01Mapping the low wage, high welfare economy
How can the government deliver on its high wage, low welfare promise?
In the first Budget speech of the new Conservative government, Chancellor George Osborne set out his aim of both reducing the UK’s spending on welfare and increasing wages.
“We have to move Britain from a low wage, high tax, high welfare society to a higher wage, lower tax, lower welfare economy.”
George Osborne, Summer Budget 2015
This chapter explores the lessons that successful cities offer the government and Chancellor as they attempt to realise this goal. These cities are places where residents already earn high wages and receive relatively low levels of welfare spending. By analysing the factors driving this success, insights can be gained into the kinds of policy support that other cities, where welfare spending is higher and wages are lower, will need in order to improve their performance.
Box 1: The use of primary urban areas
The analysis undertaken in Cities Outlook compares cities’ Primary Urban Areas (PUAs) – a measure of the built up area of a city, rather than local authority districts. Chapter 3 discusses PUAs, and the recent update of the definition, in more detail.
Cities, wages and welfare
Cities are where the majority of wages are earned in Britain, and where the majority of welfare spending takes place. As Figure 1 shows, cities account for 54 percent of the population, but generate 63 per cent of all wages in Britain. They are also home to 71 per cent of all knowledge intensive business services jobs, which tend to be higher skilled and better paid. But the wages of residents in cities tend to be lower, reflecting the fact that many urban workers actually live outside the city itself. City dwellers receive 54 per cent of all wages earned in Britain.
When looking at welfare overall, spending in cities is equivalent to population (54 per cent). But when old age benefits are removed – the majority of which are protected from cuts to welfare spending – the share of welfare spending in cities increases to 60 per cent, reflecting the younger demographic of urban Britain. These statistics underline the important role that improving city performance will have in achieving a higher wage, lower welfare economy.
Which cities are already high wage, low welfare economies?
Some places are already delivering on the government’s desire to have a higher wage, lower welfare national economy. As Figure 3 shows:
- 14 cities, such as Aberdeen and Reading, already have above average wages and below average levels of welfare per capita.
- 18 cities have below average levels of welfare, but also below average wages.
- The category with the highest number of cities is the one that the government is most concerned about; 29 cities are low wage, high welfare economies.
- Just one city, Southend, is classed as a ‘high wage, high welfare’ city, which is driven by its higher than average spend on old age benefits. For presentation purposes Southend is excluded from the following analysis.
There is a clear geography to these distinctions. As Figure 4 shows, 11 of the 14 cities that are ‘high wage, low welfare’ cities are in the South, with the exceptions being Aberdeen, Edinburgh and Warrington. And just four of the ‘low wage, high welfare’ cities are in the South – Bournemouth, Peterborough, Plymouth and Worthing.
For the government to achieve its ambition of creating a higher wage, lower welfare economy, a more detailed understanding is required of the factors driving these differences – including the ability of cities to create jobs, to attract and retain high skilled workers, and the recent growth in urban welfare spending.
Box 2: Measuring welfare in cities
Welfare spending in cities is overseen by three departments. The bulk of benefit spend, including Employment and Support Allowance and Housing Benefit, is overseen by the Department for Work and Pensions. HMRC is responsible for Child Benefit and Child and Working Tax Credits. And the Department for Communities and Local Government is responsible for Council Tax Support in England, while the devolved administrations deal with it in Wales and Scotland.
Most benefits have data available at the local authority level. Where this wasn’t the case, the regional benefit spend was apportioned to the local authority according to that authority’s demographic. For example, for maternity benefits, the share of births in a region that was in a specific local authority was used to allocate spend to the authority.
High wage, low welfare cities have created more jobs in recent years
Wage growth has been very weak across Britain in recent years. At the national level, wages were 5 per cent lower (in real terms) in 2014 than they were in 2010.
Residents in all three city groups have seen the real value of their pay packets fall. Cities with below average welfare spending have seen the largest falls, with real wages being 6 per cent lower in 2014 than 2010. This compares to the 4 per cent fall seen in the cities that have low wages and high welfare spend (see Figure 5). Even though more successful cities saw a slightly larger fall, it is worth noting that, on average, weekly wages were £155 (35 per cent) higher in these cities in 2014, than in cities that have low wages and high welfare bills.
