Social Insecurity

• As a proportion of GDP, spending on non-pensioner welfare benefits has risen from 1.7 per cent in 1948-49, peaking at 5.7 per cent following the financial crisis, and is forecast to be 4.5 per cent of GDP in 2026-27. This long-run expansion of the welfare state is, however, not matched by a rise in the generosity of the basic level of benefits: unemployment benefit in 2022-23 will be at its lowest level in real-terms since 1990-91 and is only slightly above an estimated destitution income level of £70 per week. As a proportion of average earnings, it now stands below 14 per cent, half the level it was in the 1970s.
• Three key policy choices have notably shaped the working-age social security system. First, the erosion of the contributory principle. Second, decisions to uprate working-age benefits in line with consumer prices (at best), which means benefit rates are usually falling behind average incomes. And third, targeting support for extra costs towards lower-income families. These decisions together have created a system that provides very low amounts of basic income support, and instead provides support covering extra costs for housing, children and ill-health, favouring lower-income families with children over single adults without extra costs and higher earners.
• A direct consequence of the UK’s low, flat-rate basic level of benefits is that the amount of income insurance provided by the social security system in the event of unemployment can be very low for earners who are not deemed to have additional needs. For example, the median replacement rate for a single adult with no children is 31 per cent, and just under one-third of single people get just over 20 per cent of their in-work income if they lose their job. By contrast, the fact that that a great deal of spending in the UK goes on the means-tested extra-cost benefits means that the median replacement rate for a single parent is 69 per cent.
• A consequence of this meagre income insurance is that the system provides relatively low levels of macroeconomic support in the face of aggregate shocks – the so-called automatic stabilisers. Social security spending can play a key role in supporting the economy in a downturn, but the responsiveness of UK social security spending to the economic cycle is one of the lowest among rich countries.
• The UK’s record on living standards for those at the bottom has been terrible since around 2003-04. Income has risen just 7 per cent (measured after housing costs) for a household at the 10th percentile since then, compared to 15 per cent for someone in the middle of the income spectrum. As a result, measures of poverty that use a fixed real poverty line have seen hardly any decline since 2001-02, with absolute poverty among working-age adults barely falling (from 21 per cent in 2001-02 to 17 per cent in 2019-20). This is an exceptionally poor performance: it is normally taken for granted that a modern economy can provide increases in real-terms living standards in the medium-term.
• Our existing social security system is not well-placed to meet the scale and nature of challenges ahead. The primary challenge facing the UK economy is that the pace of economic change is likely to increase in the decade ahead as the UK adjusts to a new context post-Covid-19, outside the EU, and as we decarbonise the economy.  That is likely to involve elevated levels of job change – something that our labour market has not experienced for decades – which could increase the risk of unemployment for many, highlighting the low levels of income protection provided by the UK’s social security system. Second, at the aggregate level, in an era when the role of monetary policy is limited by low interest rates, fiscal policy is likely to play a more active role in stabilising the economy during future downturns.  And third, it is increasingly clear that our current approach to working-age social security system is not going to deliver reductions in poverty and inequality.

The UK is facing a decade of unprecedented economic change as we adjust to a post-Covid-19 economy, a new economic context outside the European Union (EU), and the decarbonisation of the economy.  And the social security system has a key role to play in the years ahead: it is part of the policy toolkit for helping individuals and the economy as a whole deal with a period of enhanced labour market change, but it also needs to address the legacy problems of slow growth in living standards and high inequality.

This report considers how well the UK’s social security system for working-age   households is equipped to meet these challenges, and, in particular, how well aligned it is with the country’s likely future economic and social challenges. We begin by identifying the defining features of the UK’ social security system for working-age individuals and considering the historical policy choices and economic and social trends that have shaped it. We then assess how well it is achieving its core objectives of providing income insurance and ensuring adequate living standards. We look back to consider historical episodes during which the social security system changed to fit a new economic agenda, and then assess how well suited our current social security system is for the challenges of 2020s

This work forms part of The Economy 2030 Inquiry. Later this year we will publish an interim report that will assess and integrate all the evidence gathered on the performance of the UK’s economic strategy in the face of the key challenges posed by the 2020s. As part of this, it will consider the key interdependencies between the UK’s social security system, labour market policy and our approach to human capital formation, skills and retraining.

