The cost of getting people back to work

the pitfalls in welfare to work

IT IS NOT surprising that Gordon Brown, a famously workaholic Labour chancellor, does not much like the idle rich. But nor does he like the idle poor. Getting people off welfare and into work is a central objective of this Government. But does he have a coherent strategy to deal with the inherent conflict between encouraging people to find work and paying them a subsistence income if they fail? Many assert he doesn't. They are right in that he has not really addressed the question of incentives for the existing stock of unemployed. But I believe he does have an interesting, though very long-term, strategy to induce a work culture in the young and stem the flow of new, young unemployed on to the dole.

To see how intractable the unemployment problem is, suppose for a moment that in an advanced industrial society like ours the least able 10 per cent of the working population are incapable of supporting themselves by selling their labour on a free market. Most of the things that they can do can be done more cost effectively by machines at home or by cheap labour abroad. However, this shouldn't mean that these people starve. The combination of technical progress and economic specialisation that has marginalised the bottom 10 per cent of our nation has made the rest of us rich enough to support them. Indeed, the relief of poverty is surprisingly cheap. The cost of giving 2 million people pounds 100 per week is pounds 10bn. That is a tiny fraction of the total public spending bill of pounds 260bn and surprisingly small in relation to a total social security bill of around pounds 80bn.

There is, unfortunately, a further hidden cost to giving the poor enough to live on. The problem leaps into focus as soon as you start to think about the 10 per cent just above the bottom 10 per cent. How do they feel about getting up on a dark winter's morning and struggling into work to bring home a wage of say pounds 120 for a 40 hour week? Compared with a life of leisure on pounds 100 per week, 40 hours work for pounds 120 may seem a poor deal. Work that seemed worth doing for pounds 3 per hour looks distinctly less appealing when the net gain, compared with the dole, is only 50p an hour.

That, in a nutshell, is the central problem that welfare-to-work must resolve. Once the state pays people for doing nothing, anyone with low earning power, whether in or out of work, will calculate that it is barely worth working. That is the poverty trap created by the well-intended relief of poverty.

Do the unemployed really choose not to work or is joblessness thrust upon them? In the 1980 or 1990 recessions many of the unemployed had no choice in the matter. But in the current, service-sector led boom many of those who do not work have turned down jobs as not good enough. So it is, to some extent, a matter of choice and incentives. One well known solution to the incentive problem is to give everybody a basic income (paid for out of taxation) of pounds 100 per week, whether they work or not. This would mean that the second poorest 10 per cent would, in effect, get the dole along with the bottom 10 per cent. Their reward for working would be restored to pounds 3 per hour. But it will not have escaped the reader that giving everybody pounds 100 per week is 10 times as expensive as giving this sum only to the bottom 10 per cent. The cost is pounds 100bn, equivalent to over 50p on the basic rate of income tax.

These back-of-envelope sums reveal a basic but important truth: relieving poverty is quite cheap, but getting rid of the poverty trap is very expensive. It would involve increases in taxation that Mr Brown is committed not to impose. Yet, as long as the poverty trap exists, it will be extremely hard to move people from welfare into work.

Expressing the cost in tax terms helps us to understand another key point. The poor, who lose their welfare payments as they start to work, face a very high marginal rate of tax. We can prevent that by giving the dole to everybody, so that there is no benefit withdrawal as you move from welfare to work. But that is expensive, as we have seen. So the cost of eliminating the high marginal rate of tax on the poor is to impose a high rate of tax on everybody else. What actually happens, of course, is that benefits taper off as in-work income increases. Tapered benefits cost more than withdrawing the dole completely as soon as you get a job, but are much less expensive than giving the dole to everybody. The more gradually benefit is withdrawn, the greater the incentive to take a job, but the greater the cost to the Exchequer and the higher the taxes on the better off.

In other words, the price of encouraging the poor back into work might be tax rates that discourage the better off from working so hard. This is a trade-off that the Government has never talked about, not surprisingly as it has ruled out higher taxation, yet wants to encourage the poor back to work. Does this mean that Welfare-to-Work is doomed to failure?

Not necessarily. If you can't afford to make the poor better off in work, then the only other option open to you is to make them worse off out of work. This, in effect, and on a modest scale, is the new strategy: get young people back to work by telling them that the dole is simply not an option. If they won't work, or be trained, then they must live on their parents or beg on the streets. The strategy has been criticised for its narrow focus on the youngest unemployed. But that is to misunderstand it completely. For the reasons explained above Mr Brown cannot afford to give adequate incentives to find work for all those currently without it. He has, therefore, adopted a more limited objective of reducing the number of new young unemployed. The strategy includes a stick (dole not an option) as well as carrots, such as help finding work, subsidies to employers, etc.

What is clever about the strategy is that is not politically acceptable to say to an out-of-work 30-year-old father of two that the dole is not an option. But it is politically acceptable to say that to a school leaver. A gradualist way of tackling the unemployment problem is to steadily raise the age below which the dole is not an option (eg no dole for students). Behind this strategy lies another important idea, which is essentially that being in work is habit forming, as is being on the dole. If you can inculcate the work habit at an early age, then you will create a nation of people whose instinct is to look for work, even if in the short run it pays little more than the dole. That idea is backed by another: our hypothetical person who opts for the dole at pounds 100 rather than work at pounds 120 is actually behaving rather short-sightedly. The point about having a job is that it can lead to a much better paid job. Forcing people on to the jobs ladder is a way of preventing short sighted behaviour that can condemn youths to a lifetime on the dole.

Clearly, it would be wrong to expect overnight miracles from welfare to work. The "why work?" syndrome will not be quickly eliminated without a major reform of the tax and benefit system that does not seem to be on the agenda. But, in the meantime, it would be churlish not to applaud and support a strategy aimed at persuading the young that working, even for low wages, is infinitely more rewarding in all senses than life on the dole.

Bill Robinson is a Director of the consultancy London Economics

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