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The promise of shared prosperity is key to our social contract
Countries are bound together in a sense of shared endeavour by many things, from a common history to the collective provision of security for our homes, families and communities. But as traditional hierarchies have weakened and advanced economies become more diverse, the role of the state in delivering shared prosperity has become more central in underpinning social contracts. Rising wages, higher employment and the security of the welfare state have all helped deliver this in the past. Real wages nearly quadrupled, while state spending on healthcare as a share of the economy almost trebled, between the Second World War and the turn of the millennium.
But that progress, and the strength it gives to our society and democracy, should not be taken for granted. There are periods when the social contract comes under pressure; when a clear route to a better tomorrow is lacking, the improvements people expect dry up and some groups are left wondering whether the country works for them. Britain, as we outline in this final report of the Economy 2030 Inquiry, is in this undesirable position today.
That promise is under threat. The cost of living crisis is the immediate issue, but our ambitions must extend beyond getting through it
The early 2020s have been tumultuous years. Britain emerged from the pandemic straight into the cost of living crisis, and the highest inflation in four decades. Energy bills surged, food prices followed and now housing costs are on the rise. Despite government support totalling £78 billion, hardship is everywhere to be seen: homelessness has hit record levels. This is not the recovery from the pandemic anyone was hoping for.
But as pressing as today’s issues are, policy makers must lift their sights to broader challenges to our shared prosperity. British households went into this crisis with low levels of financial resilience, and a sluggish living standards recovery is expected as we come out of it: household incomes are not expected to reach their pre-cost of living crisis peak until 2027 at the earliest.
This is the result of an economy defined by a decade and a half of stagnant incomes, and a generation and a half of high inequality, posing risks not only to our prosperity, but to our social fabric and democracy too. This makes the UK a stagnation nation.
Britain’s huge strengths are not being harnessed: we are 15 years into relative economic decline
We were catching up with more-productive countries like France, Germany and the US during the 1990s and early 2000s. But that came to an end in the mid-2000s and our relative performance has been declining ever since, reflecting a productivity slowdown far surpassing those seen in similar economies. Labour productivity grew by just 0.4 per cent a year in the UK in the 12 years following the financial crisis, half the rate of the 25 richest OECD countries (0.9 per cent). The UK’s productivity gap with France, Germany and the US has doubled since 2008 to 18 per cent, costing us £3,400 in lost output per person.
Claims that these measures of economic progress mean little for ordinary workers are common but painfully wide off the mark. Weak productivity growth has fed directly into flatlining wages and sluggish income growth: real wages grew by an average of 33 per cent a decade from 1970 to 2007, but this fell to below zero in the 2010s. In mid-2023 wages were back where they were during the financial crisis. 15 years of lost wage growth has cost the average worker £10,700 a year.
Gaps between people and places are too high – the UK has the highest income inequality of any major European economy
While Britons have been living with stagnant wages for the last 15 years, high inequality has been a problem for more than twice as long. Having surged during the 1980s, and remained consistently high ever since, income inequality in the UK is higher than any other large European country. This is not a league table we should be aiming to top.
The persistence of high income inequality comes despite the success of the National Minimum Wage in reducing hourly wage inequality. Its stubborn grip reflects the top (largely men) having pulled away from the middle, benefit cuts, lower earners working shorter hours and housing costs rising for poorer households.
Income and productivity gaps between places both matter, and in the UK both are high and persistent. Income per person in the richest local authority – Kensington and Chelsea (£52,500) – was 4.5 times that of the poorest – Nottingham (£11,700) – in 2019.
Meanwhile, 80 per cent of the income variation between areas we see today is explained by the differences back in 1997. Productivity disparities are larger still, with that between the leading city and their other large counterparts being greater than in peer countries such as France; London is 41 per cent more productive than Manchester whereas Paris is only 26 per cent more productive than Lyon.
Low growth and high inequality are a toxic combination for low-to-middle income Britain and the young
The twin challenges that Britain faces – low growth and high inequality – are substantial issues on their own, but together they create a toxic combination.
Slow growth is always a problem, but even more so when lower-income households lack financial resilience: over one-in-four adults went into the pandemic saying they would not be able to manage on their savings for a month if their income stopped. Inequality seems to matter more when the economic music stops: the share of the public citing poverty and inequality as one of the most important issues facing the country rose from 7 per cent in 2010 to 19 per cent pre-pandemic.
This toxic combination is a disaster for low-to-middle income Britain and younger generations. We might like to think of ourselves as a country on a par with the likes of France and Germany, but we need to recognise that, except for those at the top, this is simply no longer true when it comes to living standards.
Middle-income Brits are now 20 per cent poorer than their peers in Germany and 9 per cent poorer than those in France. Worse, low-income households in the UK are now around 27 per cent poorer than their French and German counterparts. It’s important to comprehend just how material these gaps are: the living standards of the lowest-income households in the UK are £4,300 lower than their French equivalents.