As a proportion of GDP, spending on non-pensioner welfare benefits has risen from 1.7 per cent in 1948-49, peaking at 5.7 per cent following the financial crisis, and is forecast to be 4.5 per cent of GDP in 2026-27. This long-run expansion of the welfare state is, however, not matched by a rise in the generosity of the basic level of benefits: unemployment benefit in 2022-23 will be at its lowest level in real-terms since 1990-91 and is only slightly above an estimated destitution income level of £70 per week. As a proportion of average earnings, it now stands below 14 per cent, half the level it was in the 1970s.

Low levels of basic benefit generosity should be seen in the context of a change in the composition of spending: income-related benefits now make up almost two-thirds (65 per cent) of working-age welfare spending, while contributory benefits – dependent on past payments – make up just 8 per cent. Partly in response to low levels of basic benefits, the UK system has instead evolved to focus social security spending on those with extra, unavoidable costs such as parents, those facing high housing costs and those who are long-term sick or have disabilities. As a result, the amount of benefits paid to low-income families per child was at most 41 per cent of the basic amount of unemployment benefit paid to an adult in 1977-78; by 2010, the system paid 14 per cent more for the first child than an adult, although it has fallen back slightly since then. Spending on Housing Benefit and its predecessor benefits has risen from 0.2 per cent of GDP in 1980-81 to 1.0 per cent in 2012-13 (since when the phase-in of Universal Credit makes comparisons difficult), and spending on disability benefits rose from 0.1 per cent of GDP in 1980-81 to 0.7 per cent of GDP in 2020-21.

This approach marks the UK out from many other developed countries. We spend only 0.1 per cent of GDP on unemployment benefits, lower than nearly all other OECD countries. But the UK spends 1.3 per cent of GDP on housing benefits-in-kind, the highest rate in the OECD, and 2.1 per cent of GDP on family cash benefits, the second highest rate in OECD.

The current social security system is often traced back to the one introduced just after the Second World War in the wake of the Beveridge report. But our current system is almost unrecognisable to that created in the mid-20^th century, and now owes very little to the principles that shaped Beveridge’s plans. A culmination of policy choices during several periods of significant economic and social change, as well as differing ideologies or priorities, has reshaped the social security system to meet a changing set of needs.

Three key policy choices have notably shaped the working-age social security system. First, the erosion of the contributory principle. Second, decisions to uprate working-age benefits in line with consumer prices (at best), which means benefit rates are usually falling behind average incomes. And third, targeting support for extra costs towards lower-income families.

These decisions together have created a system that provides very low amounts of basic income support, and instead provides support covering extra costs for housing, children and ill-health, favouring lower-income families with children over single adults without extra costs and higher earners. This contrasts with a more ‘Bismarckian’ northern European model of generous earnings-related benefits favouring workers, with a less-generous means-tested safety net underneath for those who lack contributions. Policy for working-age benefits also stands in contrast to current policy for pensioners: the desire to reduce pensioner poverty and to avoid undermining saving incentives through generous means-tested benefits have combined to mean that the system is dominated by an increasingly universal State Pension that is uprated by earnings or more.

The economic and social context has been transformed over the past 50 years. Three trends are particularly important for the development of social security policy in the UK. The first is the growth in inequalities in earnings at the family level. In the 1980s, this was driven by increased wage and earnings inequality. But many measures of wage or earnings inequality between workers peaked in the early 1990s and have fallen since. However, inequality in the total earnings of the family continued rising to about 2016. Indeed, the 90:10 ratios for hourly wages and weekly earnings in 2019 were almost identical to their levels in 1968. But the 90:10 ratio for family earnings has more than doubled in that 50-year period.

This trend has been driven by changes in family structures, and in labour market behaviour within households and between genders. In particular, there has been an increase in the proportion of couples who have two earners (and a corresponding decline in the proportion who have no earners). There has also been a decline in the fraction of single-adult families who are in work, or who are working full time. In the 1980s and 1990s, this was due to a rising number of single parent families; more recently, it has been due to falling employment among single men (in 2019, three-in-ten working-age single men without children were not in employment). This has put considerable pressure on the social security system to make up the difference if income inequality is not to rise further. This is one of the structural reasons why benefit spending is increasingly directed at working families, where it plays a vital role in mitigating widening inequality.

