The truth about welfare

How times change. Seventy years ago, the Beveridge Report was launched to popular acclaim. People queued around the block to pick up their copy of the seminal blockbuster. Welfare was a vote-winner.

In the intervening 70 years, the descent from Beveridge has been total. Public attitudes have hardened, 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 recreate the optimism of that time. But there is no escaping the fact that today’s welfare system 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 30 years, successive governments have pursued broadly similar strategies that have mixed successes with some negative economic side effects. Today, 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 benefits is a paradox, simultaneously meagre and unpopular. At just £71.70 per 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 anywhere in the OECD. The value of JSA, as the main social security benefit for unemployed people, has flat-lined since the early 1970s, while average incomes and consumption have roughly doubled. For an average earning couple with children, the picture is little better, with income replacement rates typically well below the OECD average. What’s more claims tend to be 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 twenty years the support for our system of working age welfare has declined precipitously. Public outrage over incidents like the recent Philpott case often stems from a reaction to the benefit system in general. But the unemployed are usually the particular focus of this opprobrium.

Fully 62% of people now think that ‘benefit payments are too high and discourage work’, up from only 27% in 1991. In 2001, 88% of the British public agreed with the statement that 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%. These trends appear to have continued despite the dire state of the economy in recent years.

Our welfare system is failing politically. It neither inspires confidence among taxpayers, nor does it provide effective support for those who need it. It is increasingly seen to be over-generous, disincentivising work, and out of control. Yet, paradoxically, for the overwhelming 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 post-war welfare system in place sowed the seeds of today’s problems. The level of insurance-based benefits, derived from past contributions, persistently slipped below the means-tested minimum. Consequently, little advantage accrued to those who had worked hard and paid in.

This problem was compounded by the reforms of later governments. First, Beveridge’s flat-rate contribution was replaced with earnings-related contributions in return for the promise of earnings-related benefits. But over time those earnings-related 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. For millions, welfare wasn’t looking like such a good deal any more. In 1996, even the nominal distinction between insurance-based and means-tested benefits was erased with the introduction of Jobseeker’s Allowance.

For contributors, that close association of JSA with means-tested benefits stokes the sense of injustice at claimants who get similar benefits without having contributed enough. So it is perhaps unsurprising that barely a week goes by without a politician of some variety lamenting a ‘something for nothing’ culture of the benefits system. Powerful anecdotes like the Philpott case fuel a general sense that large numbers of people are taking the rest of us for a ride, no matter the detail.

But the ‘something for nothing’ problem is very far from 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 2010-11 – had a history of spending more than half of recent years on the dole, cycling in and out of employment.

For many claimants the problem with welfare is just the opposite. Long or frequent spells on unemployment benefits are rare for typical claimants. The same Department for Work and Pensions analysis shows that 76% have spent less than a quarter of the past four years on the dole. Indeed, for 40% of typical claimants each year, the need to claim JSA is an aberration in an otherwise unbroken employment history.

Yet, despite these people’s past tax and National Insurance contributions, today’s welfare system gives them very little support. The meagre value of JSA stokes a sense that if you play by the rules, you get very little in return – a situation that researchers Kate Bell and Declan Gaffney neatly labelled the ‘nothing for something’ problem. In the current economic context, with job insecurity high, this further weakens the political legitimacy of the system.

The co-existence of ‘something for nothing’ and ‘nothing for something’ is hardwired into the structure of our unemployment benefits system. The UK’s flat-rate unemployment benefit regime has long been very unusual among developed countries. Most OECD countries – including the USA – offer benefits that are directly related 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 de-coupling 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 and tabloid hyperbole focus relentlessly on the ‘something for nothing’ problem, policy becomes increasingly designed around a small minority of the unemployed. The result is a lowest common denominator welfare regime that offers no meaningful insurance for the majority of working people. So what is the Government’s strategy to tackle the welfare problem and will it work?

The orthodox prescription

Evoking the hard-worker who leaves home early in the morning on their way to work, looking up at the closed blinds of their workshy neighbour on benefits, George Osborne paints a powerful picture of the welfare system that’s an easy sell on the doorstep. But it’s not simply populism that lies behind the Government’s reform plans. The dire state of the public finances has unavoidably put benefits 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. Successful reform, ministers hope, will make welfare more politically acceptable in the face of hardening public attitudes.

The Coalition has two main elements to its strategy. The first is to cut benefit levels in order to make work more attractive. The second is to ramp up the pressure on claimants to get back to work quickly, deploying more stringent sanctions if people miss appointments at the Jobcentre, refuse job offers or don’t search hard enough. These policies represent an intensification of, rather than a departure from, labour market policy for the past 30 years. But it’s time we re-examined just how successful some aspects of this orthodox approach really are.

Some of the Coalition’s positive work incentive measures have grabbed headlines. But a slightly more generous Universal Credit for working people won’t make good the erosion of existing in-work support since 2010. For working families, the gains have therefore generally been more than offset by the losses, as the Institute for Fiscal Studies has shown. All this is perhaps inevitable given the scale of the deficit reduction challenge the Coalition faces. With no spare money for work incentive carrots, the Government is reliant on the stick of making out-of-work benefits less generous.

