The conservative victory and the welfare state: Here comes the pain

The Conservatives have won an unexpected majority. Now must come the cuts. Even Ian Duncan Smith is worried about the scale of the cuts promised. In this post I review the good, the bad, the ugly and unknown proposals that the conservatives have in stock for the welfare state. It’s an open question which ones they end up implementing and more crucially where they impose the pain of the non-specified cuts they promised in their manifesto.

The good

There may be some attempts to raise the purchasing power of low income workers. They want to raise the threshold beyond which workers start paying income tax to 12,500£. But whether this will on the net make low income workers better off depends crucially on where they cut welfare state spending further (see below). A downside is of course that this further erodes the government’s tax raising capacity. On minimum wages, they declared they would follow the recommendations from the Low Pay Commission to raise minimum wage to over $8 by the end of 2020. Again whether this will actually represent an improvement depends on the inflation rate over the next five years.

In addition to these uncertain improvements to the conditions of low income workers are two big spending promises. The first one concerns giving working parents 30 hours of free childcare for 3 and 4 years old, which they estimate will cost about £350 million. The second one is to protect the NHS by keeping it free at the point of use and increasing the NHS funding by an additional £8 billion by 2020. For the latter increase in spending to make the NHS sustainable will require additional ‘efficiency savings’ of 2% to 3% a year which are likely to be very difficult to achieve. So in all likelihood, the Conservatives will have to choose between a deterioration of quality or allocating extra spending.

Finally, two ambiguously positive proposals. First, they have promised that they would introduce a national postgraduate loan system for taught masters and PhD courses. This will not resolve much of the issues of university funding and access to undergraduate degrees, but fills a gap for postgraduate studies where access was hampered. Second, the benefit cap, which I discuss below in more detail, will not include the Disability Living Allowance.

The bad

In a context of austerity, the Conservatives are wasting tax revenues on the better off while cutting benefits on the worst off. This makes no economic sense and will likely depress the economy given the different marginal propensity to consume of different income groups: the poor will reduce their spending in response to lower benefits more than the rich will increase their spending in reactions to lower taxes. The net effect on aggregate demand, even in the absence of additional consolidation, will be negative.

Regarding benefits, they will freeze working age benefits for two years from April 2016 (except for maternity allowance, statutory maternity pay, statutory paternity pay, statutory adoption pay and statutory sick pay). Two groups are specifically targeted. First, EU immigrants: they plan to further restrict benefits (housing, JSA, etc) to EU jobseekers in the first four years. This may be consistent with EU law as long as the restriction applies to non-contributory benefits. However, studies have shown that immigrants bring more revenues than they cost so there seems to be little reasons to limit benefits on economic grounds. Second, 18-21 years old will be eligible to a less generous ‘Youth Allowance’ limited to six months and will also have less access to housing benefits.

The ugly

The three most problematicc proposals are the benefit cap, the undercutting of strikes and promotion of precarious contracts and sanctions for addicts. With respect to the first, they will lower the current benefit cap on the benefits that households can receive to £23,000 (from £26,000). In practice this will only hurt families that need it the most such as those with many children or those paying high rents.

Next, they want to rely on precarious contracts to break strikes by repealing the “nonsensical restrictions banning employers from hiring agency staff to provide essential cover during strikes”. This fundamentally undermines the right to strike as precarious contracts are likely less costly than the workers that are striking. Since those who strike are not being paid by their employers, strikes will no longer have any impact on employers.

Finally, those who refuse the “medical help they need” will see their benefits reduced. This concern both those addicted to drugs and the clinically obese. Assuming that at least some of these recipients would change their behaviour in response to the change, this still implies that some very vulnerable recipients that are not able to change their behaviour will lose benefits.

The known unknowns

Given that they have promised to protect Schools and international development, and that they will be spending more on the NHS and childcare, unspecified cuts are going to be large. In total the IFS estimates that they will have to cut £22.5 billion from departmental spending in ‘unprotected’ areas including defence, law and order, social care, and others. How much of this will be frontloaded in the first couple of years remains to be seen, but this will no doubt necessitate very drastic cuts.

