Why it's unlikely benefits increases will be linked to earnings

Gloomy projections all round.

Following another Newsnight scoop, there must be debate in Westminster about whether the coalition are going to change their approach to uprating benefits - increasing them annually in line with inflation - for people of a working age. Coalition splits have already been predicted and then resolved before the pre-Autumn statement debate has even got underway.

This issue arises because the Coalition are on the hunt for welfare savings and playing around with benefit upratings is always one of the first places HM Treasury will turn to save money.  To start with it’s worth recalling that the Coalition has already changed its uprating policy from RPI (or the derived ROSSI index) to CPI for most working age benefits – generating significant savings, arising from lower living standards for recipients - than would otherwise be the case. So any further change in upratings policy comes on top of this.

A straightforward freeze in all benefits, as has been reported in some places, will of course save significant sums – though significantly less than the £10bn annual figure that George Osborne has said he wants. But it is also been reported that as part of the hunt for savings in the future, perhaps after a two-year freeze, benefits would be uprated in line with earnings.

Now, this is rather odd. According to the OBR, earnings are expected to outpace inflation from the start of 2013, with the gap growing to around 2.5 per cent a year from 2015. Based on these projections, an earnings link would be a very expensive policy indeed.

It may well be that HM Treasury no longer believes these sorts of earnings projections. Indeed a new report out today by leading labour market economists Steve Machin and Paul Gregg provides strong grounds for expecting a very slow recovery in wages. That’s because levels of unemployment are having such a chilling effect on pay – far more so than was the case when we were seeking to recover from previous recessions (this research also helps explain why we saw wage stagnation in the years prior to the recession). Indeed, today’s FT takes a bit of a leap by suggesting that the Treasury may seize on this report to pave the way for a much gloomier outlook for wages which would in turn justify linking benefits to earnings in the future.

My guess is that this won’t happen (although you wouldn’t necessarily bet against a freeze in benefits being followed by a move to a new approach of uprating benefits by the lower of either inflation or earnings). That’s because in order for the Treasury to realise any savings by linking benefits to wages rather than inflation they would have to produce some earnings projections that the OBR would need to verify.

These would have to be radically different from the existing OBR numbers. What’s more, they would need to show that typical real-terms wages – flat since 2003, falling since 2009 – are set to carry on falling throughout the next Parliament. That’s announcing that most working people are going to carry on getting poorer during the so-called recovery. Something tells me George Osborne isn’t going to do that. 

A man walks on pennies. Photo: Getty

Gavin Kelly is a former adviser to Downing Street and the Treasury. He tweets @GavinJKelly1.

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Why relations between Theresa May and Philip Hammond became tense so quickly

The political imperative of controlling immigration is clashing with the economic imperative of maintaining growth. 

There is no relationship in government more important than that between the prime minister and the chancellor. When Theresa May entered No.10, she chose Philip Hammond, a dependable technocrat and long-standing ally who she had known since Oxford University. 

But relations between the pair have proved far tenser than anticipated. On Wednesday, Hammond suggested that students could be excluded from the net migration target. "We are having conversations within government about the most appropriate way to record and address net migration," he told the Treasury select committee. The Chancellor, in common with many others, has long regarded the inclusion of students as an obstacle to growth. 

The following day Hammond was publicly rebuked by No.10. "Our position on who is included in the figures has not changed, and we are categorically not reviewing whether or not students are included," a spokesman said (as I reported in advance, May believes that the public would see this move as "a fix"). 

This is not the only clash in May's first 100 days. Hammond was aggrieved by the Prime Minister's criticisms of loose monetary policy (which forced No.10 to state that it "respects the independence of the Bank of England") and is resisting tougher controls on foreign takeovers. The Chancellor has also struck a more sceptical tone on the UK's economic prospects. "It is clear to me that the British people did not vote on June 23 to become poorer," he declared in his conference speech, a signal that national prosperity must come before control of immigration. 

May and Hammond's relationship was never going to match the remarkable bond between David Cameron and George Osborne. But should relations worsen it risks becoming closer to that beween Gordon Brown and Alistair Darling. Like Hammond, Darling entered the Treasury as a calm technocrat and an ally of the PM. But the extraordinary circumstances of the financial crisis transformed him into a far more assertive figure.

In times of turmoil, there is an inevitable clash between political and economic priorities. As prime minister, Brown resisted talk of cuts for fear of the electoral consequences. But as chancellor, Darling was more concerned with the bottom line (backing a rise in VAT). By analogy, May is focused on the political imperative of controlling immigration, while Hammond is focused on the economic imperative of maintaining growth. If their relationship is to endure far tougher times they will soon need to find a middle way. 

George Eaton is political editor of the New Statesman.