Meanwhile the young have seen generational pay progress grind to a halt and those born in the early 1980s were almost half as likely as their parents’ generation to own their own home at 30. We cannot go on like this.
The great changes of the 2020s cannot be relied on to end stagnation
Countries can go through phases of relative stability, but the UK in the 2020s will not be such a country. Long-standing demographic and technological shifts will combine with Brexit, rising geopolitical tensions and the net zero transition. These will bring significant disruption for some, though not the radical reset for our economy or large job losses that many predict. Instead, rather than solving our stagnation, these challenges risk reinforcing it.
Brexit has already brought change, albeit not always in the form widely expected. Foreign direct investment has actually held up since the referendum, and three years into our new trading relationship it is not clear that exports to the EU have fallen disproportionately. Instead, the UK has suffered a broad-based fall in both openness and competitiveness. By 2023, UK trade as a share of GDP was down 2.2 percentage points on pre-pandemic levels (compared to a rise of 0.5 percentage points across the rest of the G7). This decline is focused on goods, with the UK losing market share across EU and non-EU markets, including the US, Canada, and Japan.
More change is to come as some sectors serving the EU market shrink and others grow as a result of less competition domestically. Fishing output will fall by 30 per cent, while food manufacturing could increase by more than 5 per cent. But these shifts will not lead to the benefits some hoped for: a manufacturing revival or a more regionally-balanced economy. UK manufacturing will change rather than grow, as high-productivity sectors like chemicals and electronics shrink even as lower-productivity food manufacturing expands. Wages in London, Wales and the North East will be hardest hit by the resulting decline in productivity which, across the country as a whole, means workers will be £470 worse off by the end of the decade.
Covid-19 caused huge disruption to our economy and our lives. But just as face masks no longer pile up in people’s homes, so many of the economic shifts wrought by the pandemic have unwound. What remains is a shift to home working for higher earners (the proportion working from home regularly surged during the pandemic, and remains high at 38 per cent of workers). This undoubtedly makes life easier for many, but hardly lives up to excitable claims that Covid-19 would transform our economic geography or our productivity. Far from a global pandemic bringing big silver linings to our shores, its legacy includes the inflation surge we are still living through. And while the long-term impact of AI is highly uncertain, it’s clear that the robots we were told would imminently take our jobs and raise our productivity have done neither.
The net zero transition brings many changes and some opportunities. But it is not a silver bullet
The net zero transition is crucial to the planet, and to making the UK a greener and healthier place to live. Our ability to navigate it is underpinned by a high degree of public consensus, but maintaining that requires clear sightedness about the opportunities, and disruption, it brings. The latter won’t be in the form of large-scale job losses, with job change rather than destruction the norm. For example, 24 per cent of those working in emissions-intensive ‘brown’ jobs are large goods vehicle drivers – whose jobs will not disappear even as the vehicles they use become greener.
Instead, major disruption risks hitting people as consumers, as our net zero commitments require significant investment in low-carbon infrastructure that has to be paid for before benefits from lower operating costs arrive. In the 2020s, this is principally about making our homes more energy efficient. Here there is a risk of outright failure to accelerate the transition, which has stalled after a 90 per cent fall in insulation installations since 2013. In order to remain on track, the challenge facing policy makers will be to ensure the costs of insulating homes and installing heat pumps are fairly borne.
Low-income property owners are most exposed. With the disposable income of poorer homeowners averaging £9,100, and the cost of insulating leaky homes over £8,000 per household, it is plain that the necessary investment isn’t going to happen without major government intervention. Current support – for example for heat pump installations – is available to any household irrespective of their financial means, which is affordable only because of very slow progress. The scale of the change to come means it will need to be targeted on the basis of both household income and wealth.
The concrete question of how these investments will be paid for should receive more attention than misplaced claims that net zero is a silver bullet that will hugely boost, or a catastrophe that will hold back, growth. The UK should learn from Joe Biden’s Inflation Reduction Act, rather than pretending it can ignore or emulate it. There are new opportunities to be seized and green innovations to be exploited, but during the 2020s the main impact of the net zero transition on GDP will be to alter its composition, as we invest more but consume less, rather than change its level.
These changes do not provide the answers to the toxic combination of low growth and high inequality – but they provide the context within which any attempt to renew the country’s path to economic success needs to be placed.
We cannot go on like this. Britain needs a new economic strategy
Relying on supposed silver linings or silver bullets is part of a wider problem: the belief that a policy shift in one area holds the answer to stagnation. It won’t. Instead the task is to craft a new economic strategy, rebuilding the UK’s route to shared economic success.
Why is a strategy needed? First, because the challenges are large and persistent. Almost 9 million younger Brits have never worked in an economy that has sustained rising average wages. Second, because those deep-rooted challenges and disruptions to come are inter-dependent. And third, because the financial crisis and Brexit have blown up major components of the UK’s long-standing growth-model, which had itself been found wanting given the large and persistent gaps between people and places.
