What’s really been happening to living standards?

Despite the fact that it’s been centre-stage for a number of years, there is still a lot of confusion about the squeeze on household incomes: who has really been hit and by how much?  Given that this will be a central political issue between now and the election it’s worth pausing over. Currently there are at least three overlapping conversations running about living standards. Cacophony rather than clarity is sometimes the result.

The first conversation concerns the parts of the income distribution that have been hit hardest since the financial crisis. The so-called typical household – the one slap bang in the middle of the income distribution in 2013/14 – is 6% worse off, after taxes and benefits, than the equivalent household at the start of the financial crisis (the below is from the IFS, Resolution Foundation gets a similar figure). Over the whole period since the start of the financial crisis the poorest households have seen a smaller fall and the richest households a larger one – though the pattern since 2010 is more even across the income distribution.

Importantly, the IFS analysis not only looked at real incomes using the CPI (as in the chart above), it also recognised that different groups in society face very different inflation rates due to varying patterns of household spending. Using income-adjusted inflation rates they show that the poorest have actually seen their real incomes fall by far more than official estimates suggest – indeed by almost exactly the same amount as the very richest: around 10% (a fall that is obviously dramatically harder to absorb for those with the least).

Whatever measure is used, however, what is most notable is less the difference in the size of the squeeze affecting varying income groups and more the scale of the loss they have all experienced. Most parts of the income distribution have been hit – though until 2010 the poorest saw their incomes rise significantly through the down-turn. So, looked at in this way, it’s not a case of the squeezed bottom, middle or top. It’s not even the squeezed majority, it’s been near enough universal. (Well, almost: there is quite significant variation by generation: the typical income of pensioner households grew steadily throughout the down-turn whilst those of the working age have plummeted.)

This brings us to a second conversation about the squeeze: which part of the income distribution has been hit most during the down-turn as a direct result of government policy (i.e. tax and benefit measures)? This is a different question to the one above – mostly because it ignores the big impact of real wages on households. Given this, it is surprising how often the two get muddled up, but they do, leading to the sweeping assertion that overall the middle has done well during the down-turn but the poorest and richest have not.

As we’ve just seen, that’s not the case. But if we just look at the impact of government measures, as this second IFS chart looking at the cumulative impact of tax and benefit changes shows, the poorest and very richest have been much more affected by tax and benefit changes than those in between. So it’s absolutely correct to say that the government has squeezed the middle much less hard than other groups. (Strictly, it’s less the ‘middle’ and more the ‘upper-middle’ – especially around 60% to 90% of the way up the income distribution – that have lost proportionately far less than others.) This pattern is due to the interplay of many policy changes – not just one – but it’s worth noting that this is precisely the same part of the income distribution that has gained the most from the Coalition’s flagship policy of increasing the personal tax threshold.

The third conversation is different in nature: it concerns whether these changes mean that households who started the downturn at similar points in the income distribution are likely to have shared a broadly similar fate, staying in roughly the same part of the distribution over time?  

To which the answer is a resounding ‘no’. The statistics cited above are averages based on annual snap shots of the income distribution. The data used in them doesn’t track the same families over time. It can’t give us any sense of how many households within any given category did much better than the average over time and how many did worse.

Looking carefully at trajectories of specific households reveals the swirling flux that always sits underneath aggregate data. Work from the Resolution Foundation has shown that there is actually quite a lot of income and earnings mobility across the distribution – more than is often assumed given the prevalence of lazy generalisations about ‘falling social mobility’. Snap-shots don’t tell us about this.

And that’s where today’s report by the SMF comes in. It highlights that even while the level of the ‘middle income’ in Britain has plummeted between 2007/8 to 2011/12 there has been quite a lot of upwards and downwards movement into and out of this part of the income distribution over the same period. What the study usefully highlights is that it’s perfectly possible to have, say, quite high levels of mobility between the middle and upper-middle part of the distribution at the same time as the typical household at both points in the distribution has become significantly poorer. It’s also correct to emphasise that many households have found ways of protecting their income levels – particularly those with two-earners. And given the overall trend in incomes has been sharply downwards, those who have been able to stand still will have moved upwards compared to others. Those who have improved their plight in real terms will have lept up the ladder.

It’s important to note that these movements are relative: if one household goes up that means another one must come down. They don’t tell us about the overall level of living standards. And even for the specific households that have been tracked over-time we can’t conclude that much about their plight given that the study ignores all the important changes in taxes and benefits that took place during this period (it is based on original incomes). It’s also hard to conclude whether there has been more or less mobility than normal over this four year period as there aren’t comparisons across other points in time (e.g. previous recessions).

What it does nonetheless do is serve as a reminder of just how diverse the experience of the Great Recession has been. Every average arising from a snap-shot conceals a multitude of stories. The importance of looking at dynamics over time was also brought home by a recent study by the Resolution Foundation which tracked the experience of a large number of low-earning individuals over several decades. It showed that while the size of the population on low pay was relatively static the numbers permanently stuck in this position had actually fallen, while the numbers exiting low pay never to look back have grown, as had the size of the group that constantly churned in and out of low paid work. These dynamics matter greatly.

So where does this leave the different conversations about living standards? Well, it’s clearly wrong to imply that in general terms the middle or any other part of the (working-age) population has prospered over recent years. The whole income distribution has shifted sharply downwards. But it’s absolutely right to highlight that the middle (especially the upper-middle) part of the spectrum has been spared most of the fiscal pain arising from policy decisions that have hit the poor and (a smaller number of) the rich.  And it’s fair and useful to point out that within these big generalisations there will be highly diverse and confounding tales of large numbers of households that do far better – and worse – than any average would ever suggest.