Living standards· Inequality & poverty The Living Standards Audit 2022 4 July 2022 Adam Corlett Felicia Odamtten Lalitha Try This report, the 14th in an annual series, takes a long view of what has happened to household incomes in Britain over recent decades, what has driven periods of growth and stagnation, and the lessons that need to be learned if Britain is to return to stronger income growth in the decade ahead. The report warns that Britain has experienced a toxic combination of both low growth and persistently high income inequality, and this has led to some groups being particularly exposed to the cost-of-living crisis. Despite some claiming that economic growth no longer feeds through to household living standards, we show that productivity, pay and incomes generally move in lockstep with each other. Stronger income growth will not only allow households to enjoy higher living standards in good times, but will also help provide stronger protection in tougher economic times. Explore the report: Read the report’s Executive Summary below, or download a PDF of the full report. Executive summary The UK is in the middle of a remarkable real income shock, as inflation tops 9 per cent, its highest since the early 1980s, and the Government has responded with over £30 billion of direct support for households. But we must also assess how households were positioned going into this crisis (and the Covid-19 pandemic before it), and look to the medium-term future – where this income hit only adds to the need for a sustained period of strong, progressive income growth. As our Economy 2030 Inquiry is exploring, the 2020s are an important decade in which the UK must grapple with numerous challenges and seek to improve living standards, particularly for low-to-middle income households. This report – the latest in our long-running annual series – therefore sets out the key lessons we should learn from historic trends in UK incomes as well as from comparisons with other countries. In work to follow later this year, we will assess the immediate future for household incomes, and discuss the Chancellor’s options in his autumn Budget. The UK experienced sustained low growth in household incomes in the 15 years leading up to the pandemic History teaches us that real growth in household incomes is normal. The typical household income after housing costs tripled between 1961 and 2019-20: growing by an average of 1.9 per cent a year, or 20 per cent each decade. Taking an even longer-term view, real GDP per capita has grown by an average of 1.3 per cent a year over the past two hundred years. But this growth has not been steady, and the UK’s recent track record has been particularly weak. Even before Covid-19, the 15 years between 2004 and 2019 were the weakest for growth in GDP per capita since 1919 to 1934. This has been mirrored in household income growth: the median non-pensioner income grew by 12 per cent (0.7 per cent a year) between 2004-05 and 2019-20, compared to the previous average since 1961 of 40 per cent every 15 years (2.3 per cent a year). Income growth towards the top of the income distribution also slowed dramatically to 0.7 per year, and incomes of the poorest people stagnated between 2004-05 and 2019-20, with a change of 0.1 per cent per year (by comparison, in the period from 1979 to 1994-95, the poorest were left behind but incomes generally grew). Even within the past two decades, there has been a lot of variation in income growth, however. There was a mixed picture before the financial crisis, with weak growth for some groups such as poorer non-pensioners; a large income hit following the financial crisis; a period of income recovery (between 2012-13 to 2016-17); and a somewhat weaker period following the Brexit referendum, although incomes seem to have been growing strongly immediately before the advent of Covid-19 and high inflation. Comparing households’ typical spending power across European countries suggests that the UK performed worse than most from 2007 to 2018, with only households in Greece and Cyprus seeing less growth. Typical incomes rose by 34 per cent in France and 27 per cent in Germany, for example, over this period. But, when we adjust for purchasing power differences, the typical UK income actually fell by 2 per cent over this period. While the UK is undoubtedly a rich country by global standards, there are therefore now large living standards gaps with many of our peers. Compared to the UK, typical incomes are notably higher now in countries including Ireland (by 6 per cent), France (10 per cent) and Germany (19 per cent), to say nothing of even richer countries such as the US or Norway. One of the consequences of this poor income growth was a relatively low level of financial resilience among British households. Newly-available data covering the 24 months leading up to the pandemic confirms this, with just over one-in-four (26 per cent) of all adults (or just under four-in-ten of those in the bottom two income deciles) saying that they would not be able to manage for a month if their main source of income