Some of the ingredients of a more comprehensive approach are visible, from the UK Government’s focus on closing economic gaps between places, to the Labour Party’s green investment plans, or the Welsh Government’s prioritisation of social partnership. But the test for a broader economic strategy is that it combines: goal orientation, being clear about the problem a strategy is trying to solve; clarity about context, understanding the type of country we are and the opportunities and constraints this brings, without nostalgia about the past or wishful thinking about the future; realism about trade-offs, recognising the tensions that always exist; policies of sufficient scale to plausibly move the dial; and, finally, staying power, because change takes time and short-termism has been a key UK weakness for decades.
No one believes that Britain has such a strategy guiding policy and shaping private decisions today. There is a recognition, from the Prime Minister downwards, that we cannot continue as we are, but we are not on course towards setting any such strategy – indeed we are not serious about the task. Some argue we don’t need growth at all because it won’t translate into gains for ordinary households, ignoring the reality that a lack of growth is the cause of flatlining wages. More common is to recognise that growth is necessary, or that inequality is too high, but to be deeply unserious about what it might take to improve things. The realities of modern Britain are regularly ignored and the trade-offs between different objectives wished away. We are short-term to our core. Some seem to believe decline is inevitable, others that ‘world beating’ rhetoric automatically translates into ‘world beating’ reality. We need to move beyond both fatalism and boosterism.
Understanding your country is a prerequisite for making a success of it: we are a services superpower
Not being serious begins at the most fundamental level: failing to understand what Britain’s 21st century economy actually looks like. Talk of the UK economy being narrowly built on banking is as common and misplaced as the claim that there is an easy route to turning ourselves into a German-style manufacturing superpower.
These lazy narratives obscure the reality that Britain is a broad-based services economy, built on successful musicians and architects as well as bankers. We’re about ICT, education, culture and marketing, as well as finance (whose fraction of total exports fell from 12 per cent in 2009 to 9 per cent in 2022). No one celebrates it, but the UK is the second largest exporter of services in the world. And our services specialism does not lie behind our recent underperformance: on average, services-led economies tend to be richer than manufacturing-driven ones.
We have narrower, but important, manufacturing strengths too: aerospace and beverages stand out, while there are green technologies, from offshore wind to carbon capture, where specialisms can be built on. But the services-led nature of our economy is not going away, and our path to future prosperity lies in being a better version of Britain, not a British version of Germany. The things countries are good at are highly persistent: of the top 10 products the UK was most specialised in back in 1989, seven were in our top 10 in 2019. Even Brexit, the biggest shake-up to our economic place in the world in decades, will have little impact on the balance between goods and services – indeed the biggest risk is that it will change the quality, rather than the quantity, of British manufacturing. And not in a good way.
The UK needs to rethink and reorientate its approach on trade
EU membership provided Britain’s trade strategy for the last half century. Post-Brexit a new one has yet to emerge, but it must if the shift of domestic manufacturing towards lower productivity activities is to be avoided, and the opportunities of growing global services trade seized.
The defensive priority now is securing EU market access for high-value-added manufacturing firms struggling to retain their place in European supply chains. Half-way houses, even joining the EU’s Customs Union, will not address the fundamental issue faced by British manufacturers: the existence of the UK-EU border for goods. Instead the objective should be a ‘UK Protocol,’ building on the current position of Northern Ireland to restore the lost benefits of being part of the EU’s customs territory and the single market for goods. This will not be easy, but it is essential to the future of some of our most successful manufacturing industries.
On services, trade policy must be more expansive in focus and innovative in approach. Here the UK is less dependent on the EU market – even before Brexit 63 per cent of services exports went outside the EU – and there is the potential to harness the UK’s service specialism; global trade in the services Britain specialises in has tripled since 2005, growing twice as fast as trade in goods. Traditional, goods focused, free trade agreements have little to offer in this regard, so the UK should pioneer new services trade agreements with the likes of Singapore, Australia, Canada, Switzerland and Japan.
Turning around our second cities will boost national income and shrink regional gaps, but needs change on a scale not yet contemplated
Recognising the nature of our economy is not the same thing as welcoming all aspects of it, but a strategy which fails to understand the starting point is no strategy at all. A key challenge for a services-dominated economy is that exports and productive activity tend to be geographically concentrated. In the UK, that currently means in the capital, which accounts for 63 per cent of the UK’s surplus in services trade. This holds back Britain’s ability to take advantage of growing global markets.
While our current economic specialisation is consistent with future shared prosperity, our regional divides are not. Understanding the drivers of success in a services-led economy guides us to the best way of releasing the brake on its growth. High-value services thrive in large places with highly educated populations where many similar firms can co-locate: cities.
But far too few of our conurbations, all deeply scarred by deindustrialisation, have successfully made the transition to a services economy; all of England’s biggest cities outside London have productivity levels below the national average. A strategy to turn this around is what an industrial strategy in a service-dominated economy looks like. This is not a strategy for the few: the UK may be a ‘green and pleasant land’, but 69 per cent of the UK population live in cities or their hinterlands, compared to 56 per cent in France and just 40 per cent in Italy.
