Podcast | How the UK’s economic challenges may affect us in years to come

Article Header

November 25, 2022

34 mins read

We spoke to Paul Johnson, CBE, Director at the Institute for Fiscal Studies, about public sector strikes, shrinking household incomes, rising taxes, economic inactivity and the challenges faced by younger people.


Voice Over: The Thinking Forward podcast brought to you by Standard Life.

Sangita Chawla: Welcome to our Thinking Forward, thought leadership podcast series. In this series, we discuss trends and developments impacting the UK pensions industry in order to understand how more people in the UK can achieve financial security now and in later life. I'm Sangita Chawla, Chief Marketing Officer at Standard Life. Today we're here to discuss the likely impact of the UK's economic challenges on people's pensions, their retirement plans, and their broader financial priorities.

To help with this discussion, I'm very excited to have as our guest speaker, Paul Johnson. Paul has been director of the IFS since January 2011. He's also currently visiting professor in the Department of Economics at University College London and a regular contributor on the economy in the press, the TV, and the radio, and I'm sure many of you will have heard of him. Hi, Paul. Welcome to Thinking Forward.

Paul Johnson: Hi. Thank you very much.

Sangita: We'll see what interesting conversation and cheery conversation we can have on the economic market today, Paul. I thought I might just start by some scene setting if I can ask a first question of you. Now, many people today, as we know, facing increased financial pressures and vulnerability due to the UK's current economic challenges. Why are we in this situation in the first place?

Paul: As ever, there's quite a number of reasons, but the first most immediate issue that we're facing, of course, is the big increase in prices, particularly of energy, partly resulting from the Russian invasion of Ukraine, but by no means only that, but also increases in food prices and many other prices. A lot of that has been created by supply problems across the world. The amount that we are paying for a lot of what we import has gone up. The short answer to your question is as a result of that, we've just got poorer and quite significantly poorer. It's what economists call a terms of trade shock.

In other words, the stuff that we import has got a lot more expensive relative to the stuff that we produce here. That's resulted in, for example, The Office for Budget Responsibility saying they expect household incomes to fall by 7% over two years this year and next, which if that comes to pass, will be much the worst two years for household incomes since the data started being collected back in the 1940s.

I'm afraid what's makes this even harder is this comes off the back of a period of 15 years or so when incomes have barely increased at all, particularly for people of working age. Earnings have done very badly. We've probably had the worst 15 years for earnings growth, probably since the beginning of the industrial revolution or thereabouts. This fall in income that we're seeing at the moment, as it often does, come off the back of a nice long period when it comes to being rising, but of a period when it comes of being doing really quite badly. That's why it really does feel quite tough for a lot of people.

Sangita: Thanks, Paul. Thanks for clarifying. I was going to say that doesn't sound a great position for many of us to be in. We have the chancellor's Autumn Statement and a lot of press, including from yourself around the conversation of higher taxes. Are we set to get poorer still as people next year, do you think? Disposable income, I know you just touched upon is that people are strained at the moment. How's that going to affect us all next year?

Paul: Income's not going to look too good next year either. Inflation is still going to be relatively high. Earnings don't look like they're going to keep up with inflation over that period. Indeed, as you say, there'll be some tax rises as well, and that's part of the 7% fall that I've just been talking about. If you put this year and next together, then you get that fall in income over the two years as a whole. We're already seeing that at the moment because earnings aren't going up as fast as prices. I expect we'll see something similar next year.

As we go further through time, hopefully, the economy will pick up again and we'll start to see incomes and earnings rise over the middle and later part of the 2020s. It probably still will mean that we don't get back to the sorts of incomes we had pre-pandemic until certainly past the middle of this decade. That will be, again, a very poor period of income growth for people over that time.

At the same time, as you were saying, taxes at least on current plans will continue to rise not least through the way in which all of the income tax allowances and thresholds are being frozen for another-- Already being frozen for a year or two and another four or five years of freezes to go, which will bring more and more of our income and earnings into the tax system.

Sangita: Thank you. What more do you think we should be thinking about doing? The government is saying they're doing their bit. Is there something that we as providers or employers or other stakeholders in the market, how can we be helping people more do you think?

Paul: At a macro level, as I say, we as a country have got poorer. There isn't going to be an enormous amount that non-government actors can do to stop that overall. Obviously, in individual cases, there are choices that can be made about how earnings increases are given. A lot of organizations, instead of giving a flat percentage increase at the moment, are giving rather more to their lowest-paid workers relative to higher-paid workers. That's something you can see. That said, right at the top of the earnings distribution, there are certainly some firms that are being very generous to their very top earners.