Squeezing workless benefits for the unemployed has the virtue of making work more attractive while also saving money. Unsurprisingly, it’s been high on the policy agenda. Multi-billion pound cuts to housing benefit and tax credits that reduce entitlements for those out of work, have sharpened work incentives to a degree, despite also affecting those in work. Last December’s Autumn Statement was evidence of a further step in this direction. The Government plans to save around £2.5bn from working age benefits by 2015 by restricting annual uprating to just 1%, irrespective of inflation. When it comes to unemployment benefits, that might save money, but is it economically wise?

The link between benefits and the duration of claimants’ unemployment spells has been thoroughly explored 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 choosey 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. On this view benefits may be a social necessity but they are an economic drag to be minimised.

But 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 get back to work can be economically damaging. If the government wants to equip the UK’s workforce to compete in the global economy, their 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. This isn’t just good for the jobseeker, but 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 redundancies they oil the wheels of economic change.

Economists increasingly see these aspects as important, but policymakers overlook them. In a world where workers have diverse skills and employers have diverse labour requirements, 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 its suitability for their skills. But from a personal and societal perspective, this is a wasted opportunity. We simply can’t afford to have our rocket scientists stacking shelves in Poundland, nor our HGV drivers driving taxis.

As the OECD has argued, the benefits of better job matches go further than just making the best use of existing skills. Good matches lengthen job tenure, which improves employees’ skills through both experience and their greater likelihood of 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, finding the right job takes longer and is more valuable for both employee and employer than in the low-skilled economy of the past. And in the context of rapid technological change and the economic restructuring that occurs in a recession, the importance of labour market institutions in making the right job match grows, and the dividend from careful job search increases.

None of this is to deny that more generous unemployment benefits also dampen incentives to find work. The policy challenge is, of course, to strike the right balance between giving people more time to search for the right job, and risking that they might be kicking their heels at the expense of the taxpayer. So how well are we striking the balance right now?

Recent evidence suggests we’re doing badly. Harvard economist Raj Chetty has shown that unemployed people who have access to funds – either savings or a redundancy payment – tend to 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 it will ultimately yield a better outcome and hence prove to be a worthwhile investment. Meanwhile, those reliant only on unemployment insurance move back more quickly, simply because they are not in a position to turn down work, even if it is inappropriate for their skills and experience.

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 than they are 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. The mix of jobs in the economy can be improved by raising unemployment benefit. And as MIT’s Darron Acemoglu puts it a “moderate level of unemployment insurance…encourages workers to take on more risk, and increases both welfare and the level of output.”

Given the UK’s outlier status in the benefit generosity stakes, the economic case for whittling away what remains of JSA for those with skills and experience is therefore threadbare.

So if the strategy on financial incentives looks economically suspect, what about the other strand of the Government’s response to the legitimacy crisis? Backed by the threat of benefit sanctions, ‘activation’ strategies aim to push people to search more intensively for work, and speed up their return to employment.

Since the 1980s it has been clear that activation works to get people out of unemployment more quickly. The success of the Thatcher government’s Restart Programme, in 1986, led to its extension throughout the benefits system. Work-focused interviews and monitoring came to be at the heart of the JSA regime we have today. Evaluations of that programme and many of its successors have shown their effectiveness at shortening unemployment durations. In tackling the scourge of long-term unemployment, activation has been an important step forward in employment policy.

But for most jobseekers, the tough sanction regime is of questionable economic value. The available evidence echoes the findings on unemployment benefit generosity. Rapid re-entry into employment tends to come at the cost of lower quality jobs. Unsurprisingly, 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.

It’s unsurprising, then, to find that that UK has a high level of people moving in and out of work. In normal times, around four out of five people on unemployment benefit are back in work before six months has elapsed. That sounds like a success. But a 2007 study of short-term JSA claimants who found work highlighted the fact that fully 73% of the sample had left it again within a year, suggesting extremely poor job matching.

Activation might prevent people slipping into inactivity and irretrievable worklessness. But its intensive use to shorten unemployment spells of those with good skills and sound work experience, regardless of the appropriateness of the job matches that result, is misguided.


The welfare system is mired in a deep crisis of legitimacy. The Government’s solution of greater conditionality and uniformly lower generosity is a bleak prospectus. Its highest ambition is to minimise the public cost of the system, regardless of the economic consequences.

But that approach will never resolve the ‘something for nothing’ problem that stems from the fundamental design of the system. And more importantly, in respect of skilled and experienced workers, cutting support and tightening sanctions is economic folly.

Employment policy matters not just because it directly affects people’s lives, but also because the labour market needs well-designed institutions in order to thrive. Economics has moved on in its analysis, but policy remains marooned in the 1980s. We can equip our workforce to succeed in the ‘global race’, but we need a smarter approach to unemployment. The current prescription won’t help our businesses, won’t help our families, and it won’t have people queuing round the block for the next government report on the benefit system.

A version of this article first appeared in the New Statesman on 17 May 2013. This article is extracted from the SMF’s Beveridge Rebooted.


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