The debate about the funding of social care has reopened the arguments about the inequality of wealth distribution in the UK between the old and the young.
The generally accepted narrative, aggressively promoted in Lord Willetts’ book, The Pinch – How the baby boomers took their children’s future – and why they should give it back, and the subject of a leading article in the latest Spectator by editor Fraser Nelson is that the rise in house prices has promoted an unintended redistribution of wealth from the young to the old which needs to be reversed.
At first sight this seems plausible. Everyone knows that UK house prices are sky-high and that they have risen consistently over the years. The difficulty for young people finding accommodation, especially in Central London (at least pre-pandemic) is also very obvious.
And yet. Cebr research for Legal and General published last month shows that older people have been increasingly forced to stay in the labour force because of a lack of sufficient wealth to pay for their old age. The proportion of UK over-50s having to work has risen from 31 per cent in 1992 to 40 per cent in 2020 and is set to reach 47 per cent by 2030.
If the Willetts/Nelson narrative were true, it would be unlikely that nearly half of those over 50 would be forced to have to keep working to pay for their old age.
So what is really going on?
To understand what is happening, the key point that needs to be remembered is that money is only worth what you can buy with it. It is easy to get fixated on the crude figures but any sensible analysis about the distribution of wealth should focus on the spending power generated by that wealth, not just on the crude numbers.
And when the veil of what economists technically call “money illusion” is drawn back, what emerges is a very different picture indeed from that which is assumed by those who accept the conventional wisdom.
The bulk of the rise in house prices that has taken place over the past 30 years has been driven by the fall in mortgage rates. The amount spent on housing in relation to incomes has been remarkably stable. Average mortgage payments as a percentage of average earnings peaked in 2007 at 50 per cent but have since fallen back to 32 per cent – close to the long term average. While house prices have risen, mortgage rates have fallen and roughly over time the two have offset each other. The government’s experimental series for rents only covers the period since 2005. But since then rents have risen by 33 per cent compared with an average earnings increase of 39 per cent (and the 39 per cent was held down by the pandemic!). The RPI data for housing rent goes back further and in the period since 1997 this has risen by 75 per cent compared with average earnings, rising by 83 per cent over the same period. So in relation to earnings rents have gone down, not up.
The baby boomers who purchased property in the last quarter of the 20th century made huge sacrifices to make these purchases at mortgage rates of 15 per cent and more. One of the reasons that I am such a bad skier, relying on strength to compensate for lack of technique, is that I simply couldn’t afford a skiing holiday before I was 35 because of the crippling costs of mortgage repayment. Young people today would laugh not just at my skiing technique but at the thought that people in the 1980s and 1990s prioritised paying mortgages over going on holiday.
Meanwhile, the cost of retirement has sky rocketed. In 1979 it cost only £55,600 to buy an annuity at age 65 to provide an average income of £10,000 a year. Now the same annuity would cost £201,300. This has been driven by two causes – increasing longevity and falling yields.
So the true picture, once you adjust for spending power and buying power, is that the young are not particularly badly off – as indeed can be seen from their spending on holidays and eating and drinking out. But they are less interested in saving for their old age despite the fact that mortgage repayments are historically affordable even after allowing for higher house prices. While at the same time the old are chronically worried about whether they can make ends meet because of rising life expectancy and falling yields.
Of course there is an extent to which the conventional wisdom of expensive housing and over-wealthy pensioners based on purely cash-based calculations is true. Young people still have to raise large sums of cash to pay the deposits when they enter the housing market. This acts as a barrier to entry to those who cannot benefit from what my Cebr colleagues named The Bank of Mum and Dad (BOMAD), where middle class parents use their own housing equity to pay for the deposits on house purchases for their children.
And older people could raise cash to make their old age much more comfortable by selling their houses and downsizing. But crippling stamp duties of as much as 12 per cent make this much more difficult than it might appear. With the transactions costs of moving house running at around 9 per cent paying for movers, solicitors, estate agents and the like, much of the wealth that might be liberated by downsizing disappears in tax and moving costs. In reality one would need to move to a property worth about half the value of one’s current property before liberating a significant amount of cash. So people stay put in larger properties than they need. And their theoretical wealth is just notional – and although it would be possible to use various lending devices to borrow against their housing wealth and to finance their lifestyles, older people do not like doing this.
So, if the baby boomers did not in fact steal young people’s future, why are the young unhappy?
The biggest change in young people’s financing arrangements from when I was younger is that many more people go to university but the Treasury has funded this though the student loan scheme instead of the grants that were available in earlier years and has allowed universities to charge higher fees. The original Treasury intention was that bringing the market into academic education would lead to an improvement in courses and better value for money. It appears that the opposite has happened. There has been an explosion of courses, and though many are likely to be of economic value, many are not. While universities have grabbed the extra cash to pay their senior staff (especially the non-academic staff) significant salary increases. Vice-chancellors in particular have benefitted to the extent that the average pay for a vice-chancellor of a Russell Group university last year had reached £389,340.
Because those who don’t reach the earnings threshold don’t have to repay their loans, which eventually get written off, there is a disincentive for many students to study those courses that will lead to high levels of remuneration. My Cebr colleagues estimate that the UK may need as many as a 177,000 additional experts in Artificial Intelligence by 2031. This compares with only 355 new students enrolled in the subject at all UK universities this year. At the current rate it would take 498 years to educate those whom we need in ten years’ time. So the unintended result of the Treasury’s cunning scheme has been to leave the better off students funding unnecessary courses, overpaid vice-chancellors as well as their less successful contemporaries. This is unfair on just so many levels besides creating adverse incentives that damage the economy.
What does this mean for the funding of social care and the associated redistribution of wealth?
Any sensible reform of age care needs to factor in three things.
First, those who save to build up wealth should not be disincentivised excessively over those who do not. The UK has always had a relatively low savings ratio and with demographic trends against saving it is important not to make this problem worse.
Second, it should be made easier for older people to release cash by downsizing their housing by removing the huge and damaging stamp duty charge.
Third, the Bank of Mum and Dad needs to be made less discriminatory by being made more available to those who do not have the privilege of rich parents to pay their deposits on their houses. I suggested in my book, The Inequality Paradox, that inheritance tax could be restructured to make its effects more redistributional.
The idea that the baby boomers have stolen the young’s inheritance is, like the crocodiles breeding in the sewerage system, an urban myth.
If anyone has stolen anything from the young, it is the Treasury and the universities.
Douglas McWilliams is Deputy Chairman of the economics consultancy Cebr which he founded in 1993.