In a post-crisis context where there is a heightened need for the welfare state there are very few policy domains that be cut without imposing significant hardships. As I’ve argued elsewhere, the many new challenges related to ageing and changing labour market structures would also require more rather than less welfare state spending.

UK Election: What’s in it for the welfare state?

In this short post I would like to discuss what I see as the key issues for welfare and to briefly compare them to parts of the labour, conservative, liberal democrats, greens and UKIP manifestos. Though one could no doubt identify other issues, to keep this text short I have decided to focus on two big issues the manifestos should address if the welfare state is to remain fit for the 21st century.

Ageing: Parties lack an overall long term strategy

The first issue concerns the ability of the welfare state to cope with ageing societies. This is something we all know about but it’s worth mentioning a few numbers. There are currently about 10 million people that are over 65 years old.  And – if we believe the current projections – this number will increase to nearly 20 million by 2050 (8 million will be more than 80 years old). This will put pressure on at least two policy domains.

The most obvious is pensions. Indeed, well over half the benefit expenditure by the Department for Work and Pensions goes to those over the working age. I think the UK is comparatively well placed to tackle this challenge but one worry is to ensure that the elderly are properly covered by future pensions. Most – though not all – pension spending is now means-tested and not particularly generous so it’s important that pensions are protected. The Greens probably have the most generous and most costly proposition (and I should note in passing this is the case for most policies!). The so-called triple lock – which protects the value of state pensions – is adhered to by the Liberals and Labour, while the Conservatives have said they will not freeze benefits for the old. This protected status is not surprising given that pensions remain the public’s favourite area for additional welfare spending (though there has been a recent drop in support).

The second policy domain where ageing puts pressure is Health. As an example, in 2007/08 the average value of NHS services for retired households was £5,200 compared with £2,800 for non-retired people. Health is already underfunded and a well quoted report estimates the shortfall to rise by 2020 to 30 billion in the absence of efficiency savings! Recent surveys also suggest 92% of the population thinks there’s a funding crisis. The Lib Dems promise an extra £8 billion a year into the NHS by 2020, and so do more or less the Conservatives, while Labour promises £2.5 billion more than the Conservatives.

What’s lacking from all manifestos is a long term vision to address the ageing issue. For instance, except for the Greens, no one proposes sufficient funding for social care. Ring fencing or increasing pension and health care will also make it hard to balance the books[1] let alone address the next set big issue I will mention now.

New social risks in the labour market

This second big issue concerns the ability of the welfare state to tackle labour market risks, and in particular (in-work) poverty, unstable contracts and reconciling work and family. While pensioner poverty has been falling, the absolute (but not relative) poverty of children has increased in the last couple of years. In 2013, 8% of people in employment, aged 18 to 64, were identified as being in poverty (approximately 3 million people). The evidence suggest that both increasing hours and increasing hourly earnings are crucial to unable people to exit in work poverty.

With respect to the most extreme form of unstable work, ONS figures suggest that at the end of 2014 there were 1.8 million people with non-guaranteed hours, including Zero Hours Contracts (ZHC). Most parties promise some form of actions on ZHC: Liberals want to ‘stamp out abuse’; Conservatives want to eradicate ‘exclusivity’ in ZHC; UKIP will prevent the NHS from hiring ZHCs; Labour says it will (missing verb here) abolish ‘exploitative’ zero hours contracts, and those who work regular hours for more than 12 weeks will have a right to a regular contract; Greens want to abolish it entirely.

With respect to wages most manifestos want to give some boost to wages. This is clearest in the case of minimum wages: the Greens suggest £10 an hour by 2020; Labour wants to increase it to more than £8 an hour by October 2019. They also want to incentivise employers to pay a living wage using tax rebates; Conservatives are more ambiguous, I quote: “they accept the recommendations of the Low Pay Commission that the National Minimum Wage should rise to £6.70 this autumn, on course for a Minimum Wage that will be over £8 by the end of the decade”; UKIP wants to end income tax on minimum wage; Lib Dems limit their demands to better enforcement and I quote “asking the Low Pay Commission to look at ways of raising the National Minimum Wage, without damaging employment opportunities”.

