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.

Photo: Getty
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In the row over public sector pay, don't forget that Theresa May is no longer in charge

Downing Street's view on public sector pay is just that – Conservative MPs pull the strings now.

One important detail of Theresa May’s deal with the Democratic Unionist Party went unnoticed – that it was not May, but the Conservatives’ Chief Whip, Gavin Williamson, who signed the accord, alongside his opposite number, the DUP MP Jeffrey Donaldson.

That highlighted two things: firstly that the Conservative Party is already planning for life after May. The deal runs for two years and is bound to the party, not the leadership of Theresa May. The second is that while May is the Prime Minister, it is the Conservative Party that runs the show.

That’s an important thing to remember about today’s confusion about whether or not the government will end the freeze in public sector pay, where raises have been capped at one per cent since 2012 and have effectively been frozen in real terms since the financial crisis.

Michael Fallon, the Defence Secretary, signalled that the government could end the freeze, as did Chris Grayling, the Transport Secretary. (For what it’s worth, Gavin Barwell, now Theresa May’s chief of staff, said before he took up the post that he thought anger at the freeze contributed to the election result.)

In terms of the government’s deficit target, it’s worth remembering that they can very easily meet Philip Hammond’s timetable and increase public sector pay in line with inflation. They have around £30bn worth of extra wriggle room in this year alone, and ending the pay cap would cost about £4.1bn.

So the Conservatives don’t even have to U-turn on their overall target if they want to scrap the pay freeze.

And yet Downing Street has said that the freeze remains in place for the present, while the Treasury is also unenthusiastic about the move. Which in the world before 8 June would have been the end of it.

But the important thing to remember about the government now is effectively the only minister who isn’t unsackable is the Prime Minister. What matters is the mood, firstly of the Cabinet and of the Conservative parliamentary party.

Among Conservative MPs, there are three big areas that, regardless of who is in charge, will have to change. The first is that they will never go into an election again in which teachers and parents are angry and worried about cuts to school funding – in other words, more money for schools. The second is that the relationship with doctors needs to be repaired and reset – in other words, more money for hospitals.

The government can just about do all of those things within Hammond’s more expansive target. And regardless of what Hammond stood up and said last year, what matters a lot more than any Downing Street statement or Treasury feeling is the mood of Conservative MPs. It is they, not May, that pulls the strings now.

Stephen Bush is special correspondent at the New Statesman. His daily briefing, Morning Call, provides a quick and essential guide to domestic and global politics.

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