stopped. Financial resilience for families in Germany and France was stronger than that for those in the UK as the pandemic hit, with low-to-middle income households in Germany and France having higher incomes and savings. The UK has had persistently high income inequality The UK is also marked by high inequality, by historic and international standards. Having increased by 13 percentage points between 1978 and 1992, the Gini coefficient of inequality rose by a further 2 percentage points up to 2019-20 (although it fell during 2020-21). So, although there has been a period of weak growth for everyone, all of the top ten most unequal years on record have happened in the 21st century, and five of them were between 2013-14 and 2019-20. Within that overall measure of inequality, the groups with the lowest typical incomes pre-Covid-19 (2017-18 to 2019-20) include social and private renters (37 and 24 per cent below the overall median), children (20 per cent below in the case of under 5s) and single parents (35 per cent below). The richest groups include mortgagors (27 per cent above the overall median – though this gap is likely to shrink over the next couple of years as interest rates rise), couples without children (33 per cent above), 55-to-60-year-olds (19 per cent above) and those in the South East of England (12 per cent above). On the whole, however, most between-group gaps (for groups defined by age, region, disability, family type and ethnicity) are slightly smaller than twenty years earlier, if still too large in many cases. The UK’s Gini coefficient is also high by international standards. In international data, the UK’s Gini coefficient for disposable income was 0.37, lower than that in the US’s (0.39) but higher than all other G7 countries, and higher than every country in Europe other than Bulgaria. Strikingly, across a wide range of rich nations, the top 10 per cent’s share of disposable income is considerably lower than it is in the UK, where it is 29 per cent (matching the US). For example, in Ireland the top 10 per cent’s share is 24 per cent (5 percentage points lower), and in Australia it is 26 per cent (4 points lower). The flipside is that in most rich OECD nations except the US, the bottom 80 per cent of the population receives a higher share of total income than in the UK. Overall, the UK’s poor growth, income distribution and levels of financial resilience meant that too many households entered the double crises of the early 2020s in a weak state. To do better we will need to learn from the past on the key drivers of household income growth and inequalities Real household income growth will require real earnings growth, which in turn will require productivity growth (as the Economy 2030 Inquiry is exploring in detail). For most of the non-pensioner population, earnings (either employee or self-employed), benefits, taxes, and housing are the key determinants of household incomes. Even among the poorer half of the non-pensioner population, earnings make up 70 per cent of total gross income (with benefits making up most of the remainder). The importance of pay – and particularly hourly pay and hourly productivity – is also evident from international and historic relationships. The UK lags internationally on hourly pay (adjusted for purchasing power) just as it does for household incomes, and the international correlation between levels of pay and household income is very strong. Historically, typical incomes, pay and productivity have generally moved in lockstep – with all three having more than doubled since 1975. Looking at GDP per capita, we can also see that changes in average hours and changes in the employment rate have been much less significant drivers of growth than hourly productivity has. Indeed, from 1971 to 2008, productivity growth accounted for over 100 per cent of growth in GDP per capita, with average hours falling. The collapse in productivity and pay growth since the financial crisis was therefore clearly a terrible loss for living standards too. Average wages are no higher today than they were before the financial crisis, representing a wage loss of £9,200 per year, compared to a world in which pay growth had continued its pre-financial crisis trend. One helpful labour market change for low-income households recently has been the rise in employment (which, at the aggregate level, is driven by women). Between 2007-08 and 2019-20, the employment rate rose by 6 percentage points in the bottom half of the income distribution, compared to 2 percentage points in the top half. Over a longer period, the proportion of working-age families with no household earnings fell by 6 percentage points between 1994-95 and 2019-20. This trend helped to keep household-level earnings inequality broadly flat over the same period, in the face of rising earnings inequality among working families. Although the minimum wage has been pushing up pay at the bottom, it has not closed wage gaps at the top, and a recent tendency for low-wage men to work fewer hours, and high-wage men to work more hours, meant that inequality in weekly