At the heart of this problem are the UK’s twin second cities: Greater Manchester and Birmingham. With populations of around 2.8 million each, their size means they must be centre stage not just for the sake of their own prosperity, but also for the sake of Britain’s. They are too big to fail.
Closing their productivity gaps with London to those that Lyon and Toulouse have with Paris would narrow the UK’s output gap to Germany by a fifth. But honesty about the scale of change required is essential. It would require increasing each city’s business capital stock by 15 to 20 per cent; over 160,000 additional high-skilled workers in each city; city centres expanding up or out; and billions of central government investment to expand transport networks.
Ensuring more places can be at the cutting edge of the UK economy holds out the possibility of raising national growth and shrinking regional productivity gaps, reducing both national inequality and local poverty. Yet within-region inequality could widen – a richer Greater Manchester would have less poverty, but more higher earners too. Housebuilding must be expanded, because the goal is more successful cities, not clones of London with low earners facing exorbitant housing costs.
Residents are understandably ambivalent about higher local inequality, and the significant disruption involved in going for growth. This is why meaningful progress will not happen without bold and empowered local leadership able to manage the disruption involved, which in turn reinforces the case for genuine fiscal devolution.
The UK is a country living off its past, not investing in its future
Investing too little for one year is manageable, but doing so year after year is a recipe for relative decline. This is precisely what the UK has been doing and where it finds itself. In the 40 years to 2022, total fixed investment in the UK averaged 19 per cent of GDP, the lowest in the G7. Virtually all of the productivity gap with France is explained by French workers having more capital to work with.
Public sector investment is too low and too volatile
Although the majority of investment is in the private sector, public investment matters too. Here, the average OECD country invests nearly 50 per cent more than the UK and the results are everywhere to be seen: UK hospitals have fewer beds than all but one OECD advanced economy and UK workers spend more time commuting than those in all but two. Addressing this legacy requires a higher public investment future, as does a new challenge – the net zero transition.
Our public investment is not just too low, it is too volatile – the second-most volatile among advanced economies over the past 60 years. This prevents forward planning, raising the costs and challenges of getting investment done: even where public investment increases have been planned, £1 in every £6 allocated hasn’t been spent.
This volatility reflects incentives for investment to be cut when belt tightening calls, as happened recently in the aftermath of the ill-fated mini-budget of September 2022. It is easier to cancel a bridge tomorrow than fire a nurse, or raise a tax, today. This short-termism is reinforced by a fiscal framework that treats investment spending identically to day-to-day spending, ignoring the value of assets on the public sector balance sheet. The UK’s fiscal rules should be reformed to banish feast and (more common) famines, in favour of sustained public investment of 3 per cent of GDP. The Treasury should switch its focus to improving the quality, not fiddling with the quantity, of public investment.
Stability alone won’t raise business investment – reforms must stoke firms’ desire to invest and ability to get things built
British business has caught the same low investment disease as the British state, consistently lying in the relegation zone (bottom 10 per cent) of the OECD business investment league table. If UK business investment had matched the average of France, Germany and the US since 2008 our GDP would be nearly 4 per cent higher today, boosting wages by around £1,250 a year.
The sheer scale of political and economic instability hasn’t helped. Since 2010 we have had Brexit, Liz Truss, nine Business Secretaries, four versions of the business department and almost annual changes to corporation tax. That last bit of policy instability should be ended by making the temporary full expensing of investment permanent. The stability and quality of policy could also be improved with a statutory National Growth Board, advising government and reporting to Parliament. But stability will not be enough, given that business investment fell during the politically and economically stable mid-2000s.
The UK stands out for low investment, but not low returns on investment when it does take place. So what constrains firms’ desire or ability to realise those returns? For one thing, an unusual lack of pressure on British managers from above – via engaged owners – or below – from empowered workers – to focus on long term growth. For another, the difficulty of getting anything built.
Ownership of British firms has become more remote, with foreign ownership rising from 10 per cent in 1990 to over 55 per cent in 2020, and extremely dispersed, as our pension funds – the overwhelmingly most important source of domestic capital and ownership – moved away from holding equities directly: only 2 per cent of their assets are now directly held UK equities. Diffuse owners, rationally for them but dangerously for Britain, do not incur the substantial costs of monitoring management, risking firms being run myopically with profitable investment foregone. It is time for a major programme of pension fund consolidation: a far smaller number of far larger, and more active, pension funds is what UK PLC needs.
In contrast to many European countries, the lack of ‘owner voice’ is matched by a lack of worker voice. This should change, with worker representatives on the board of all larger UK firms, which research on Germany, Finland and Norway suggest would raise investment levels. This would be a big change for British companies, but hardly an unimaginable one – a Conservative Prime Minister recently proposed this exact change.
