Living standards and the recovery: the difficulties with defining income groups

April 7, 2014

The debate around falling living standards is in the news again today. The Social Market Foundation has produced new research on how middle income households have fared over the course of the recession, and Ed Miliband’s article for The Independent continues Labour’s pre-election narrative on a “cost of living crisis”. Both pieces focus attention on earners in the middle of the income distribution, and both foresee – despite the economy’s improving health – that this group will experience several more years of a living standards squeeze. However, it is not just one specific part of the income distribution that has been affected by the fall-out from the financial crisis, and no specific part will escape the fact that the economy is still a long way from what can be regarded as normality.

The SMF’s findings show the difficulties in defining groups within the income distribution, not least because the proportion of middle-earners moving up it since 2007 is greater than the proportion moving down it. This not only highlights the significant labour market churn that can occur during a period of economic stress, but also that pay progression and mobility can be achieved. The research also shows how middle-income households combatted the downturn between 2007 and 2012; food bills were reduced by switching to cheaper products, spending on leisure activities was cut back, and mortgages became cheaper due to historically low interest rates. But these benefits cannot, by and large, be realised by low-income households, which face a different set of problems. As IFS analysis shows, those at the bottom of the income distribution spend a greater proportion of household budgets on food and rent than those at the top, and less on leisure activities and mortgage interest payments. This means that there is less capacity to substitute away from spending on leisure when real incomes fall, and less direct gain from five years of a 0.5% Base Rate. The flip side of this is that these households are likely to gain more from state tax and benefit transfers than middle income households.

This shows that different parts of the income distribution can have very different characteristics, and there are numerous factors that can dictate changes in living standards. Looking further back than the start of the crisis, distinct income patterns are also evident. Policy Exchange research has found that between 1997 and 2009 wage growth was slowest in the lower-middle part of the income distribution, and fastest at the bottom and top, which raises questions around the “hollowing out” of the labour market, the ability of employees to achieve pay progression and the impact of the National Minimum Wage across all incomes. This led us to ask what type of public policy intervention could help all pay packets, and in our recent report, Taxing Jobs, we argued that the link between productivity and pay has remained robust during the recession, and that the most effective way to stimulate a recovery in wages would be to cut Employer National Insurance contributions. Not only would this incentivise hiring and competition amongst firms to attract workers, it also recognises what the evidence tells us, which is that trying to pin down interventions for specific income groups is very difficult to achieve.

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