The government, of course, is doing quite a lot. It's holding average energy bills down to £2,500 a year at the moment. They're going to allow that to rise to £3,000 in the spring. That's costing them tens of billions, and they're providing additional income for those on [unintelligible 00:07:09] benefits and for pensioners. For employers and for others here, it depends, obviously, on the resources they've got. It's a question for them on how they distribute that among their workforce, and of course, the impact they have on consumers. What we often see is that, as the cost of the imports and energies and so on rise, the prices rise and that itself has a negative impact on consumers.

Sangita: Thank you. We're actually doing quite a lot ourselves as an employer. We introduced a couple of months ago, actually, free lunches for people when they come into the office. That's really gone down well as a way of helping out. We ourselves are also looking at how we can spread the salary rises that we are looking to give next year to the people that need them the most and looking at different distributions. I know many other employers are looking at the same thing.

I think you're absolutely right. Employers have to use the tools that they've got within their disposal to think about what they can do. If I push you a little bit on who are you worried about the most, do you see the current scenario affecting younger age groups the more or the underserved segments quite often those are always left behind when times are tough or is it the people who are actually retiring or about to retire? Have you got a key worry group that you're focused on at the moment?

Paul: Quite a few in a way. Obviously, people on the very lowest incomes are those who are most affected here. They tend to spend a higher fraction of their budgets on energy and food. The inflation they face is actually higher than the inflation that other people face. That said, government has been relatively generous to a lot of people on these benefits with significant additional payments for them. Of course, there have been quite big increases in the national living wage.

I think probably, in a sense, the groups who might find this the biggest shock may actually be those who are somewhat on slightly higher incomes, maybe around average earnings, maybe earning £25,000 £30,000, £35,000 a year because they may not be getting any additional help beyond the cap on their energy bills and may well be seeing their earnings going up much less quickly than usual. I think that's a group who may be struggling.

You asked about those near and post-retirement. Of course, this big increase in prices could well be coming as quite a shock for people who have recently retired or who are planning to retire and have got the pension pot, the defined contribution pension pot or some other form of savings. That's now looking like that will go a lot less far.

Now, the surprising thing, under those circumstances, is that at least up till now, it looks like more people are deciding to retire early rather than holding on to build up their savings. Now, that may start to go into reverse. I think people, obviously, who have got a fixed income or expecting to live off savings as we saw very dramatically in the 1970s, may find this a particularly difficult period.

Sangita: Thanks. I think in our own experience, what we're seeing from people who are thinking about taking retirement or were planning to this year are quite often delaying it because they're waiting to see what happens if they can. We are starting to see a trend in that way. We do have people who are retired, certainly concerned about how their money will stretch, particularly as the markets haven't done so well. A lot of their savings have fallen in value compared to where they were at the start of the year.

As we know, Paul, those people who are more mature into their retirement, inflation does hit them hard, doesn't it? Because the things that they're wanting to purchase are all the things that are going up in price, the food, the energy bills. I think there is quite a lot there that are facing all the people in that age group. We're actually interested to see whether people are thinking about returning to work. Some of the early insights we are getting from data is that people are starting to think about that.

We saw, didn't we, Paul, that through COVID, there was quite a big exodus of people over the age of 50. What impact would that help the economy or would it not help the economy if we got more people back to work?

Paul: It would definitely help the economy. It's one of the many problems the economy is facing is a diminishing labour force. The number of people who have left the labour force over the last couple of years since the beginning of COVID has been very unusual. We've been seeing for about 25 years a constant increase in the fraction of people over 55 or so who are working and who are in the labour force. It's not only have we moved away from that trend. It's an increase in numbers.

We've actually moved to a situation in which there's been a decrease among that age group and that's quite a shock for the labour market. What we don't know is whether this is just for this particular cohort who have this experience through COVID and have decided to do things a bit differently or whether that will result in a longer-term change in more people from slightly younger cohorts doing the same thing. As you say, we also don't know whether there may actually be quite a sudden reversal because of what's happening to cost of living.

I think this is one of the many big uncertainties about the economy over the next few years. Certainly getting more of that group back into the labour market would unquestionably be of help. Partly, it would have some small but a downward pressure on wage inflation and inflation. It would also result in greater output and more potential for the economy to grow.

Sangita: It would be certainly interesting if we could do that. I wonder if when we see people coming back into work, we might have people just come in for a couple of years only. They may come back for a period of time, then realize they checked out [chuckles] because they didn't enjoy it, and then will check out again. I just guess what you're saying is even two or three years will probably make a difference at this stage.