Even if firms have the desire to invest, they also need the ability to do so – specifically the ability to get things built; in stark contrast to every other G7 economy, the UK has seen no increase in the amount of built-up land per capita since 1990. The cost of planning applications is five times higher in 2023 than 1990, and the outcomes far too unpredictable, also holding back housing and badly needed energy infrastructure. In future, businesses submitting applications consistent with local plans should be automatically approved. While planning for housing should take place locally, subject to meeting nationally set housing targets, decision-making for business developments should be at a wider geographical level: it’s time the benefits, not just the costs, of investment were recognised.
Claims that there are too many degrees distract us from the fact we need to invest more in skills, not less
When it comes to human capital, policy makers are distracted. They question whether we are doing too much education, despite the reality that the very growth sectors which the UK’s future prosperity relies on are especially hungry for graduates. Fears of a brain drain from poorer communities are common. But in truth, young people from the most-deprived areas are two-and-a-half times less likely to leave their home area than their more affluent peers.
While the UK has a world-class university system and performs reasonably when it comes to school attainment at 16, provision after that for those not following an academic route is patchy at best, and a disgrace at worst. Almost a third of young people are not undertaking any education by age 18 – compared to just one in five in France and Germany. And only one in ten workers are qualified at sub-degree level (Level 4 and 5), half the share it should be given the make-up of the UK economy. Far too many young people peak at GCSE or A level equivalents in Britain, holding back future wages and careers.
Clearer non-academic routes, buttressed by increased student support, are needed. At the heart of these reforms should be a new ‘apprentice guarantee’ for all qualified young people, with two thirds of the Apprenticeship Levy ringfenced for the under-25s to reverse the trend of employers increasingly focusing on existing, older employees – apprenticeship starts for 19-24-year-olds have fallen by a third in the past decade.
Higher investment has to be paid for
In time, higher investment will create higher living standards, not to mention a greener economy. But only in time. A new economic strategy backing higher investment needs to confront the more immediate consequences with an unflinching eye: it requires higher savings (lower consumption) at home, or more borrowing from abroad. There are strong resilience arguments for higher investment to be accompanied by higher saving. The UK is a country that already borrows a lot – our current account deficit averaged 4 per cent of GDP over last decade – and a society where over two fifths of families had savings of less than one month’s income when the pandemic hit. The success of pension auto-enrolment should be built on, with a 50 per cent increase in minimum contribution rates. But savings at the level of the economy as a whole do not just reflect the behaviour of households. The state also has an important role to play, too.
Investment and growth require a sustainable macroeconomic framework – we don’t have one today
Economic, not just policy, stability underpins investment. Important guarantors of that are the ability to support the economy during downturns and keep the public finances on a sustainable path. The repeated ‘once-in-a lifetime’ shocks of the past 15 years have seen public sector net debt rise from 36 to around 100 per cent of GDP – an unprecedented peace-time rise. The lesson of those shocks is that both main parties’ focus on debt falling slightly outside of recessions will not be enough in practice to avoid debt being on an upward trajectory.
A tighter fiscal policy will have to be run in good times. The best way to keep the requisite tightening manageable is to contain the pressure for the Treasury to spend big in bad times. The scope for the Bank of England to cut rates in a downturn should be increased by preparing for slightly negative interest rates (as seen in the likes of Denmark and Switzerland). And, if we return to a low-interest rate world, the inflation target should also be raised from 2 to 3 per cent in coordination with other advanced economies. Meanwhile, the Treasury needs to avoid being backed into providing hugely expensive universal programmes of support, such as the recent Energy Price Guarantee, due to the lack of more agile alternative options. Building a flexible payments infrastructure to target emergency support when needed would be an investment with high returns.
We must be as hard-headed about lower inequality as higher growth
Success for Britain does not look like becoming America. Despite being far richer, the past decade in the US has shown the dangers to democracy from being the most unequal advanced economy in the world. And there is nothing economically or democratically sustainable about a UK status quo that saw almost 4 million people experience destitution in 2022. We must be just as serious about reducing inequality as boosting growth.
But that is not where we are today. Some businesses think it’s enough to talk about environmental, social and governance (ESG) issues, while each new crisis sees us patching up the welfare state rather than ensuring it is fit for purpose in the first place.
To make a serious dent in inequality, we need a two-pronged approach: good work must be a central objective of a new economic strategy, not a hoped-for by-product of it, while choices on tax and benefits ensure rewards and sacrifices are equitably shared.
Good jobs must be centre-stage, building on past successes as well as tackling stubborn weaknesses
Successes need to be built on, as well as entrenched problems addressed, in the world of work. The UK’s high employment rate is a strength we should not take for granted: the poorest half of households experienced two-thirds of the jobs growth in the decade after the financial crisis. Further progress can be made. Reforms to the private pensions regime could nudge the better-off into working longer. Universal Credit should be reformed and childcare support simplified to ensure work pays for mothers. A priority must be made of helping the growing number who become sick or disabled remain attached to their current employer.
