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The truth about welfare

The system is broken and the government is making it worse.

How times change. In 1942, the Beveridge report was launched to popular acclaim. People queued around the block to pick up a copy. Welfare was a vote-winner. In the intervening seven decades, the descent from Beveridge has been total. Public attitudes have turned and the political parties now compete to sound tough on “scroungers”. In setting out their proposals, politicians invoke Beveridge, however tenuously, in a forlorn effort to re-create the optimism of that time. Yet there is no escaping facts – our welfare system today is politically toxic and the public debate about it has become untethered from evidence or a semblance of rational discussion.

Beneath the hyperbole, the government’s welfare reform agenda offers no solution to this deep crisis of legitimacy. For three decades, successive governments have pursued broadly similar strategies that have had mixed success with some negative economic side effects. Since 2010, the challenge of deficit reduction has spurred the coalition to intensify the usual policy prescriptions. But this approach is fast running out of road. It offers no vision for a welfare system that might once again command popular support. And critically, the agenda is damaging the country’s productivity and prosperity. If the Prime Minister wants to equip the UK for the “global race”, he needs to know the truth about welfare.

A paradox

The politics of unemployment benefit is a paradox: it is simultaneously meager and unpopular. At just £71.70 a week for a single adult, the main unemployment benefit, Jobseeker’s Allowance (JSA), is among the most limited in the world. On becoming unemployed, a single childless person on average earnings in the UK faces the biggest drop in income of any jobless person anywhere in the OECD. 

The value of JSA as the main social security benefit for unemployed people has flatlined since the early 1970s, while average incomes and consumption have roughly doubled. For the average earning couple who have children, the picture is little better. What’s more, the claims are usually brief. Nine out of ten JSA claimants are back in work within the year.

So unemployment protection in the UK is remarkably ungenerous. And yet, over the past 20 years, the public’s support for our system of working-age welfare provision has declined precipitously. Public outrage over incidents such as the recent Philpott case in Derby often stems from a reaction to the benefit system in general. But the unemployed are usually the particular focus of this opprobrium.

Fully 62 per cent of people now think that “benefit payments are too high and discourage work”, up from 27 per cent in 1991. In 2001, 88 per cent of the British public agreed with the statement that our government should be “mainly responsible for ensuring that people have enough to live on if they become unemployed”. A decade later, this had fallen to 59 per cent.

Our welfare system is failing politically. It does not inspire confidence among taxpayers, nor does it provide effective support for those who need it. Increasingly it is seen to be overgenerous, disincentivising work, and out of control. Yet paradoxically, for the vast majority of workers, it provides some of the least generous support available in the developed world for people who experience the misfortune of unemployment.

How did this situation come about?

Explaining the paradox

Despite Beveridge’s grand vision, the compromises made to get the postwar welfare system in place sowed the seeds of today’s problems. The level of insurance-based benefits, which derived from past contributions, persistently slipped below the means-tested minimum. Consequently, little advantage accrued to those who had worked hard and paid in to the system.

This problem was compounded by the reforms instituted by later governments. First, Beveridge’s flat-rate contribution was replaced with earnings-related contributions in return for the promise of earnings-related benefits. Over time, however, those earningsrelated entitlements were left to wither. That widened the gap between what people on middle and higher incomes paid in and what they could expect to get out of the system. In 1996, even the nominal distinction between insurance-based and means-tested benefits was erased with the introduction of Jobseeker’s Allowance.

For contributors, these problems stoke the sense of injustice at claimants who get similar benefits without having paid in enough. So it is unsurprising that barely a week goes by without a politician of some variety lamenting a “something for nothing” culture of the benefits system. Tabloid hyperbole fuels the sense that large numbers of people are taking the rest of us for a ride, no matter the detail.

Yet that is not the whole story. Recent government analysis of a typical group of unemployed adults shows that only a small minority – 11 per cent of claimants in 2010-2011 – have a history of spending more than half of recent years on the dole, moving cyclically in and out of employment.

For many claimants the problem with welfare is just the opposite. It is rare for typical claimants to have long or frequent spells on unemployment benefits. The same analysis shows that 76 per cent have spent less than a quarter of the past four years on the dole. Indeed, for 40 per cent of typical claimants each year, the need to claim Jobseeker’s Allowance is an aberration in an otherwise unbroken employment history.

Yet, despite these people’s past tax and National Insurance contributions, the welfare system today gives them scant support. The meagre value of JSA stokes a sense that if you play by the rules, you get very little in return. In the current economic context, with job insecurity high, this further weakens the political legitimacy of the system.

The coexistence of “something for nothing” and “nothing for something” is hard-wired into the structure of our unemployment benefit system. The UK’s flat-rate unemployment benefit regime is very unusual among developed countries. Most members of the OECD – including the United States – offer benefits that relate directly to people’s prior earnings, ensuring an association between what people pay in and what they can expect to get out of the system. By decoupling the entitlements of those who have paid in from those who have not, such systems have proven much more politically resilient over time.

In the UK, by contrast, as political debate revolves relentlessly around the “something for nothing” problem, policy becomes increasingly designed around a small minority of the unemployed. The result is a lowest-common- denominator welfare reg ime that offers no meaningful insurance for most working people.

The orthodox prescription

It’s not simply populism that lies behind the government’s reform plans. The dire state of the public finances has unavoidably put benefit spending under greater scrutiny than ever. In that context, the coalition is cutting entitlement levels to save money directly, but also in a genuine effort to get more people back to work.

There are two main elements to the coalition’s strategy. The first is to cut benefit levels to make work more attractive. The second is to ramp up the pressure on claimants to return to work quickly, using stringent sanctions. These policies represent an intensification of labour-market policy of the past 30 years, rather than a departure from it. But it’s time we re-examined just how successful some aspects of this orthodox approach are.