Paul: Yes. If you look at the look over time, we are not talking about people retiring 10 years earlier than they previously would've done, just a bit earlier than they previously would've done. When you add all of those people together, that makes quite a big difference to the number of people in the labour market. When we do know that over time people, there are numbers of people who leave work, say they're retiring and then decide to go back.

Now, that, of course, can be a difficult transition. Quite often, people will end up going back to somewhat lower-paid work and they may not be willing to do that, but certainly, even if it's an extra two or three years, if that's a lot of people, that is a significant change.

Sangita: In your conversations that you are having with other market stakeholders, whether it's the government or regulators or commentators or other industry experts. Do you hear much conversation around the need to get people back into work? Is that something you're hearing or is that something that people aren't really getting to yet?

Paul: Oh, it's absolutely. Jeremy Hunt, in the Autumn Statement, said this was a clear priority. There's lots of work going on to try and understand what's happened at the moment. There's some evidence that it's down to poorer health. I think our work has suggested that it's more likely to be down to voluntary early retirement. This is, and my impression from talking to people, this is a big priority for government, for treasury, for the Department of Work and Pensions, for the business department.

It's by no means, the only one but it's one of the things that's holding the economy back. Absolutely, it's a priority, I think, within government at the moment.

Sangita: I wonder actually myself, whether we'll see more people think about this as we go through next year. This is only a personal view but I wonder how much people really understand the impact of sustained long-term inflation. We're not used to it as a country, are we? Prices rising regularly and staying sustainably higher than they have been. We've been in a scenario of low inflation and low-interest rates for quite some time. I just wonder whether people understand what it means.

Paul: I think you are right. We have had a long period of relatively stable inflation. It has only averaged near enough the Bank of England's target 2% over the last 25 years so this is a big shock. It creates all sorts of problems for government as it tries to work out how to use its money. We were seeing nurses and teachers, and on strike at the moment as government's been offering much less than inflationary increases. It's going to be a shock for people who've got money in the bank, or as you say, losing money in the markets over the last year or two. That's a double whammy there.

We don't know what's going to happen in the housing market. Again, that may come as a shock for people if we end up with house prices falling. We know that there's a shock through higher interest rates. One of the concerns in a lot of this is that after a period of time, we do tend to get used to whatever the economy looks like. We got used to, in the 1980s, relatively high-interest rates and big increases in earnings and then in the period since the mid-1990s, we got used to low inflation. In the period since 2010, we got used to very low interest rates.

What we forget is that just because these things have been going on for 5, 10, 15, even 20 years, doesn't mean they'll go on forever. When that norm, that reality changes, it can be quite a shock as people come to terms with that new reality. I think we're going to see that as people worry about inflation, as people worry about interest rates over the next few years.

Sangita: I was just thinking about housing, actually, and that's the other big impact of the current market scenario is on mortgages and also new entrance into the markets. What about the people in the 20s and 30s? Are they wanting to purchase a house or are we going to have a renting culture, do you think? Where do we end up with those youngsters?

Paul: We've already moved in a big way to a renting culture but it was forced renting. There've been near enough a halving in the number of people around the age of 30 who are on occupies compared with 25 years ago. That's an extraordinary reversal in a long trend of increased owner occupation. That obviously is related to the big increases in house prices over that period.

Now, with higher interest rates, what you might get. What is stopping people buying houses? It's mostly the lack of an adequate deposit because when interest rates were incredibly low, then for a lot of people, not for everyone but for a lot of people, the barrier was not so much the monthly payment on the mortgage, particularly given the how high rents were, it was being able to get over that barrier of having cash upfront to get on the housing ladder.

Now, it'll be interesting to see what happens to the housing market over the next few years with higher interest rates. We might, I think, expect house prices, at the very least, not to go up and quite possibly to fall. Who knows? I'm not going to make any predictions. Actually, a combination of higher interest rates and lower prices might provide a better opportunity for young people trying to get on the housing market than this long period of very high house prices combined with low-interest rates.

What that did was really provide a big boost to people who owned homes and owned assets prior to the financial crisis up to 2008. They then found their housing costs dropped dramatically over that period, could build up lots of money they would otherwise have been spending on mortgage interest. A lot of them, a remarkable number, have bought second properties.

After all of that renting, all the people renting, they're renting off someone else and broadly speaking, they're renting off their parents' generation. It's possible at least that, and aren't certain that higher interest rates will help there. [00:20:34] I'm certainly much more comfortable with an economy where we've got interest rates which might settle at, I don't know, 2%, 3%, 4% than I was with an economy with interest rates at near enough zero.

