range of things that bear little resemblance to most people’s understanding of income, including assumed rents among homeowners and the income of universities and charities.

To get a clearer sense of the direction of household incomes, we’ve taken official outturn data on pay, employment and population since 2012-13 and used that to roll forward the authoritative survey data by 18 months to cover calendar year 2014. We’ve applied different projections for over 100 separate clusters of individuals and family-types in order to best capture the experience of different groups.

Taking account of changes in tax and benefit policies too, we find that median income is approaching its pre-crisis level. And we expect it to complete its return at some point in 2015. But we find that average (mean) income remains some way short of its pre-crisis level. Unlike the median, the average was still falling in 2012-13. We project that it recovered only slowly in the following 18 months, leaving it some 3 per cent below the level recorded in 2007-08.

This divergence between the mean and median reflects differential outcomes across the income distribution. Between 2007-08 and 2012-13, the squeeze on incomes was hardest felt towards the top of the distribution. In contrast, the poorest fifth of households continued to achieve very small increases in income, supported by real-terms increases in benefits and tax credits in the first couple of years of the downturn and by a minimum wage that fell in real-terms, but by less than average wages did.

More recently, our projections suggest that incomes have started to recover across much of the middle part of the distribution. That they have continued to fall at the top owes much to the repeated reduction in the real-terms value of the point at which higher rate tax becomes payable and the withdrawal of Child Benefit from higher earners from January 2013. Troublingly, this latest period suggests that incomes have been falling sharply at the bottom as well, reflecting the fact that the lowest income households have been untouched by sizeable (and expensive) increases in the personal tax allowance but have faced substantial reductions in benefits.

And there are other distinctions. The combination of strong employment growth, a relatively mild pay squeeze and the protection offered by the ‘triple lock’ mean that typical pensioner incomes rose by around 10 per cent between 2007-08 and 2014. In contrast, working-age incomes remain around 4 per cent below their pre-crisis level.

Regionally, the fact that living standards have fared much better in the relatively low-income North East (median income rose by around 4 per cent between 2007-08 and 2014) than they have in the high-income South East (they remain more than 3 per cent below pre-crisis levels) is likely in part to reflect the pattern of changes across the income distribution already noted.

But there’s more to it than that, because other low-income areas – such as the West Midlands and Northern Ireland – have suffered reductions in living standards on a par with the South East. And typical incomes in the relatively high-income East of England have fared as well as anywhere outside the North East. What appears to matter is the precise labour market trends playing out in different localities – not just whether or not employment is growing, but also the type of new jobs being created.

This all adds up to an improving, but complex picture. The lack of a single, timely and authoritative source on incomes means that we’re likely to hear claim and counter-claim about the state of living standards during the election debate. Yet wide variation in experiences across households means that whatever message wins out on earnings and incomes, many will struggle to relate to it.