Although real wage growth has been disappointing in recent years, job creation has not. In 2014, there were over 1 million more jobs in Britain than in 2010. And this net job creation has been felt almost everywhere – just seven cities saw an overall fall in their number of jobs over the period. But both the size and type of this growth has varied across cities.
Private sector jobs have increased across all three groups of cities. But growth has been by far the strongest in the high wage cities that also have low welfare spending, which had 11 per cent more of these jobs in 2014 than in 2010. This was triple the increase seen in the low wage, high welfare group (see Figure 6).
The type of private sector jobs created has also varied across the three groups. Around one in three net new private sector jobs created in high wage, low welfare cities has been in knowledge intensive business services (KIBS), which tend to be higher skilled, better paid jobs. In the low wage cities that have high welfare spending, this figure was one in four. Interestingly, in low wage, low welfare cities – where private sector growth has been the lowest – the contribution of KIBS has been the highest – more than one in two net new private sector jobs was a KIBS job.
High wage cities with low welfare spending have also seen the strongest growth of publicly funded jobs in recent years. This is for two reasons: firstly, they have seen the smallest cuts to jobs in public administration. Secondly, reflecting their larger population growth and greater demand on services, they have also seen the largest increases in jobs in health and education, as shown in Figure 6.2
Box 3: Definition of publicly-funded jobs
Publicly funded jobs are defined in this work as those jobs that fall into the sectors of:
- Public administration and defence
This definition is not perfect. But according to the ONS, it captured 85 percent of what the ONS classes as ‘public sector’ in 2013.3 And of the remaining 15 percent, 7 percent were jobs in financial services – principally RBS, which is likely to be re-privatised – and communications – principally Royal Mail, which has now been privatised.
Our definition also captures those jobs, such as GPs, universities and sixth form colleges – the latter classed as public sector in Wales and Scotland but private sector in England – that are principally funded by the public sector. This does of course mean that private education and health care providers are also captured in this measurement, but unfortunately the data is not made available to create a more refined definition.
High wage, low welfare cities also tend to have much higher shares of skilled residents
High wage, low welfare cities tend to have more highly qualified people living in them. Cities with large shares of high skilled residents living in and around them are attractive to high skilled businesses. The higher skilled a person is, the more likely it is that they will be able to find employment and the less likely it is that they will require welfare support. For both of these reasons, skills is a very important factor in explaining the divergence seen between the different groups of cities.
As Figure 7 shows, almost half of working age people in cities with high wages have a degree, compared to around one in three in low wage cities. School performance tends to be much higher too – cities that have higher paid residents and low welfare spend tend to see a higher share of pupils get at least five good GCSEs. This means that not only do high wage, low welfare cities have a larger stock of high skilled residents, but also that those entering either the workplace or higher education tend to be more highly qualified.
But high wage, low welfare cities have seen the largest growth of welfare in recent years
Spending on benefits in Britain has risen sharply in recent years. Between 2004/05 and 2010/11, real benefit spending increased by 24 per cent. But the geography of this is surprising – it was the cities with the lowest benefit spend at the start of this period, rather than the highest, which saw the largest increases.
Milton Keynes saw the largest increase of all cities – its total welfare bill increased by 45 per cent. It was followed by Peterborough, Slough and Swindon. Meanwhile Aberdeen, Dundee and Glasgow saw the smallest increases.
There were two principal reasons for this. Firstly, high wage cities with low welfare spending saw larger increases in housing benefit spend than low wage cities with a high welfare spend (see Figure 8). Secondly these cities also saw much larger population growth, which increased benefits spending linked to demographics, such as maternity pay and child benefit.
Box 4: National welfare spending since 2004/05
Over the term of the last Labour government, welfare spending outstripped economic growth. Between 2004/05 and 2010/11 the welfare bill grew at over 4 per cent a year in real terms, compared to an average annual growth rate of the national economy of 0.8 per cent. This growth of welfare spending was driven by tax credits, pension benefits and housing benefit.
In the first couple of years of the last parliament, welfare spending slowed, particularly welfare spending on things other than old age benefits, but it did continue to grow. This has changed since 2012/13. Benefit spend has declined in real terms, with welfare spend excluding old age benefits falling by 0.7 per cent a year. This decrease has been driven in part by the fall in unemployment seen in recent years, which has reduced spending on Jobseekers’ Allowance. But cuts to Child Benefit and Child and Working Tax Credits have also been important.