Squeezing workless benefits for the unemployed has the virtue of making work more attractive and also saving money. Unsurprisingly, it has been high on the policy agenda. Multibillion-pound cuts to benefits have been made and more lie ahead. On the whole, these will strengthen incentives to return to work. When it comes to unemploymentrelated benefits they may save money – but are they economically wise?

The link between benefits and the duration of claimants’ unemployment spells has been explored thoroughly by researchers. From the 1980s onwards, an influential body of literature highlighted how high benefit levels slow the pace at which people return to work.

And it stands to reason. Generous benefits can make people less inclined to return to work quickly, or more selective about what work they take, because someone else is paying. Meagre levels of support, on the other hand, cause people to get back to work as soon as possible – the better for them and for taxpayers, it is argued. In this view, benefits may be a social necessity but they are an economic drag and should be minimised.

However, this is an inadequate description of how the labour market works and the role that unemployment benefits play. More recent evidence demonstrates that putting too much financial pressure on people to return to work can be economically damaging. If the government wants to equip the UK’s workforce to compete in the global economy, its policies need to reflect this fact.

Unemployment benefits play a crucial role in allowing people time to search, not just for any job, but for the right job – one that puts their skills and experience to the best use. Not only is this good for the jobseeker but it benefits the employer and makes the economy more productive. Higher benefits for skilled workers also facilitate a more flexible workforce. By cushioning the social consequences of redundancy, they oil the wheels of economic change.

Economists increasingly see these aspects as important but policymakers overlook them. Labour-force productivity depends crucially on the effectiveness of the job search and matching process. Where benefits are slight, jobseekers often have no choice but to take the first job that comes along, regardless of whether it suits their skills. Viewed from a personal and societal perspective, however, this is a wasted opportunity. We can’t afford to have our rocket scientists stacking shelves in Poundland.

As the OECD has argued, the benefits of better job matches go further than making the best use of existing skills. Good matches lengthen job tenure, which improves employees’ skills through experience and through the greater likelihood of their receiving further training. Poor matches cause workers’ prior skills to deteriorate, making past training redundant and raising staff turnover. And in an environment where getting people back to work immediately is the policy priority, there is little incentive for workers to invest in their own skills. Other economists have identified these dynamics as an important part of the explanation for growing wage inequality in countries where financial support is low compared to continental Europe.

There are good reasons to think that job matching is increasingly important for productivity. In today’s high-skilled knowledge economy, it takes longer to find the right job and finding the right job is more valuable to both employee and employer than in the lowskilled economy of the past. In the context of rapid technological change and the economic restructuring that occurs in a recession, the importance of labour-market institutions in refining the job match grows.

None of this is to deny that more generous unemployment benefits also dampen incentives to find work. The challenge is to strike a balance. So, how well are we doing?

Recent evidence suggests that we’re doing badly. The Harvard economist Raj Chetty has shown that most unemployed people with access to funds – either savings or a redundancy payment – spend longer looking for the right job. Where benefits are low, evidence that people are willing to spend their own savings to fund longer work search indicates their belief that ultimately it will yield a better outcome and hence be a worthwhile investment. Meanwhile, those who are wholly dependent on unemployment insurance move back more quickly, because they are not in a position to turn down unsuitable work.

Chetty concludes that, for the most part, the longer unemployment spells that come from more generous unemployment support are evidence of productive job-hunting, more so than they are a sign of slacking. For all these reasons, where unemployment insurance is too low, the labour market does not function effectively, damaging the economy and reducing prosperity. Daron Acemoglu of the Massachusetts Institute of Technology argues that a moderate level of unemployment insurance can improve the functioning of the economy and the level of output.

If the financial incentives strategy seems economically suspect, what about the other strand of the government’s response to the welfare legitimacy crisis? Backed by the threat of benefit sanctions, state “activation strategies” aim to push people to search for work more intensively and speed up their return to employment. The case for making the UK unemployment system even more stingy looks threadbare.

Since the 1980s, it has been clear that socalled activation works to get people out of unemployment more quickly. The Thatcher government’s Restart programme, launched in 1986, put work-focused interviews and monitoring at the heart of the unemployment regime, where they remain today. Evaluations of such programmes have shown their effectiveness in tackling the scourge of longterm unemployment.

And yet, for most jobseekers, the tough sanctions regime is of questionable economic value. Rapid re-entry into employment often comes at the cost of lower-quality jobs. Where jobseekers are pushed hard to take the first job that comes along, the usual result is a poorer job matches, lower wages and higher turnover. As such, it’s not surprising to find that the UK has a high level of people moving in and out of work. Activation might prevent people slipping into inactivity and irretrievable worklessness. But its intensive use solely to shorten unemployment spells of those with good skills and sound work experience is misguided.

Our welfare system is mired in a crisis of legitimacy. The government proposes a solution of greater conditionality and uniformly lower generosity. It is a bleak prospectus. Its highest ambition is to minimise the public cost of the system, regardless of the economic consequences. That approach will never resolve the “something for nothing” problem that flows from the fundamental design of the system. And more importantly, in respect of skilled and experienced workers, cutting support and tightening sanctions is pure economic folly.

Employment policy matters not just because it affects people’s lives directly but because the labour market needs well-designed institutions in order to thrive. Economics has moved on in its analysis, but the policy remains marooned in the 1980s. We can equip our workforce to succeed in the “global race”, but we need a smarter approach to tackling the unemployment challenge.

Ian Mulheirn is the director of the Social Market Foundation. This essay is an edited extract from his forthcoming publication “Beveridge Rebooted”

By Ian Mulheirn

Ian Mulheirn is the director of the Social Market Foundation.

This article first appeared in The Dream Ticket