Before the Boil: Addressing the UK's Living Standards Crisis

‘Too many people in Whitehall are comfortable in the tepid bath of managed decline.’ In delivering his Plan for Change speech on 5 December 2024, the Prime Minister's characterisation of the UK civil service raised eyebrows.

But the situation may in fact be more serious.

Governments—and, more fundamentally, democratic systems themselves—live and die by the extent to which they are perceived to contribute towards making people's lives better. For the UK, the evidence suggests the opposite is happening. As of May 2025, 7.1 million low-income households were going without essentials, like food, hot showers and basic toiletries.

The Office for Budget Responsibility’s (OBR) March 2025 forecasts imply that households are set to become gradually poorer each year from 2025 onwards, with the lowest income third of families set to get poorer twice as fast as the middle and the top–see Figure 1 (source: JRF analysis using the IPPR tax and benefit microsimulation model. Modelling prior to April 2025 based on outturn data and from April 2025 onwards based on data from the OBR’s March 2025 forecast).

But money is not everything. The government has allocated significant resources for public services. Unfortunately, the bulk of additional cash is needed simply to stand still, offsetting the deep cuts that were planned by the previous government. It nets out as the shallowest real-terms increase in overall public funding during a modern spending review period outside of the contractions during George Osborne's austerity years.

This may not be a survivable record to defend at the ballot box. A significant course correction is required—and in precious little time—which requires getting the diagnosis right first.

So, where does this outlook of decline come from?

The economic headwinds for UK living standards are substantial. They combine both structural shifts, like an aging population, with more immediate pressures from supply constraints and restrictive interest rates. Part of this fits with the story of longer-term economic decline that transcends a single country or single business cycle.

Across richer nations, the higher-spending, higher-producing and lower-dependency working-age population is shrinking (relative to the population as a whole), while the lower-spending, lower-producing and higher-dependency non-working-age population is growing. The decline in the share of working-age adults directly impacts the supply side of the economy, with fewer workers available to produce goods and services. Globalisation has offered ways to counteract some of the risks of labour shortages. Increased inward migration and the offshoring of supply chains abroad have helped increase living standards for some through higher economic growth and lower prices.

But globalisation and industrial shift has also brought its own challenges. The growth in intermediary services around finance and real estate may have diverted inward investment away from more genuinely productivity-raising activities in other sectors.

Industrial shifts into services have also contributed to a two-tier labour market, with higher levels of wage inequality. This depresses spending relative to a more equal distribution of wage labour, given that higher-income households are more likely to save rather than spend their additional earnings.

Population aging itself also puts a break on demand growth. Pensioners tend to have lower incomes than working-age adults, and in anticipation of living longer lives, the working-age population saves more for its future retirement income. Both of these dynamics lead to reduced spending in the present.

Sustained weakness in demand can feed a downward spiral in supply across multiple economic cycles. At the macro level, the combination of low demand momentum in the UK, combined with rising savings, sees real business investment flow abroad owing to less attractive opportunities at home. At the micro level, pessimism and uncertainty over future demand make UK firms less likely to invest.

Lower investment in, and adoption of, more productive equipment, technology and business practices here in the UK reduces productivity and therefore overall economic supply, which in turn feeds back into lower wages and weaker demand growth, which sees the spiral of downward pressure continue.

Policy makers have variously risked either temporarily ameliorating, or unwittingly aggravating, these underlying dynamics. Prior to the financial crisis, policy supported cheap credit and rapid asset price growth that concealed structural weaknesses. But the bubble burst. Following the financial crisis, the UK—like many countries—was demand-deficient. Deep cuts to government spending and investment, as well as the vote to leave the EU, compounded this. Consequently, interest rates could not lift away from their effective lower bound (at close to zero) for more than a decade.

Since global shocks from Covid and Russia's invasion of Ukraine, policy makers have largely assumed that the binding constraint on the economy has been on the supply side. Fiscal policy pulled back from its pandemic role of propping up demand and industrial strategy focussed on lower corporate taxation and increasing labour supply. Meanwhile, interest rates have remained high and restrictive. This leaves us with the immediate outlook implied by the latest OBR forecasts: falling real disposable incomes (after housing costs) and declining resources for public services while population aging continues to accelerate.