But addressing new social risks and precarious work also requires better childcare provisions which are particularly unsatisfactory in the UK. With respect to childcare, the main parties are getting to grip with this but there’s too little too late, and funding is a question mark. Surprisingly, out of the three main parties, Labour has the least generous policy proposal. It wants to provide 25 hours of free childcare per week to all 3 and 4 year-olds with working parents (costing £500 million). Conservatives are slightly more generous and propose to give working parents of 3 and 4-year-olds 30 hours of free childcare a week. IFS suggests that the funding for the policy is more plausible for labour than for the conservative. The Lib Dems have, in their words, the most ‘ambitious aspiration’ to provide free childcare to all parents with children aged two to four, and all working parents with children aged from nine months to two years. They estimate that this could cost around £2 billion: it’s not clear where the money would come from, so cuts to ‘unprotected’ departmental spending would be required.

We also need a better policy to tackle unemployment without increasing poverty, which in 2013 was around 30% for those aged 18 to 64 and not working. As far as I can tell, no parties propose significant increases in the generosity of benefits for the unemployed, not surprisingly given the increasingly negative public attitudes towards these benefits, including among labour supporters. Conservatives go in opposite direction with two-year freeze on rates of various working age benefits, lowering the household benefits cap, and some changes to benefit entitlements for 18–21 year olds. The Lib Dems also want to retain overall cap on households’ benefits and believe this should continue to be set at around the average family income. We also have more workfare in both Labour and Conservative manifestos, particularly for the young, with the conditioning benefits on acceptance of jobs.

Overall, impact of ageing should in short term be manageable but we lack a long term vision. In a context where parties feel rightly or wrongly that they have to contain costs and given how expensive pensions and health care, this limits our capacity to tackle new social risks. This is partly because of the much greater electoral support for pensions and health care than benefits, and hence a normal electoral mechanism. But this victory of ‘politics over economics’ will undermine our long term potential and limit our ability to tackle inequality and poverty.


[1] Achieving budget balance while protecting pensions and healthcare suggest further drastic cuts in other policy domains that have already been hit hard. Indeed, spending outside of the NHS, education and aid has already been cut by 18.1% between 2010–11 and 2014–15.

An appeal to the Labour Party to stop the anti-immigration rhetoric: Restricting migrants’ benefits makes no sense and they should know better

It is disappointing to see that the Labour party has given in to the anti-immigration game by pandering to the – presumed – anti-immigrants feelings of parts of the population. At the special election question time, Labour decided to reiterate its proposal to limit immigrants’ eligibility to benefits in the first two years they reside in the country.

This is not so much an affront to the party’s founding principles as it is an affront to reason. It misrepresents the problem the country faces, it will do little to reduce immigration, and is at odds with the aim to protect all workers.

Immigration is not a problem

Limiting immigrants’ access is wrong because it validates the misplaced idea that immigrants are to blame for the problems the country faces. It’s obvious to everyone that Labour is ‘piggy backing’ on UKIP’s and conservatives’ manifestos in an attempt to capture some of their voters. But Labour cannot outcompete UKIP and conservatives who will always be more able to use, and benefit from, an anti-immigrant rhetoric that labour can be.

This cheap electoral ploy would not be so disheartening if it was anchored in some underlying reality. It is not. As a result the proposal makes no sense.

Immigrants of course did not cause the financial crisis. They did not create the subsequent debt and economic crises either. On the contrary, their contribution to the fiscal position of the UK has been shown to be positive. Immigrants’ younger age profile means they are less likely to rely on the health care system but contribute more. This mitigates the problem arising from ageing. They are more likely to be in work and less likely to claim benefits so that on the net the welfare system’s position is improved by immigration.

The number of immigrants coming into the country is also thrown around carelessly, often comparing what net immigration was like in some semi distant past with what it has been in the recent past. But the reality is that the UK population growth rate is not particularly high, so that there might be a distributional issue around where that population is located in the country but not an aggregate issue of the total number of people living the country. The population density of London is more than 10 times that of the country, whereas average national population density increased by roughly 10% between 1981 and 2009.