The minimum wage has seen the lowest earners consistently receive the fastest pay rises for over two decades, with particularly large gains for women and younger workers, and no material negative effect on employment. This is what a policy triumph looks like. The current pace of minimum wage rises should be maintained, with a new ambition for the minimum wage to reach 73 per cent of median pay (£14 on current forecasts) by 2029. Celebrating the success of the minimum wage must not, however, blind us to the total lack of progress elsewhere. A good work agenda must be more than a one-trick pony.
It is time to go beyond the minimum wage
As the minimum wage has ramped up this century, job satisfaction for lower earners has fallen. Too often, work does not offer them the security, flexibility or control that higher earners take for granted. Low earners are four times as likely as high earners to experience volatility in their hours or pay. Indefensibly, half of shift workers in Britain receive less than a week’s notice of their working schedules. Workers should have new rights to a contract enshrining minimum hours reflecting their usual work pattern, and two weeks’ advance notice of shifts. Illness is bad for the financial, as well as physical, health for too many lower earners. Statutory Sick Pay leaves many to live on just £44 if they are sick for a week, and should be reformed to pay 65 per cent of normal earnings.
After raising the floor for workplace standards, we also need to enforce it. That is not a task taken seriously in a country that sees 334,000 employees paid less than the legal minimum. We have too many enforcement agencies (six, overseen by seven government departments) with too few boots on the grounds (just 0.29 labour market inspectors per 10,000 workers), putting the onus on workers to protect their own rights via employment tribunals – something the groups most at risk of having their rights breached are least likely to do. This system works for bad employers, but not their competitors who end up being undercut, nor their underpaid workers. Instead we need a Single Enforcement Body, issuing meaningful fines and addressing systemic problems.
Power and institutions matter in the labour market; not all problems can be addressed with national minimum standards. Trade unions remain important but membership has declined from 52 to 22 per cent of the workforce since 1980. Behind that decline lie not just structural changes, such as deindustrialisation. Legislative changes, that were meant to create a level playing field between employers and unions, have instead tilted the pitch against the latter. Antiquated restrictions, including unions having no right to enter workplaces and bans on online voting, should be lifted.
It is wishful thinking, though, to rely on a union renaissance or indeed a tight labour market to remedy poor conditions in the most problematic sectors. Here, institutional innovation is required, addressing industry specific problems that general employment law is too blunt a tool to crack. Learning from the experience of other flexible labour markets with well-established, or recently developed, sectoral bodies, from Ireland to New Zealand, ‘Good Work Agreements’ should bring together workers and employers to solve knotty problems about the quality of work in their industry, setting minimum standards or ways of working to be adopted sector-wide. The first should be established in social care where a predominately female (77 per cent) workforce is often illegally underpaid, with warehousing and cleaning next in line.
Politicians’ promises that every type of job will be available everywhere are very far from serious. But ensuring good jobs exist in every part of our country – particularly in the non-tradable sectors that provide largely for the domestic market, from care to hospitality – is a promise a new economic strategy can and must make.
High housing costs hold down living standards and push up inequality
The share of income families dedicate to housing has doubled since 1980. The rise has been largest for those on low incomes, whose home now costs them a third of their income. They increasingly rely on the private-rented sector, where costs are too high and quality too low.
Also too low is the number of homes in the UK. While the likes of France and Italy have seen big increases in the number of homes relative to inhabitants, the UK has made no progress. The building of homes for social rent fell from over 40,000 homes a year in the 1990s, to just 8,000 a year over the past decade. Higher standards in the private rented sector and higher housing supply are both needed – the 300,000 homes a year target included in the 2019 Conservative Manifesto and adopted by the Labour Party provides a good starting point, so long as they are focused in the areas of the country where housing costs are high or fast rising.
If Britain as a whole returns to steady growth, we should expect further increases in housing costs to follow. Of particular concern are those who may not benefit from that rising prosperity but nonetheless see their housing costs increase in response to it. Housing support in the benefit system exists precisely to protect them. Unfortunately, it has not been allowed to rise in line with rents since 2019. This is directly hitting poorer households, and also locking them out of those parts of the country where they might find better opportunities. Relinking housing support to rent levels will lean against inequality and facilitate mobility. Reducing residential stamp duty would also help boost the latter.
A decent society does not allow poorer people to fall ever further behind
We have an obligation to pensioners, and the 11 million people of working age for whom earnings make up less than half of their income, very often because of caring responsibilities or disabilities. So markets, however fair, and jobs, however good, cannot ensure that growth automatically boosts the living standards of the whole population. This is the job of the social security system, but it is not fulfilling that role today.
The UK has chosen a low level of basic income protection. Working-age benefits have for many decades risen only in line with prices, rather than keeping pace with (generally faster growing) earnings. In practice, we haven’t even managed that recently – benefit levels have failed to keep pace with prices in 10 of the past 15 years. Along with wider cuts since 2010, this has reduced incomes of poorest fifth by just under £3,000 a year. As a result, over a quarter of households with a disabled adult are in poverty, as are more than two-fifths of families with three or more children (up from one-third in 2012-13), and inequality hasn’t fallen despite the rising minimum wage and those progressive employment gains.