Nationalist, protectionist and illiberal politics from the right offer little by way of a meaningful response to the substantive economic challenges of decline. The political shifts today would feel eerily familiar to those who lived through 1920s and 1930s Europe. Finding a path through this that avoids the catastrophic convulsions of the first half of the twentieth century is now the imperative—both in the UK and further afield.

What can be done?

Against a backdrop of structural global change, the position and influence of a UK government might feel relatively powerless and parochial. In many ways, it is. But government nonetheless has options.

Effective delivery, however, requires some prerequisites.

Let us assume that UK policy makers desire a future economic equilibrium that is both higher productivity and more distributionally equal than the one we have today, that getting there must contend with the continued underlying dynamics of stagnation as well as more immediate supply constraints, alongside the need to support and accelerate the transition to a more environmentally sustainable future, and all of this must be delivered within the political shelf-life afforded by parliamentary democracy. What might be the strategy for policy that follows?

Such a strategy would require three elements: long-term investment and supply side reform; immediate and direct support for living standards; and a new strategy for tax. Only the first of these elements is currently being pursued with conviction in the UK.

It is difficult to know in real time whether an economy is primarily demand- or supply-constrained. But there are signs that long-term demand side risks may be re-emerging. Unemployment continues to rise while job vacancies continue to fall. Real earnings have barely risen since September 2024. The savings rate from households has been rising sharply for three years and is now higher than at any point during the 2010s. Research produced at the Bank of England suggests that interest rates are likely to be excessively restricting demand.

The conventional view is that government ought to do very little: just let the Bank of England cut interest rates at the appropriate pace. But the Bank's mandate is narrower than the government's, with the emphasis on prices rather than incomes. So, when faced with mixed or uncertain data, the Bank might be expected to respond more slowly and less decisively than a strategy focused on raising incomes might require. Yet economic scarring caused by prolonged demand deficiency is harder to detect and more permanent in its effects if left unaddressed.

For a government that wanted to confront this challenge, the first priority is to put a strategy for direct and immediate increases in living standards at the heart of the government's mission for growth. Raising living standards needs to be seen as an input to a strong economy—both on the supply and demand sides—not merely a desired outcome. Support needs to be targeted at those families with the highest propensity to spend rather than save—families with the lowest incomes and greatest need—while also remaining sufficiently broad-based to sustain political support for the strategy beyond one parliamentary term.

Alongside this, policy also needs to maximise positive spillover effects from higher living standards into the supply side of the economy; more secure families are more likely retrain or start a business, for example.

There are two types of intervention government can explore. The first might be described as ‘cross-market’. This will often require government spending and fiscal policy to redistribute resources from a given group of people (either in the present via tax or in the future through public borrowing) to another group.

By far the most efficient way to do this is to increase spending on social security. Immediate measures would include cancelling the remaining cuts to people with long-term health conditions, reversing the two-child limit in universal credit, scrapping the benefit cap and permanently unfreezing local housing allowance. Going further, the basic payment from universal credit should rise to cover at least the cost of essential goods and services.

The second category of intervention can be described as ‘within-market’, where government facilitates a cross-subsidy between different consumers or between producers and consumers—often through legal or regulatory change. This can reach a broader base of households beyond means-tested benefits, and can focus on root causes of insecurity, like statutory employment rights; affordability of childcare; or the affordability of electricity.

The final major element is a new strategy for taxation. This should increase progressivity (across income and wealth), enhance neutrality (by equalising the tax treatment of otherwise similar economic activities) and improve predictability (in terms of the clarity and stability of new regimes).

Possibilities include bringing effective rates of taxation on capital income into line with the taxation of earnings from work. Another could be expanding national insurance contributions beyond just earnings to include things like dividends, rents and returns on savings. Taken together, these measures alone are estimated to raise more than £20 billion a year.

Absent a significant change in direction, most voters in the UK are currently forecast to fare much worse under five years of Keir Starmer than Americans did under four years of Joe Biden, before they voted the Democrats out. But the economic and political fate of the present UK government is not sealed. Nonetheless, a reset is required. Rather than being the desired outcome of an economic strategy, raising living standards directly is the crucial missing input.