Immigrants might be putting – perceived or real – pressures in communities receiving large influx of immigration, but what is the nature of the problem? Most often it is about pressures on public services and housing, not hordes of immigrants claiming benefits. This is a problem about the distribution of the population across the country and this problem is not caused by immigration. And given that immigrants improve the viability of the state, they make the problem easier to solve.

Why it won’t fix the actual problems

Assuming immigration is a problem, is this proposed policy likely to solve it? No. And again elementary logic suffices to reach this conclusion. Reducing benefits cannot substantially reduce immigration if most immigrants come to work, which they do. The amazing thing is that this is acknowledged by the very parties that want to restrict benefits.

The ridiculous discussion about the ‘freedom to claim benefits’ is not about benefits at all, it is about creating a minimum floor for workers, whether native or immigrant, to survive while they look for a job. This is something the Labour Party should understand. Such a floor is conducive to the bargaining power of all workers, both natives and immigrants. If restricting benefits to immigrants won’t stop immigration, what it will do is force them to accept almost any job. To the extent that employers use immigrants to undercut labour standards, restricting benefits will accentuate this problem and is therefore contradictory with the proposal to fight such abuses.

The notion that one can comfortably live off job seekers’ allowance while doing nothing to search for a job is a myth. If you believe it, just look at the requirements imposed on benefit recipients and the sanctions that are imposed for not looking sufficiently actively for jobs or not attending an interview, or losing a job that you were given. Unemployment benefits are not generous, certainly compared to many other European countries.

The solution should therefore not be to restrict benefits to immigrants but to use the extra fiscal revenues that they generate to alleviate pressure on certain public services and to rebalance the UK economy regionally away from the south east and sectorally away from financial services.

Note: All the numbers are taken from a related post I’ve written on this topic.

Labour costs in 2012

Latest Eurostat labour costs statistics are out. The first figure shows the regional variation of hourly labour costs expressed in euros in 2012.

Most – though not all – Western European regions have average hourly costs superior to 30 Euros while Eastern European regions (including parts of Eastern Germany) all have less than 10 Euros average hourly costs. In between those two groups lie parts of Spain and parts of the UK, as well as Portugal, with between 10 and 20 Euros average hourly costs.


The second figure shows national differences in hourly costs expressed in Euros as well as adjusted for purchasing power (i.e. differences in cost of living in different countries). Not surprisingly, the variation in purchasing power terms is lower but does not erase cross-national differences.

It’s also interesting to note that the UK – where the immigration debate is currently heavily skewed against immigration – average hourly labour costs adjusted are lower than than the EU28 average.


Why Cameron is wrong on migrants’ benefits

The Prime Minister is at it again. Saddened by the rise of immigration above ‘the tens of thousands’ promised, David Cameron proposed new curbs on EU immigrants’ access to UK benefits in a recent speech. This proposal is unlikely to be feasible given current EU legislation. Because it is based on a flawed assessment of the problem, this proposal is also unlikely to have any effect on EU immigration and will probably make things worse.

What’s the problem?

According to the Office for national statistics, net migration – the difference between those leaving (323,000) and those entering (583,000) the country – was 260,000. One often throws this number around in the hope that it will sound big. However, common sense suggests otherwise. Indeed, this represents 0.36% of the total population of the UK (64 million). Yes, 0.36% and you are meant to believe this is a major problem facing the country today. Indeed Cameron criticises the “complacent view that says the levels of immigration we’ve seen in the past decade aren’t really a problem at all”.

But the truly amazing thing is that not even half of those entering the UK are EU citizens: of the 583,000 entering the country, only 228,000 came from other EU countries in the year ending June 2014. And about 20% of EU immigrants came to study. Compare this with the latest number of births (812,970) and deaths (569,024) in the UK. Or think about the fact that we still have 1.96 million people seeking work (only 0.93 million receiving job seeker’s allowance) and 9 million not in the labour force (i.e. those between 16 and 64 either not seeking or not available to work).