Looking ahead, rather than in the rear-view mirror, the current approach means disconnecting the living standards of poorer households from the rest of the population. Any economic strategy that claims to be serious about reducing inequality will need to change tack.
Ultimately social security benefits must grow in line with wages rather than prices. This is a big change, but the argument for it has already been won in countries such as New Zealand and Germany and here, too, on pensions. Concerns it will harm work incentives are overdone in the context of a fast-rising minimum wage; cutting out-of-work benefits is not the only way to improve work incentives. The costs are real, but over half of them can be covered by uprating pensions on the same basis as working age benefits, rather than via the ‘triple lock’. This combined approach, along with fixing the most glaring holes in the safety net by abolishing two child limit, will cost 0.6 per cent GDP by 2039-40.
We need better, not just higher, taxes
Taxes are up, but their quality is not. Having averaged 33 per cent of GDP in the first two decades of this century, the tax take is now on course to rise by over 4 per cent of GDP (£4,200 per household) by 2027-28. The exact size of the state depends on political choices, but a new economic strategy must plan on higher taxes being here to stay. Higher debt interest costs and the state of public services point in that direction, before we even get to the pressures from our ageing population and the net zero transition. This is why politicians declaring their low-tax ‘instincts’ have raised taxes to their highest levels since the 1940s.
The growth and fairness penalties from our incoherent tax system are rising with the higher tax take. A new approach must recognise that the burden cannot continue to fall disproportionately on employees, which means taxing income consistently whatever its source so that landlords pay the same taxes as their tenants and taxes on self-employed corporate lawyers are levelled up to those facing bankers. This is an agenda that will push up unjustifiably low rates for some on higher incomes, while also cutting the highest marginal rates, including ending rates of 100 per cent facing some parents as their child benefit is taxed away.
Wealth also needs to take more of the strain. Household wealth has risen from three to over seven times national income since the 1980s, while poorly designed wealth taxes have not risen at all as a share of GDP. Council tax cannot continue as a near-poll tax, only weakly linked to three-decades-old property values. An inheritance tax with fewer reliefs would be harder for the well advised to abuse and could halve tax rates for smaller estates.
Our tax system also needs to keep pace with the net zero transition. To ensure the burden of motoring taxes does not fall on poorer households yet to switch to electric vehicles, a 6p per mile charge (equivalent to fuel duty) should be introduced for EVs. By 2039-40 this policy will raise around 0.7 per cent of GDP. Combined with the broader package above, this amounts to a significant increase in revenues of 1.3 per cent of GDP by the end of the next decade. But importantly it will mean better, not just higher, taxes.
Economic change has slowed down – it must be embraced, and steered
The goal for a new economic strategy is not a somewhat richer, somewhat fairer, version of the UK’s stagnant status quo, but a more enduring shift in direction. The pace of economic change, contrary to popular claims that it is speeding up, is slowing down; the reallocation of labour between sectors is at its lowest level in over 90 years. That matters: higher productivity sectors growing and lower productivity ones shrinking used to add 0.4 percentage points per year to growth in the pre-financial crisis decade.
The notion that it is somehow improper to take a view on the future shape of our economy, must be dispatched. Change must be steered, not with wishful thinking (the UK does not shape global technology developments) but via an understanding that even in a liberal market economy the government can and does shape outcomes.
This book sets out a strategy to grow higher-productivity tradable activity. For the UK, the size of these sectors servicing global demand is far from set in stone and small changes make a big difference: halving the pace of decline in our share of global service exports between 2005 and 2018 would have meant an extra 585,000 people working in these growth-critical fields.
It is easy to point at sectors it would be nice to grow, but a serious strategy must also wrestle with what should not expand. Hospitality, accounting for over 60 per cent of employment growth across lower-paying sectors since 2008, is a crucial employer, not to mention source of significant pleasure. Its size reflects in part a set of choices. The proportion of total consumption that hospitality represents is higher in the UK than anywhere else in Europe. Why? Because it is relatively cheap.
Improving pay and conditions for workers in this and other lower productivity sectors will over time change that. This is a feature, not a bug, of how improved labour market conditions can make Britain a fairer country; workers in lower income households benefit most from higher pay, while richer households, who spend a larger share of their budgets on face to face services, are most affected by the higher prices that follow.
Bad firms need to feel more competitive pressure
Shifting resources from low to high performing firms is much more important to raising national productivity than the current focus on supporting the ‘long tail’ of firms to improve. This type of dynamic change as some firms shrink and others grow has also slowed, and is directly discouraged by a tax system that favours small firms over large – encouraging some not to grow. Bad firms not only hold back the economy as a whole, but also the wages and wellbeing of those working in them. Support should be focused on young, rather than small, firms, while competitive pressures should be fostered via greater trade-openness and by pincering poor performers between higher investing competitors and rising labour standards.