The second trend has been the high and growing cost of housing for low-income households. Additional programmes to help with rental costs have existed for many decades, but the surge in housing costs in the late 1980s and early 1990s, and a more recent shift in tenure patterns that means fewer low-income households are owner-occupiers, have resulted in considerably higher spending on these programmes – rising from 0.2 per cent of GDP in 1980-81 to 1.0 per cent in 2012-13.

A third trend has been the rising number of people in receipt of a disability benefit – growing from 1.2 million in 1997 to 2.5 million in 2021-22. Moreover, in recent decades an increasing proportion of those in receipt of a disability benefit have mental health, rather than physical health, problems. Mental health conditions now account for over a quarter (27 per cent) of all inactive people with a health condition, up from 16 per cent in 2003.

A direct consequence of the UK’s low, flat-rate basic level of benefits is that the amount of income insurance provided by the social security system in the event of unemployment can be very low for earners who are not deemed to have additional needs. For example, the median replacement rate for a single adult with no children is 31 per cent, and just under one-third of single people get just over 20 per cent of their in-work income if they lose their job. By contrast, the fact that that a great deal of spending in the UK goes on the means-tested extra-cost benefits means that the median replacement rate for a single parent is 69 per cent.

International comparisons show that the UK stands out in this regard. For a single person with no children on the average wage, the UK has one of the lowest income replacement rates in the OECD: 40 per cent compared to an average of 59 per cent. But for those family types likely to be eligible for our extra costs benefits, the picture is different, with the UK having a much higher replacement rate of 67 per cent for a single person with two children on two-thirds of the average wage, compared to the 77 per cent OECD average.

A consequence of this meagre income insurance is that the system provides relatively low levels of macroeconomic support in the face of aggregate shocks – the so-called automatic stabilisers. Social security spending can play a key role in supporting the economy in a downturn, but the responsiveness of UK social security spending to the economic cycle is one of the lowest among rich countries.

The issues of weak and variable income insurance, and inadequate incomes for low-income households highlighted are not just theoretical issues – they have had very real impacts during the pandemic. The creation of the Job Retention Scheme and grants for the self-employed revealed the limitations of the UK’s existing social security system: we had to invent national wage insurance scheme in real-time in the eye of the storm. The pandemic also highlighted that our existing Statutory Sick Pay system gives workers little protection against being ill, and so puts more of us at risk from an infectious disease (as well as excluding self-employed workers entirely).

Alongside providing protection against shocks, the other core task for the social security system is to ensure adequate incomes for out-of-work or low-income families. Here, it is clear that the UK’s system is not succeeding.

The UK’s record on living standards for those at the bottom has been terrible since around 2003-04. Income has risen just 7 per cent (measured after housing costs) for a household at the 10^th percentile since then, compared to 15 per cent for someone in the middle of the income spectrum. As a result, measures of poverty that use a fixed real poverty line have seen hardly any decline since 2001-02, with absolute poverty among working-age adults barely falling (from 21 per cent in 2001-02 to 17 per cent in 2019-20). This is an exceptionally poor performance: it is normally taken for granted that a modern economy can provide increases in real-terms living standards in the medium-term. In the decade before 2001, for example, the proportion of working-age adults below that same line fell by just under 10 percentage points. The level of income for households towards the bottom is not just failing to grow with the economy, but is also inadequate. Just over 7 per cent of adults, and over 12 per cent of children lived in a food-insecure household before the pandemic, and food bank use increased by 135 per cent between 2016 and the midst of the Covid-19 crisis in 2020.  The £20 uplift in Universal Credit during the pandemic was in part a recognition that benefit levels had fallen too far.

A better long-run measure is the relative poverty rate, which has risen from 8 per cent in 1961 for working-age adults to 20 per cent in 2019-20. This is broadly the level it reached in the early 1990s. Pre-crisis data shows that, across comparable countries, the UK has high rates of relative poverty for both children and working-age adults. However, poverty rates among pensioners fell from 34 per cent in 1991 to a low of 13 per cent in 2012-13.