The proposed solution

Despite no evidence that the bulk of immigration is driven by benefits, Cameron proposes two measures that are entirely based on this assumption:

  • He first suggestsEU migrants should have a job offer before they come here” but then contends that “UK taxpayers will not support them if they don’t”, which begs the question: how could UK taxpayers support them if they are not allowed to come here in the first place without having a job offer? Never mind that people also pay taxes when they consume goods and services.
  • Second, he proposed introducing a two-tier system where “once they are in work, they [EU citizens] won’t get benefits or social housing from Britain unless they have been here for at least four years.” It’s totally unclear of course how this is supposed to influence EU immigration into the country. It’s also grossly unfair since it will – arbitrarily – prevent people who are contributing to government revenues to claim certain benefits.

Why it doesn’t make sense

The first issue with the proposed reform is a misreading of what’s driving EU immigrants’ to come to the UK. Cameron argues that the “generous welfare system, including for those in work – makes the UK a magnetic destination for workers from other European countries”. But many of the benefits are in fact not more generous than in many other EU countries. And migrants are less likely to claim benefits than natives.

In fact, immigrants that are from Central and Eastern European countries are 60% less likely than natives to receive state benefits or tax credits and 58% less likely to live in social housing. In 2011, across all benefits given by Department of Work and Pensions, 6.4% were non-UK nationals and only a quarter of those were from within the European Union. Ironically, Cameron himself concedes as much: “And let me be clear: the great majority of those who come here from Europe come to work, work hard and pay their taxes.” If the majority of immigrants come to work – and they do – restricting benefits would at best alter the immigration decisions of very few people.

Second, the reform is unnecessary. Indeed, as Cameron himself argues the surge in EU immigration is temporary and driven by the economic downturn in other EU countries: “And once economic growth returns to the countries of the Eurozone, and those economies start to grow and prosper, the economic pendulum will start to swing back.” If the problem is a temporary downturn in other EU economies, a permanent curb on EU immigrants’ benefits is unlikely to solve it.

Third, the reform would make matters worse. Cameron boasts that “So as Universal Credit is introduced we will pass a new law that means EU jobseekers will not be able to claim it. […] So instead of £600, they will get nothing.” But if the concern over immigration, as is frequently voiced, is that it puts pressure on the employment conditions and wages of workers in certain occupations, then making EU immigrants non-eligible to benefits will increase rather than decrease the pressure that takes place.

Indeed, faced with literally no safety net, EU immigrants would be forced to accept any work at any wages. Current evidence in any case suggests that immigration has at worst a mixed impact on native workers – beneficial for some workers and detrimental to others. Immigration also entails a clearly beneficial effect on the net fiscal position of the government. Thus, if successful in preventing immigration the reform would paradoxically lead to a worsening of public finances.

Last but not least, to the extent that a high and localised influx of immigrants does indeed put pressure on public services, reducing the overall number of those who come in the foreseeable future, while deteriorating EU immigrants’ social protection, does nothing to alleviate the pressure that has already accumulated. Pressure on public services is an allocation problem: immigration and indeed the general population concentrate in certain parts of the UK territory.

The solution is therefore twofold. First, making other parts of the UK more economically attractive would distribute population more evenly across the UK.The UK does not have an usustainable population growth: it had the 152nd highest rate of population growth of the world. Its net migration rate per 1,000 persons is lower than in Ireland, Cyprus, Norway, Spain, Australia, Canada, Sweden,Switzerland, Italy, and Portugal. The UK population density – people per square Km – did increase from 230 in 1981 to 255 in 2009 (table 6). But compare this to density in London: 4,932 people per square kilometre in 2009 (page 20).

Second, we should invest in the public services that are under pressure. To the extent that EU immigrants have a positive net fiscal effect, they should facilitate such an investment. Some may argue that it is EU immigration that puts pressure on these services. However, given net economic gains of immigration the solution should not be to reduce immigration but rather to use the extra tax revenues that EU workers generate to invest in pressurised locations.

An EU version of this solution could also be pushed by this government: to create an ‘EU immigration compensation fund’ that helps local communities cope with the pressures that large influx of immigrants may generate. In a context where the EU is associated with austerity, thereby fuelling extremism, this fund would improve public services where it is most needed while addressing EU citizens’ legitimate concerns over immigration.