Dynamic labour markets are about more than freedom to hire and fire
For good firms or higher productivity sectors to grow, workers need to move to them. But for too long we have assumed the UK’s flexible labour regime, with the relative ease of hiring and firing, automatically engenders a truly dynamic labour market. It does not: the proportion of workers switching job each quarter declined by 25 per cent between 2000 and 2019. This is not good news: workers’ jobs typically enjoy pay growth 4 percentage points higher than individuals staying put. The missing ingredient is empowered workers, willing and able to take risks.
A key barrier for higher earners is a welfare state that offers them next to no income protection, so new Unemployment Insurance should cover 65 per cent of previous wages for the first three months. In contrast, lower earners receive greater income protection from the benefits system, but often risk losing informal security and flexibility over the hours they work when moving on. Stronger rights to security will mean taking a leap for a new job is more of a promise, and less of a threat.
Slow growth and high inequality are not inevitable. Britain has huge catch-up potential
Renewing the UK’s economic strategy will be far from easy. Some might question how achievable a material increase in growth or reduction in inequality is for a relatively small and mature economy like the UK. But such fatalism misjudges the UK’s room for improvement; we have a lot of catch-up potential.
Consider a set of similar comparator economies: Australia, Canada, France, Germany, and the Netherlands. We would long have considered them our peers and, though impressive, they are not the richest, or most equal, countries in the world. But all are now richer and more equal than Britain. We’re 16 per cent poorer than these countries on average, suggesting catch-up potential that dwarfs the Office for Budget Responsibility’s forecast of a 4 per cent hit from Brexit.
If Britain exploited its catch-up potential, closing its average income and inequality gaps with these peer economies, the typical household would be 25 per cent (£8,300) better off, with income gains of 37 per cent for the poorest households.
A better future for the UK does not need global growth to suddenly accelerate, or Britain to match American levels of productivity and Scandinavian levels of inequality. It just requires us to have the resolve to do what is necessary to converge with similar countries who, in the scheme of things, are not so very different to us. There is a lot to play for.
Moving the UK back into the pack is realistic – and transformative
The strategy outlined in this book could move us in that direction. Over 15 years, improved physical and human capital might mean GDP being 7 per cent higher than currently expected. Wages would receive a 5 per cent boost, sufficient to repair all of the damage done to UK pay levels relative to the G7 average between 2008 and 2022.
Raising growth alone would also raise inequality, with the top half seeing twice the income gains of the bottom half, but our reform agenda would shift the rewards decisively. Progressive wage growth, driven by a rising minimum wage, would raise living standards for middle income households in particular, while further employment gains would be concentrated at the bottom. When combined with our proposed tax and benefit reforms, the poorest households would see the fastest income gains of everyone. This is a new economic strategy capable of raising growth and cutting inequality.
Typical incomes before housing costs for the working-age population would rise by 11 per cent (almost £4,000) more than they otherwise would, sufficient to overtake France and halve the income gap with the Netherlands and Germany. Relative poverty, rather than rising by 1.1 million as currently expected, would be cut by 1.3 million people.
This would amount to a Britain back into the pack of peer economies, but with lots more work to do. And, with only 60 per cent of the eventual impact of higher business investment manifesting within the 15-year frame of our projections, this is an economic strategy whose impact would continue to build.
It is also a strategy to help resolve some of the big macroeconomic trade-offs facing the country. Faster growth, combined with the tax changes proposed, would raise revenues to the tune of 3 per cent of GDP by the end of the 2030s. That would provide useful resources to boost public investment, see to it that the debt burden is genuinely falling, and also support the rebuilding of public services.
Towards a fairer and more prosperous Britain
Ending stagnation is far from automatic, as Italy demonstrates. Disappointing economic outcomes, of the kind the UK has experienced, erode confidence that a better future is possible. Winners from the status quo may oppose change, be they older generations benefiting from the rise of wealth, younger ones confident of inheriting it, or richer households, relatively protected from the UK’s relative decline by its high inequality.
But it is increasingly clear that there is a majority for change. It is middle income Brits, as well as just the poorest, who now find themselves far behind their peers in similar countries. It is not only millennials facing disappointment; those in Generation X are entering their 50s and rightly wondering why their wages peaked in the 2000s. Older voters care about the lives of younger relatives, and also the lack of growth that threatens the funding of the services that they rely on themselves. Many, comfortably off themselves, do not want to live in a nation where every town needs a food bank. Today six in 10 Britons think the country is heading in the wrong direction, with far fewer – just 16 per cent – thinking it is on the right track.
This book brings together an analysis of the key challenges facing the UK and the strengths that can be brought to bear in addressing them. It outlines the contours of an economic strategy that could provide a plausible path to ending stagnation, an agenda that builds on our strengths, invests in our future, delivers good jobs and fairly shares rewards and sacrifices. History teaches us that growth can speed up as well as slow down, and inequality can fall as well as rise. This stagnant chapter of British life has gone on long enough. It is time to turn the page.
Read the full report, Ending Stagnation, here