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What are the effects of Covid-19 on poverty and inequality?

The technique of ‘nowcasting’ provides insights into how the UK’s distribution of income is changing as a consequence of the pandemic. The key determinant of living standards and the impact on the poorest is what happens in the labour market.

It is too soon to say with certainty what the overall impact of the crisis is likely to be on measures of poverty or inequality. High-quality data on household incomes, of the sort that is used to estimate income inequality and rates of relative poverty, tend to be released with long lags.

For example, the two most important estimates of the level and distribution of household living standards in the UK both tend to be published 11 months after the financial year spanned by the data (these are the Department of Work and Pension's ‘Households Below Average Income’ publication, and the Office for National Statistics release on household income inequality). This means that official estimates of income poverty and inequality for the current financial year – 2020/21 – won’t be available until March 2022.

Because of these very large lags, in recent years, researchers have developed a technique to estimate poverty and inequality at the current moment (see, for example, Navicke et al, 2014).

This is called ‘nowcasting’ and uses real-time information on how the economy and the labour market are evolving, together with detailed data on the distribution of income in the past, to estimate what is happening to the distribution of income right now. The precise details can vary between studies, and the results are heavily dependent on the methods used and the assumptions made.

Related question: How can we measure what is happening in the economy now?

How is the crisis affecting the labour market?

A crucial input to nowcasting studies is an assessment of the distributional impact of the impact of the crisis on the labour market. It is now well established that the initial labour market hit affected young workers more than middle-aged workers, low earners more than high earners, black, Asian and minority ethnic workers more than white British workers, and those on atypical contracts more than salaried workers (Adams-Prassl et al, 2020; Gardiner and Slaughter, 2020; Gustaffson, 2020; and Benzeval et al, 2020). On average, the labour market shock has hit lower earners much harder than the better off.

There is, though, a difference between having low earnings and being on a low income. Brewer and Gardiner (2020) were the first to show that the incidence of job loss or reductions in earnings during lockdown was more common in the second and third quintiles of the working-age income distribution than in the bottom quintile, because around half of adults in the bottom quintile were not in work before the pandemic began.

Similarly, Benzeval et al (2020, Table 5) show that the pattern of declines in earnings – which are greater for low-income households than for high-income households – are flatter when looking at all households, compared with when restricted just to households who had some earnings pre-pandemic. The conclusion that ‘falls in market income affect only those engaged with the market’ is uncontroversial, but it is important when considering the impact on low-income households.

How is the crisis affecting the distribution of income?

Several exercises have now been carried out to estimate how the crisis might be affecting the distribution of income. All conclude – unsurprisingly – that the initial impact of the crisis has been to reduce household disposable incomes.

The Treasury (2020) estimates an average fall of 8%, but this analysis looked only at working households. Brewer and Tasseva (2020) estimate an average fall of 8%, but this looked at the situation in April, before the self-employment grants had been paid. Brewer et al (2020) estimate a fall at the median of 5%. And Bourquin et al (2020) estimate a fall of about 4%, although it should be noted that these are not all directly comparable.

More surprisingly, all estimate that the initial falls in income are greater in proportional terms for households that would have been at the top of the income distribution. There are two reasons for this.

First, as we saw above, some of those towards the bottom of the income distribution do not work and so are unaffected (directly) by the coronavirus shock to the labour market.

More important, though, is the impact of the increase in social security benefits, which means that some low-income households are better off financially than they were before the crisis begins. Indeed, as Figure 1 (from Brewer et al, 2020) and Figure 10 of Bourquin et al (2020) show, were it not for this policy change, the crisis would have changed the distribution of income in a way that raised inequality.

Figure 1: Change in real (CPI-adjusted) average equivalised non-pensioner disposable household income, after housing costs, by income percentile, before and after benefits changes: 2019-20 to May 2020

Figure showing average annual growth in real equivalised disposable income

Source: Resolution Foundation analysis of DWP, Households below average income; and RF nowcast (2020)

So far, all studies also agree that those above working age are so far less affected, in financial terms, by the current crisis than those of working age. Lower-income people over the pension age in UK get the majority of their income from the government in social security benefits. And although asset prices have fallen and interest rates are very low (both of which tend to reduce the income that people can get from their investments or private pensions), this crisis is not rooted in the financial markets, as was the recession after the global financial crisis.

This is in line with the evidence from past crises and recessions. A summary of the research evidence after the financial crisis concluded that there is ‘a reasonably clear answer as to which groups’ living standards are likely to be most cyclical, and hence worst affected by recessions – we expect to see strong effects of recessions on the incomes of working-age individuals, but weaker effects on individuals who are retired or who are not strongly attached to the labour force.’ (Muriel and Sibieta, 2009)

Brewer et al (2020) look at measures of poverty measured against a poverty line that is just updated each year with inflation (absolute poverty), and one that is a fixed fraction of median income (relative poverty). They find that absolute poverty in the early months of the crisis increased slightly among working-age adults, and actually fell for children, reflecting that the £9 billion boost broadly offsets the impact of the labour market shock.

They also find that relative poverty measures fell considerably. This matches what we saw in the past four recessions in the UK (in the mid-1970s, the early 1980s, the early 1990s and the late 2000s), where measures of relative poverty – defined as living in a household with less than 60% of median income – fell.

What is likely to happen during the rest of 2020?

The UK government’s initial response to the need to support family incomes directly during the crisis was unprecedented. Estimates by the Office for Budget Responsibility (OBR) put the total estimated cost (including the Coronavirus Job Retention Scheme, CJRS) at around £73 billion (estimate of July 2020).

These measures have been very effective at protecting workers who have been furloughed under the CJRS, some of the self-employed and those who can claim Universal Credit (UC). Those who have lost their job or businesses but cannot claim UC – whether because they have high levels of saving, they have a partner with high earnings, or they have ‘no recourse to public funds’ because of their migration status – will be facing large falls in income.

Going forward, the key determinant of living standards and the impact on the poorest is what happens in the labour market and, in particular, what happens as the CJRS is phased out and then shut down at the end of October.

The CJRS is generous in comparison with UC: under the CJRS, the median fall in disposable income if someone is moved to 80% of their past earnings is just 9%; but that figure is 47% if people instead lose their jobs and fall on to UC (Brewer and Handscomb, 2020).

The scheme to replace the CJRS – the Job Support Scheme (JSS) – has a similar level of generosity from the employee’s point of view, but it will only support employees working at least a third of their previous hours, and requires a much greater contribution from employers. The ending of the CJRS and these design features of the JSS mean that furloughed employees who are not brought back to work as the CJRS scheme ends, and workers whose hours are cut by their employers but are not put on the JSS, are both likely to see large falls in their family income.

In all recessions, the policy responses determine the impact on the vulnerable as much as the initial economic shock. That will be true to an even greater extent in the current recession, as the nature of the public health response by necessity means a much greater role for the state in determining what economic activities can and cannot go ahead, as well as in introducing new policies or reforming old ones to help cushion the shock to household incomes.

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Author: Mike Brewer
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