Why productivity in the UK is so low: in-work benefits

We are fascinated by the government’s sudden focus on in-work benefits. Regular readers of MoneyWeek and this blog will know that we have long been campaigning for workers to earn their income from their employers rather than from the state, and for the ludicrous cost of the welfare state (up 38% under Labour) to be reduced.

We have been particularly critical of the tax credits system, which is not only insanely expensive but allows the UK’s big firms to get away with paying poverty level pay – if the state is going to take up the slack, why not?

But we also wonder if George Osborne hasn’t been looking at James Ferguson’s work on how our current benefits system is likely to be the prime reason the UK’s productivity is so pathetically low.

Look at the types of jobs created since the crisis and you will notice something odd. We have seen a shift away from unproductive, full-time public sector jobs into private sector jobs. That’s the kind of shift that should be good for productivity. But it hasn’t been – for one simple reason: all the news jobs are “equally unproductive, part-time, private-sector jobs.”

Much time has been wasted wondering why this is, when the answer is really very simple: the welfare-to-work system we have in place encourages it very strongly. “The majority of the £215bn (12.5% of GDP) of benefit expenditure is paid to the retired (£87bn) but the next largest chunk goes, not to the unemployed (just £8bn) but to the employed (£76bn), says James, “via supplementary payments to boost earned income, such as tax credit and housing benefit and other allowances”.

To qualify for tax credits, you must, if you are in a couple, work 24 hours a week between you (12 each) – if you are single you must work for 16 hours a week. It should come as no surprise to any cynic to discover that not only does a third of the working population only work part-time (nine million in total) but that the average hours worked per person is just over 12 hours per week, ie 24 hours per couple, says James.

“Although part-time work on average pays £11.24 per hour, implying post-tax income of £14,250 per annum for a couple, tax credits alone would boost disposable income for a fully able-bodied family with three children and childcare costs to £35,203 – and that’s before any other welfare entitlements, including the ubiquitous housing benefit. For a full-time salaried worker to earn the same disposable income, they’d have to be on £48,500, or almost double the average wage.”

So there you have it:  in a normal environment, workers laid off from the public sector or pushed out of unemployment by welfare changes might have found full time productive work but “the distorted incentives created by the in-work benefit regime instead channeled workers into part-time work and supplementary welfare entitlements.” An example? “Ian Duncan Smith, architect of Universal Credit, cited Big Issue sellers as immediately qualifying for tax credits and housing benefit by dint of being self-employed; even if they don’t sell a single copy.”

The only possible conclusion from this? James again…

“Encouraging people to work just 12 hours a week (2.5 hours/day) before their household qualifies for four times the poverty line is desperately inefficient. Part-time work, with its discontinuities, excessive travel time, start and finish down times and constant breaks is always going to be more unproductive than full-time work.

“From a system point-of-view though, financial transfers from productive, full-time workers to unproductive part-time ones is not only sub-optimal, it is also unfair, further distorting the incentives to work.

“Why work a six-day week in a semi-skilled job such as bus driving, when you could do a couple of hours a day on the tills at Asda and potentially ‘earn’ almost twice as much?”

That’s why the current government is looking at fundamentally restructuring the tax credit system. And it is why we applaud them for doing so.