Economics: Welfare reform starts with jobs

THE STAKES on the reform of the welfare state could not be higher. Success or failure will help to determine our economic performance and prosperity; the level of crime; the upbringing of our children; the safety net spread under the unlucky; and the spending patterns of the rest of us.

And there will be reform, as all three political parties are involved in a reassessment. The Labour Party's Commission on Social Justice under Sir Gordon Borrie's chairmanship is likely to be no less radical than the Government's own review, which a leaked Cabinet paper last week showed to be mainly driven by the desire for spending cuts.

Into this widening public debate has stepped John Hills, whose magisterial summary, published last week, reviews the main issues (1). He convinces me that the present course of government policy, particularly the failure since 1979 to raise pensions and other benefits in line with earnings rather than prices, is not sustainable.

The current policy implies a growing gap between the rising real incomes of those in work, and the stagnant real incomes of the unfortunate. Had the principle been applied since 1948, the basic single pension would be pounds 23 a week today instead of pounds 56.10.

The graph shows how the pension gap is growing, so that the poorest third of pensioners are being left behind. A similar phenomenon is occurring with other benefits. The value of unemployment benefit has now dropped to less than 30 per cent of average disposable incomes from a peak in the mid-Sixties of nearly 45 per cent. Five out of six of the unemployed in a 1987 survey had income out of work less than 80 per cent of their previous work income. Most had less than half.

This trend subtly affects the low-paid. The benefit system in effect applies a minimum wage, because people will prefer to draw benefit rather than work if their pay is too low. So the relative fall in benefits lowers the relative pay of the low-paid. This is one factor behind the growing gap between them and the well-paid, wider than at any time since the figures began in 1886.

The overall impact on inequality is substantial. If we define people in poverty as having incomes less than 40 per cent of the national average, the poor have increased from 1.7 million in 1979 to 7.7 million. This point has less force, of course, if the incomes of the poor are growing, even though the average is growing more quickly. But this is no longer true. The figures show an increase in the number of poor people whose living standards have actually fallen over the last decade.

If we define people in poverty as those who have incomes below 40 per cent of the national average when Lady Thatcher came to power in 1979, and we put all incomes into present-day pounds after allowing for price rises, then the number of poor people has nearly doubled from 1.7 million in 1979 to 3 million today. On whatever definition, poverty has increased.

Politicians, though, would be well advised not to imbibe all of Mr Hills's conclusions too swiftly. They could be damaging to their chances of election. Understandably sympathetic to the welfare state, Mr Hills seeks to argue that we could broadly maintain our present system in its current shape and form - including raising benefits in line with earnings - if we wanted to do so.

I doubt that this is practical politics, and Mr Hills's figures, far from supporting the case, merely confirm my scepticism. The main problem is that the over-65s will comprise 24 per cent of the population in 2041 compared with 16 per cent today. Even though the ageing of the population is less pronounced than almost anywhere else, it would still require extra spending worth some 5 per cent of national income each year by 2041 to maintain benefits relative to incomes.

This may not sound a lot and it is certainly not a crisis. We spend less on welfare than most developed countries and such an increase in spending would be similar to the rise over the last three recession years alone. But much of the impact on taxation of the recent rise has not yet occurred, since the surge in borrowing to 8 per cent of national income has taken the strain. Tax increases have only been delayed.

And a tax increase worth 5 per cent of national income, or some pounds 33.5bn in 1994-5, would raise the basic rate of income tax from 25 pence to 43 pence. Of course, this would all take place very slowly, since the ageing of the population is gradual. But I somehow doubt that many practising politicians would welcome a tax increase even a fraction of this size.

Whatever the opinion poll evidence suggesting that people are prepared to pay higher taxes for more public spending, the evidence of the ballot box, not just in Britain at the last general election but also in the United States in the recent state elections (where tax- increasing Democrat governors were defeated), is that we have reached the political limits of taxation. The voters simply do not trust politicians to spend their money wisely, especially when those politicians are heavily supported by trade unions representing public sector workers.

There are several ways out of this problem, which might include a package of defence cuts, a real effort to improve public sector efficiency, and the introduction of user charges, particularly for roads. But it would be surprising if we were able to avoid hard choices for the welfare state, which will have to target its resources more carefully. Targeting is the only way to square the circle of a potential tax revolt and a deepening chasm of poverty.

Take the example of child benefit, which might be clawed back through the tax system so that the Duke of Westminster repays what the Duchess of Westminster receives. But the more radical option must be to develop ways of helping the third of pensioners who rely solely on the basic pension other than through a rise that goes to better-off pensioners as well. A special supplement could, for example, be linked to earnings.

But surely the big gains would come from tackling the causes of much of the stress on the welfare state, rather than trying to suppress the symptoms. So many of its problems - poverty and low pay, family breakdown, inadequate savings, poor health, young men lacking in self-respect - are aggravated by insecure jobs punctuated by dispiriting periods of joblessness.

Quite apart from the social costs of unemployment, there are immense economic costs. Gilles Saint- Paul (2) points out that France or Italy have lost 5 per cent of national income each year for 12 years through high unemployment, a loss similar in scale to the major destructions of the European capital stock wrought by the world wars. Yet there is a clear set of workable solutions - the so-called active labour market policies that train and counsel the long-term unemployed - that have had considerable success in Sweden.

But this would involve doubling or trebling the normal 1 per cent of national income spent on training and counselling, and it would require reducing the privileges of the employed. Mr Saint- Paul concludes that governments simply do not care about the unemployed, who are a poorly organised minority. This is a chilling conclusion, not least because it may also apply to the fifth of the population who can be ranked as poor. Maybe Lady Thatcher had more sympathisers than she knew when she said that there is no such thing as society, only individuals. But if we do not begin to reawaken to the merits of a fair and cohesive society, we will come increasingly to resemble the United States.

We, the majority, will not walk the streets. We will drive from home to office, keeping the car doors locked at traffic lights. We will install ever more sophisticated alarm systems to prevent burglary. We will live in well-guarded suburban enclaves, trying ever more expensively to create private order amidst social chaos.

We have a choice. We allow the poor and the unemployed to participate in our prosperity. Or we create the drawbridge society.

(1) John Hills: The future of welfare, J Rowntree Foundation, pounds 8.50. (2) Gilles Saint-Paul: On the political economy of labour market flexibility, Centre for Economic Policy Research, paper no 803.