Sangita: Absolutely. I think your talk of deposit there for houses is where the Bank of Mum and Dad has come in, isn't it? People have struggled with getting deposits and quite often people are relying on family members to help out. I wonder if that may then further encourage people that are more mature to also think about coming back to work. Do you have a view on that at all?

Paul: Yes, absolutely. One of the depressing features of the last 10, 15 years is that the Bank of Mum and Dad in all sorts of different ways has become much more important over time. We've done plenty of research showing this that actually, it has become more important who your parents are and how much you help you can get from them and how much you might eventually inherit from them and so on over time relative to the importance of your own earnings and your own efforts over time.

We spent a century moving away from the Victorian era when [chuckles] the most important thing was inheritance and your parents. I'm afraid we've started to move, after decades of it being more important what you earned yourself, moving back to a world in which it's becoming increasingly important what help you get and how much you inherit. That's related both to the increase in house prices and other asset prices on the one hand, but also, this stagnation in earnings when there's a remarkable position where, again, people in their 30s at the moment aren't earning much more, often less than, people in the previous generation.

Sangita: Thank you. I guess there's also been an added burden to many people with debt, I guess because interest rates being so low, it was actually quite easy to get loans and more affordable. Then we've got students coming up with student debt too. I guess there's been a lot of extra pressure on those younger age groups to have money for paying off lots and lots of things. Have you done any analysis actually on debt levels now compared to how they were in the past and do you have a view on where they might get to?

Paul: It depends on what you count as debt. I don't think we would generally count student loans as debt but what student loans have done is clearly significantly increased the tax burden on younger generations. That is a big impact on the disposable income that younger graduates have relative to older generations' similar time. Actually, when you take that into account, the take-home pay of those groups has done even worse than the headline earnings numbers.

If you look at debt overall, of course, it's very unequally distributed. The data isn't great for making comparisons over time. One small light on the horizon here is that actually a lot of people, and not just the very well-off but a lot of people right down to the middle of the income distribution and below did save an awful lot through COVID. There is a lot of households by no means all, and certainly not the least well off but a lot of households do have a little bit more to fall back on than they would've done pre-COVID.

Sangita: Just picking up on your point, Paul, around nurses and teachers and rail workers on strike we see regularly more and more announcements about that in the press, do you think the government has got its focus right on the public sector worker at the moment or do you think that's going to be a continuing strain for them as we go into the next two years?

Paul: I think it is going to be a continuing strain. I think it's an incredibly difficult position the government is in, in many ways. They're working with spending totals in each department, which was set a bit more than a year ago when they expected inflation to only be 2% or 3%. The only way that they could increase public sector pay anywhere near in line with inflation would be to make more money available. We've already seen that the public finances are looking pretty difficult. Even with taxes reaching record levels, there's not an enormous amount of money available to spend more on public services in general.

I do think it's one of the hardest decisions the government is going to have to make. Over this year, they broadly speaking provided tax pay rises in line with the recommendations of the pay review bodies but that still meant significantly much lower pay rises than the rate of inflation, and in general, somewhat lower pay rises than in the private sector and that's this year. Again, next year I'd expect to see pay rises which are below what inflation is at. Don't forget that's on top of a period since 2010 when public sector pay has done even worse than that in the private sector.

Indeed, if you look at experienced teachers, nurses, civil servants, even before this year's squeeze, they were probably earning 5% to 10% less than they would've been earning back in 2010. This comes off the back of a really tough period. How government squares that circle and what the right judgement is, genuinely, I don't know. I think either you could increase taxes further in order to pay more. You could decide to reduce the workforce significantly in order to pay more.

I don't think there's an enormous amount of scope to borrow a great deal more in order to pay more or you could stick with the current strategy which is taking a bit of a middle line giving more 5% pay rises to quite a lot of these groups, much more in cash terms than they've had in the past, but much, much less than inflation and try and muddle through but in my view, this is going to be the toughest set of issues for the government over the next year or so.

Sangita: Agree with that totally. I also wonder not only are those individuals not had the pay rises that you talk about, but quite often, those systems have been under strain too. The NHS has been continually under strain as we get through to an ageing population and the demands that we place on it. Then the education sector is continually under strain and we look at improving literacy levels to all sorts of students and raising the game that we have there. It's not that those systems are also doing well in their own way even before this, I think. Would you agree with that or would you disagree with what I've just said?

Paul: No, that's absolutely right. Obviously, in much of the public sector people are working under considerable amounts of strain. We know that especially that's true in the National Health Service where there are large numbers of vacancies. We know there are all sorts of issues around management there and a lot of people saying they're burnt out or increasing likelihood of being sick. The morale in a lot of parts of the public sector is not being very good.