The low-level of core social security benefits, affected by the various real-terms cuts to benefit levels in the 2010s, is clearly a major determinant of these outcomes. But this has been exacerbated in the past decade by policy changes that undermined the idea that those with extra needs should be supported. These include the benefit cap, which now affects 165,000 families; and the two-child limit, which now affects 1.25 million children and is expected to affect 3 million when fully rolled-out by 2035. As a result, relative poverty among children has risen by 3 percentage points since 2012-13, driven entirely by rising poverty among families with three or more children.

To help us think about the role that the social security system needs to play to help households adjust to some of the challenges of the 2020s, and how social security should fit within a wider economic strategy that addresses new realities, it is useful to learn from previous experiences. Over four broad eras of social security system policy – the original Beveridge settlement, Wilson-era expansionism, the Thatcher counter-revolution and then the Blair agenda – it is possible to identify a degree of ‘strategic fit’, or coherence, between developments in social security and wider economic and public policy objectives.

Beveridge’s social insurance plan, for example, was integrated with a commitment to achieving full employment which not only became a central plank of post-war economic policy but was also a fundamental pre-requisite for Beveridge’s agenda of guaranteeing a ‘national minimum’ for all citizens.  In the mid-1960s, Harold Wilson was committed to achieving faster economic growth which, in his view, relied on the reallocation of skilled labour towards rising industries. Large-scale labour reallocation, it was thought, would be facilitated by a ‘social infrastructure’ that would help smooth the path. This included the shift towards earnings-related unemployment benefit and sick pay as well as redundancy pay, Industrial Training Boards, the pioneering of the polytechnic system, the post-Robbins expansion of universities and the launch of the Open University.

There was also a clear line of sight between economic and social security policy running through the Thatcher era, though this took a very different form. As well as the goal of reducing public spending, there was a wider objective of creating a more flexible and lightly-regulated labour market both to help reduce unemployment and create the conditions for a more dynamic economy. Like Wilson, Thatcher aimed to encourage labour shifting towards the expanding parts of the service sector but took the opposite view of how that was best achieved: benefit levels were allowed to fall relative to average wages at the same time as the labour market was deregulated and wage dispersion grew.

More recently, the Tony Blair and Gordon Brown Governments sought to align economic and social policy objectives through a drive for full employment which in turn would support their goal of cutting child poverty. Employment was promoted via a range of active labour market programmes, a work-first approach towards social security and a suite of measures to help working parents. Work was made more (financially) rewarding not least via the introduction of the first ever minimum wage. And low-to-middle income families received substantial support via a new system of tax credits. In all eras there were failures and oversights, but there were also attempts to think coherently across economic and social objectives.

It is uncertain what the UK’s economic strategy will be, and so we cannot tell what will be asked of our social security system in the decade ahead. But the nature of the economic context of the 2020s combined with the findings in this report mean that some areas of concern are already clear: we identify three.

The primary challenge facing the UK economy is that the pace of economic change is likely to increase in the decade ahead as the UK adjusts to a new context post-Covid-19, outside the EU, and as we decarbonise the economy.  That is likely to involve elevated levels of job change – something that our labour market has not experienced for decades – which could increase the risk of unemployment for many, highlighting the low levels of income protection provided by the UK’s social security system.  Moreover, the increased structural change might place pressure on the ‘work first’ approach that underpins social security and welfare and skills policy in the UK.  The UK certainly spends much less on active labour market programmes for the unemployed than our competitors: we spend 0.2 per cent of GDP on active labour market programmes; the OECD average is 0.5 per cent of GDP, and almost all comparable European economies spend more than that.

Second, at the aggregate level, in an era when the role of monetary policy is limited by low interest rates, fiscal policy is likely to play a more active role in stabilising the economy during future downturns. A question for policy makers is whether the experience of the pandemic – and particularly the effectiveness of more generous income support during a recession – has significant lessons for how we should do that in future recessions.

And third, it is increasingly clear that our current approach to working-age social security system is not going to deliver reductions in poverty and inequality. The long-held cross-party consensus to keep core benefit entitlement for adults at low levels means that too much of the work in supporting incomes is done by the extra cost benefits. That strategy in itself has been undermined by recent cuts to the way that support is provided to those with children and to renters. But it is also unsustainable to let benefits for groups who do not qualify for the top-ups fall to near-destitution levels. If tackling the UK’s legacy of high inequality and poverty is remotely part of new economic strategy for 2020s, then policy makers will need to reconsider this approach.