earnings has continued to rise until fairly recently. However, one important point is that this track record of record high employment makes it unlikely that households can repeat the performance again in the coming decade. And, although the incidence of low pay has reduced significantly thanks to bold targets for minimum wages, this alone is not a panacea for earnings and income inequalities: only 38 per cent of people with low weekly pay now have low hourly pay. While earnings growth is crucial for boosting living standards, it is not sufficient. In the absence of any active policy changes, earnings growth in isolation would increase inequality, because earnings make up a smaller share of poorer households’ incomes than that of richer households. The Basic State Pension is now (more than) linked to average earnings, via the ‘triple lock’, but there is no such automatic link for other benefits, which have additionally been subject to freezes and a switch from RPI to (lower) CPI inflation as the basis for uprating. The lack of an automatic link to earnings implies persistent upward pressure on inequality and relative poverty, and no guarantee that the poorest will share in income growth (although benefits may catch up with earnings in the short term if the Government uprates benefits in line with inflation while earnings decline in real terms). Looking internationally, one notable feature of the UK’s social security system is how low basic out-of-work support is relative to earnings when compared to our peers, with a weak social safety net to fall back on: basic unemployment support is now down to just 13 per cent of average pay, its lowest level on record. However, we also know that benefit changes can rapidly boost incomes and reduce poverty, playing an important role in cutting absolute poverty in the early 2000s and in 2020-21, for example. Tax policy can also impact on income levels and inequalities. For example, the combined effective (average) rate of Income Tax and National Insurance for a highly-paid employee (on ten times the median wage) fell from over 60 per cent in the late 1970s to 37 per cent in 1988, contributing to that group’s income growth and rising inequality. More recently, average direct tax rates on low-paid employees fell from 13 per cent in 2010 to 4 per cent in 2019. Although average direct tax rates are now rising, the UK stands out compared with our peers in how low direct tax rates are for most of the income distribution; although there are some rich nations with comparably-low top tax rates (such as the Netherlands and Germany), most have considerably higher rates. Other taxes such as Council Tax and VAT, for example, have risen over time, though the latter also has a low effective rate in the UK compared to most of its peers. In contrast to taxes, rents are typically a larger share of renters’ incomes in the UK than in most other rich nations. This, together with changes in mortgage interest costs and shifts in tenures, has had a significant impact on disposable incomes and inequalities over time. Across all households, between 2003-04 and 2008-09 the average ratio of housing costs to incomes rose from 16 to 19 per cent – which for an individual household is equivalent to a hit to incomes after housing costs of 4 per cent – but this has reversed between 2008-09 and 2019-20. Strong, progressive income growth should be a shared goal Given the current cost of living crisis, the UK’s record over the past decade or two, and its position relative to other countries, there should be a shared desire for higher income growth in the 2020s and beyond, and for growth to be fastest for lower-income households, ensuring a true ‘levelling-up’ of incomes. To make these ambitions more concrete, it is worth noting that the UK has already committed to progressive growth, on paper, through the international Sustainable Development Goals. Target 1.2 is to “by 2030, reduce at least by half the proportion of men, women and children of all ages living in poverty in all its dimensions according to national definitions”. One practical definition of this would be to reduce the absolute poverty rate (after housing costs) to less than half its 2015-16 level by 2029-30 (at the latest): a fall from around 20 per cent in 2015-16 to under 10 per cent, on current data. In addition, Target 10.1 is to “by 2030, progressively achieve and sustain income growth of the bottom 40 per cent of the population at a rate higher than the national average”. One way of interpreting that (rather loosely worded) target is that the bottom 40 per cent’s share should be higher in 2029-30 than 2015-16. In contrast, this share (for incomes after housing costs) has been fairly stable at around 17 per cent over the past three decades, only briefly rising to 18 per cent in the early 2000s. In short, the UK needs more income growth, and to ensure that low-to-middle income households in particular benefit from that growth. The Economy 2030 Inquiry will explore in more detail what success could look like, and what policies are needed to deliver sustained, shared growth.