Real terms annual average growth in welfare, 2014/15 prices
This pattern has continued since 2010/11. All categories of cities have continued to see an overall increase in real benefit spend between 2010/11 and 2014/15, mainly as a result of old age benefit spending, as discussed in Box 4. But this increase has been smallest for low wage, high welfare cities, with housing benefit once again being the principal difference between the groups (Figure 9).
This analysis reveals a number of things about the nature of welfare across our cities. Firstly, the size of the welfare bill in cities where spending is above average is not simply a result of increases in welfare budgets over the last 10 years – spend is above average despite these cities seeing slower population growth. The causes of high welfare spend in these cities are much more fundamental, and are likely to be due to long term structural weaknesses in their economies.
Secondly, the larger increases in benefit spend in high wage, low welfare cities is in part a result of their economic strength. Growing demand to live in these cities in order to access jobs has tended to outstrip increases in the supply of housing, pushing up rents, and in turn, spending on housing benefits. As Figure 11 shows, housing benefit payments in high wage, low welfare cities were more than 50 per cent higher than other cities. The increase in the benefit bill in recent years in these cities has occurred because of a structural problem not in their economies but in their housing markets.
What are the implications for policy?
Those cities that have higher than average wages and lower than average welfare bills have seen the strongest growth in jobs, but also in welfare, in recent years. And their stronger economies make them well placed to continue to grow in the coming years. The challenge for the government will be to limit further increases in welfare spending in these cities, which have in part been driven by a combination of high demand to live in them and an insufficient response in terms of the expansion of supply of housing.
In low wage, high welfare cities, the government faces a very different challenge. Welfare cuts alone will neither help improve wages in these cities or reduce their requirement for welfare. They can attempt to bring down welfare spending directly through the spending decisions they take – the intention is to reduce total welfare spending by £12 billion by 2020 – but ultimately, the size of the welfare bill and the performance of the economy are interlinked.
The weaker economies of these cities means that they will need a range of economic policy interventions if they are to experience sustained economic growth at the same time as cuts to welfare spending. And while the introduction of the ‘National Living Wage’ and reductions in the personal allowance will increase wages, they will not address the underlying reasons why wages are lower in these cities in the first place.
In responding to these challenges there are three main areas for the government to focus on in their attempt to move from a low wage, high welfare economy to a high wage, low welfare economy.
First, in cities with low wages and high welfare spending, cuts to bring down welfare must be accompanied by policies to improve the economy, particularly around skills. While much has been said about transport investment in the context of the Northern Powerhouse, much less has been said about improving school performance and adult education. But low skills will both hinder the opportunities available for people to move off welfare and into work and will hinder attempts by cities to attract investment from businesses.
Second, devolution would help all cities better integrate skills and employment interventions and welfare spending. Currently, spending on employment and skills programmes and benefit spending are not connected. This means that there are few financial incentives to invest in an employment and skills programme that helps to reduce welfare spend, because those responsible for investing in the former do not get to keep the savings made in the latter. This hinders the goal of getting people back into work.
Creating a link between these two areas of funding, for example through giving city regions control over both budgets and allowing them to keep some of the savings made, would be a way to address this. The devolution of health and social care budgets in Greater Manchester has been done with the aim of reducing spending by reducing duplication, better integrating services and allowing Greater Manchester to keep the savings made. The same principle holds for skills and employment and welfare spending, and the government should look to devolve these budgets to city regions too.
Finally, in high wage, low welfare cities, rising house prices will continue to increase demand for housing benefit. Short term freezes to housing benefit payments will temporarily limit increases in housing benefit spending, but they will not address the underlying cause of this increase. The simple answer is to build more houses in these cities. The government has announced its intention to build 400,000 extra affordable homes by 2020. These houses need to be built in cities where housing benefit payments are highest.
Each of these changes – improvements in education and skills levels, devolution and integration of budgets and services, and increases in housing supply within high demand cities – will take several years to deliver, and longer still for the full range of benefits to be felt. Creating a higher wage, lower welfare economy will, in all likelihood, be the work not of one Parliament, but of several.
Given the scale of the challenge facing a large number of cities, it is vital that the government acts now to lay the foundations for these changes, maintaining the momentum behind the devolution deals announced to date, and going much further in the years to come in equipping urban areas to fulfil their economic potential.