That's certainly true for different sorts of reasons in parts of the civil service at the moment as well. This is not a sort of, "Everything's fine except my pay is going down a little bit." It's, "Things are looking pretty difficult in many respects, and my pay is going down."

Sangita: I wonder about the role then of what people's savings and their pension has to work for as we go into these tougher economic environments. Certainly from our data this year, what we've seen is some people are taking money out of their pension to pay for private healthcare, for example, because NHS waiting times have been higher than expected. I think we've all seen the news around that and I don't see that changing particularly, as we talk around the staffing issues and the pay issues that the NHS is dealing with right now and you've just alluded to that.

I wonder what we are going to be in with the role of the pension, the role of savings, and how are people going to square away all the different things that got to make their money work harder on? Is that something that you are thinking through as well?

Paul: Yes. It's a difficult set of decisions. My guess is that nearly everyone who's auto-enrolled. They are remaining auto-enrolled because the power of the default is enormous. There is a reasonable case, I think, that are people saying, "This is a particularly hard couple of years. This is not the right time to be saving extra." I think that that's reasonable over a lifetime if you're thinking about what to do. I think there's an interesting issue here in the public sector where a lot of public sector pensions remain extremely generous.

Actually, some quite low-paid workers are putting what for them is significant levels of contributions into those. I would personally like to see government providing more flexibility so that, for example, a very low-paid worker in the NHS could take more take-home pain now in exchange for a slightly lower pension in the future. When things are difficult, I think it's perfectly reasonable for people to be focusing on the present.

Sangita: Absolutely, a very common and human nature isn't it, to actually focus on today. It's much easier than trying to predict for the future, as we all know as well. I think that's a common behavioral bias of many of us that we focus on today. Just interestingly and actually optimistically for us and we believe for the person on the street, we haven't seen as many people fully stop their contributions into their pension as we did when it was COVID. We're not seeing the mass exodus that there is or has been some press around. That's been really encouraging.

We've also not seen as many people reduce their contributions into their pension as much as they did when COVID hit two years ago. That, for us, suggests that people aren't looking at their pensions as way of actually trapping into the additional savings that they may need right now. Of course, that may change as time goes on, but that's where we are right now. Have you heard any other commentary around that from others?

Paul: It's difficult to know and not really, to be honest. [chuckles]

Sangita: That's fair enough. It's always interesting to share observations, but we think that's pretty encouraging and it's some data that we'll be sharing more and more on this as time goes by. Just conscious of time. Paul, taking up an awful lot of time and we've talked about the tough times ahead. Is there any glimmers of optimism for you as you look forward that we can hang our hat on?

Paul: I hate when people ask those questions. I really ought to have something optimistic to say but it's quite difficult. [chuckles] I mean, one thing it is worth saying is, of course, we are much, much better off than we were 30, 40, 50 years ago. Whilst we've had 15 years of stasis, that's after decades or decades of getting better off. In terms of returning growth in the future, the The Office for Budget Responsibility did suggest that the economy would be getting back to reasonably healthy growth after the end of next year.

These forecasts are uncertain and maybe things will turn out better. It does look

like gas prices, for example, aren't going to spike anywhere near as high as looked like might be the case, the worst moments over the summer. I think the government has done a reasonable job at protecting the incomes and living standards of people on the very lowest incomes. This is certainly not a government that has done nothing there.

When it comes to the period after the next election, the public finances look really quite difficult. I can't see there being lots of additional money for public services. I have to say that whilst this generation of pensioners who are currently retired are average you have done very well. I rather suspect the next generation won't have done so well. Again, there will be plenty who will be quite comfortable.

Sangita: Thanks, Paul. If nothing else, you've delivered all of that in a very cheery way so thank you for that. If I take a little bit of optimism for what you said, I think you did mention there may be some recalibration for the younger age groups. They may be able to get onto the housing market if prices level up. That's not a bad thing either for the future generations. We'll wait to see what happens.

That brings us to an end of this episode and I'd like to say a special thank you, Paul, for joining us for this fascinating discussion on the UK's economic challenges and what that might mean for people's long-term savings and retirement plans. Thank you, Paul.

Paul: Thank you.

Sangita: To our listeners. We really hope you enjoyed this discussion. Thank you again and thanks for listening to Thinking Forward.

Voice Over: The information and views in this podcast are those of each speaker and were accurate when recorded. They should not be seen as financial advice.

Share via

Related Articles