Incapacity benefit vs the banking crisis

How much could we save by reforming incapacity benefit? George Osborne is hinting at big numbers. He claims that “Incapacity Benefit and Employment Support Allowance is a very large budget“: the media are talking of £12.5bn.
However, DWP figures show that, in 2009-10, incapacity benefit and ESA (which replaced IB for new claimants in 2008) put together cost just £6.7bn. That’s less than half a percent of GDP. That £12.5bn, I suspect, is obtained by adding in income support. But that exaggerates the potential saving to be made from changing IB and ESA, because moving someone off these and onto Jobseekers Allowance might not, in itself, reduce that income support.
Let’s do a simple sum. The long-term basic rate of IB is £91.40 a week. Moving someone off IB and onto Jobseekers Allowance, which pays £65.45 a week would therefore save the tax-payer just under £26 a week. This means that even if a million people were to make the move, we’d save just under £1.4bn a year.
You might object that they wouldn’t move onto JSA, but into work. There are two possibilities here.
First, the IB claimant might somehow find work at the expense of a JSA claimant. If so, my calculation stands.
Alternatively, the increased supply of labour as people come off IB might be met by an increased demand for labour, so overall employment expands.
But this can only happen if the greater supply bids wages down. In the presence of the NMW, there’s a limit to how far this is likely. Insofar as this limit bites, employment won’t rise. But what if it doesn’t bite? Even then, the economic gains are mitigated by two factors. First, low-wage workers face lower wages, which offsets the taxes they save from not having to subsidize “scroungers“. And second, these lower wages cause an increase in tax credit payments.
The gains from reforming IB, then, are small.
This is especially so compared to the cost of the banking crisis. Michael Dicks of Barclays Wealth, working with the IFS, says:

By 2015, we estimate that potential output will be 9% of GDP (£132 billion in today’s money) lower than it would have been in the absence of the crisis .

In other words, the banking crisis costs us 100 times as much as we could save by reforming IB.
More, in fact. This cost of the banking crisis - lower GDP (not, note the sums involved in bailing out the banks) - is a pure loss. But savings on IB spending are a mere transfer - they enrich tax-payers but impoverish benefit claimants.
This raises the question. How can people be reasonably relaxed (by now) about the massive cost of the banking crisis, and yet so concerned about the much smaller costs of the IB/ESA system?
The rational possibility is that the banking crisis is a sunk cost - we can do nothing about it - whereas the benefit system isn’t.
But is this really the whole story?

Comments

[RH]

"The cost of banking crisis is a pure loss". Is it? I was led to believe that there was a massive transfer of pubic wealth to the chosen few. The banking system is now dependant on the savings from the welfare state to survive.

[chris]

Sorry RH, I should be clearer. The pure loss I'm talking about is that GDP will be permamently lower because of the crisis. You're right, that there was also a transfer to bankers, but Dicks' figures exclude that. It's a different thing.

[Luis Enrique]

It does seem that people are reasonably relaxed about the banking crisis. Strange, isn't it? The Yanks still seem pretty hot on the topic, but here in the UK, not so much. The topic was notably absent - at least in any substantive fashion - from the election.

In the US they have had various specific proposals for reform, a very public legislative process, and visible lobbying efforts by the banks, for journalists and bloggers to get stuck into (and they have enough high profile journalists and bloggers with the knowledge to do it). Here we seemed to only be interested in simple stories with pleasing villains (those reckless bankers) and there's only so many times you can tell that story. I blame the woeful state of economics reporting in this country (most of whom still use the gross cost of the bailouts to illustrate the cost of the crisis). Why aren't we reading more about proposed UK banking reforms?

Another rational possibility is that people are relaxed about the banking crisis because although it looks like the financial sector cost us £132 billion by imploding, before it imploded it also caused the path of GDP to be higher than it would have otherwise been, so the net cost is smaller. I'm not saying I buy that argument, but it does at least make sense to look at both contribution and cost.

More generally, there's going to be another recession at some point, and it's going to cost us £Xbn, so we could always say "why worry about these piffling £xbn, when that recession has cost us £Xbn" which is a recipe for never taking care of your £xbns.

[william]

Luis, we aren't 'relaxed', we are resigned. Resigned to the fact that in the UK, the people who caused the crisis will quietly slip away with all their gains, leaving others to pick up the pieces. They'll do that because their friends in government will let them.

[Dustybay]

Very good blog and more evidence that the Tory budget was an ideological one and little to do with economics. Osborne's glee in delivering "punishment" is quite obvious. And the Mantra "IT'S ALL LABOUR'S FAULT" completely ignores the roles of banks in all this.

[pablopatito]

"The Yanks still seem pretty hot on the topic"

Yeah, but they don't have a welfare state to bash do they? Maybe its just lack of a scapegoat that keeps them focussed.

[Ralph Musgrave]

Good article above Mr/Ms Stumble and Mumble. But it goes wrong in the para starting “Alternatively, the increased supply of labour....”.

The claim is made that increased demand for labour can only come if wages are reduced. I suspect you are using a micro economic law (supply and demand) at the macro economic level: common mistake.

The reality is that aggregate labour supply is increased because more ex-IB claimants are seeking work; that is anti-inflationary, which enables an increase in aggregate demand, and thus a rise in aggregate employment. This, contrary to the claims of the above article would result in a rise in the average real wage for the U.K. because more people at work rather than on benefits means a bigger GDP.

[Mark Wadsworth]

For once I am more or less agreed with you.

As separate issues

1. We ought to roll IS, JSA and IBA/ESA into a flat rate Citizen's Income and do away with means testing. And scrapping NMW, loony employment laws, get our of EU, scrap NIMBY restrictions on new construction would help.

2. The banking crisis wasn't a banking crisis. It was a Home-Owner-Ist crisis, where house prices have reached a level that can only be propped up by massive transfers from productive economy to land owners and home owners (the 'greedy bankers' are merely the well-paid foot soldiers of the Home-Owner-Ists).

[Charles Wheeler]

It's called scapegoating

[Innocent Abroad]

Chris, at least some IB recipients will pay income tax on their benefit - obviously if their income goes down so will their tax contribution. So the saving will be up to 20% less than you predict. Not sure what IB as a %age of GDP has to do with the price of fish.

[Tim]

Hello, I'm a deaf person who no doubt will be pushed onto JSA and spend the rest of my "working" life being bullied at the job centre for not getting the jobs that nobody wants to give me. I thought I'd add a few things.

The re-tests cost money. People will appeal at independent tribunals and higher courts. That will cost money. People may win their appeals (which they do.) More money. Finally, if I am eventually forced to go down the job centre, I will insist on having a sign language interpreter under the DDA. Have you seen how much they cost?

[Account Deleted]

I am discontented to know that there are range of issues that needs more clarification on certain levels with which the ESA ( Employment and Support Allowance) will be set. I would like to forward to the Department concerned providing more detailed information as an answer to this matter. I would like to hope that the department will work in close coordination with disability organizations to guarantee proper assessment be made as far as the new structure of the new benefit system is concerned, how it will affect the income of ill or disabled individuals in collation with the current system and work to alleviate inconsistencies in the system. DWP shoul make certain that the resulting benefit levels preserves the principle of no loss to existing claimants whenever a new benefit is inoculated.