Wealth extremism

The latest global wealth report by Credit Suisse has some shocking numbers on the latest level of wealth concentration

– 35 million people each have more than $1 million in wealth whereas 3.2 billlion people have less than $10,000

– If you do the sums, it means the former group is worth a combined $116 trillion whereas the latter group is worth $7.6 trillion

– In percentage terms, things look worst:  0.7% of the total population have about 44% of total wealth, whereas 70% have 2.9%

Who are the wealth millionaires?

– More than 40% are in the US

– Germany, UK, France, Japan, Italy have betwen 5% and 10%

Who are the worst performers in developed countries?

– In Hong Kong, US, and Switzerland the top decile owns more than 70% of the wealth

– In Austria, Germany, Denmark, Israel, Norway, Sweden, top decile owns more than 60% of wealth

– Top decile is worth less than 50% in Belgium and Japan

– The remaining developed countries exhibit top deciles owning between 50% and 60% of total wealth

Have all countries seen increases in wealth concentration in top decile in the last decade and a half?

– Rise: China, Egypt, Hong Kong, Turkey, Korea, Argentina, India, Russia, Taiwan, Indonesia, Israel, Czech Republic, Brazil, UK, Spain, Chile

– Little change: Greece, Austria, Thailand, Portugal, Ireland, Peru, Australia, US, Belgium, Netherlands, South Africa, Finland, Italy, Sweden, Norway

– Fall: Switzerland, Denmark, Germany, Japan, Philippines, France, Columbia, Canada, Mexico, Malaysia, New Zealand, Singapore, Saudi Arabia, Poland

Will this gets worst? The report predicts that by 2019

– The middle class will grow (percentage of population with between $10,000 and $100,000 will increase from 21 to 25%)

– Number of millionaire will reach 53 million compared to 35 million right now

Does the UK really spends too much on labour market policies?

Consistent with previous trends in reforms of labour market policies, the UK government has announced yet another restriction on unemployment benefit claimants. The striking thing about these reforms is not that they are unlikely to be effective, nor that even if they were effective they probably wouldn’t make much of a difference in reducing the unemployment rate. Instead, the main issue is that they completely misrepresent the nature and extent of the problem.

Two sets of claims generally underpin the rhetoric of these reforms. The first is that benefit recipients fraud and that one must therefore restrict their access to prevent them from doing so. As official statistics (see page 13) themselves reveal, the amount of fraud is in fact very low: fraud cost only about 2.6% of expenditure on income support and 2.9% of spending on Job seeker allowance (see table below).


The second claim is that these policies simply cost too much and that the system is too generous in the UK. To assess the validity of this perception, I look at 2009 spending data on various labour market policies (from the OECD statistics website). One should distinguish between so called active labour market policies that include training schemes, employment incentives, rehabilitation programs, etc, and passive labour market policies that are mainly composed of traditional unemployment benefits.

Starting with the former, the table below shows that the UK ranks 21st among developed countries in terms of spending on active labour market policies expressed as a percentage of GDP. Scandinavian countries and continental European countries spend important amounts on these policies, while the US, Australia and Canada, along with some eastern European countries spend much less. With respect to passive labour market policies (again expressed as a percentage of GDP), the UK ranks 31st among developed countries… If one divides the spending on these policies by the unemployment rate to get a measure of relative ‘effort’ given the ‘need’, the picture still looks bleak for the UK’s unemployed.

spending on ALMPs as of GDP



PLMPs as  GDP by UR

Of course there is significant evidence that the design of unemployment benefits (and other social policies) has important effects on recipients’ incentives to return to work. But the paradox is that as one reduces the amount that unemployed can claim, their incentive to actively seek work to avoid losing benefits actually falls (i.e. the cost of non-compliance with benefit schemes’ requirements decreases as the amount of the benefit is reduced).

In addition, for active labour market programs to be effective they need to be well-funded. In other words, improving incentives can only achieve so much if unemployed are not properly trained, there are no funds to promote their mobility, and the net gains of employment are low because an insufficient number of full time jobs . Given that the level of fraud is low and that spending on labour market policies is comparatively small, it makes no sense for the government to try to further restrict eligibility and add sanctions (on a benefit system that has already been significantly ‘activated’). Instead, there is a need to improve training and access to education, and to support aggregate demand (instead of tightening budgets) to increase the number of vacancies that have no yet recovered:

New Picture (1)