Stagnation generation? The case for renewing the intergenerational contract

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Executive Summary

The social contract between the generations shows signs of fraying

Much of David Cameron’s premiership was characterised by the debate on living standards. This was driven both by the generalised squeeze on incomes that followed the financial crisis of 2008, and by deeper-rooted questions about the distribution of the gains from growth. Those issues remain painfully relevant today, with many groups facing typical incomes that are no higher than at the turn of the century, and inequality within generations remaining too high. But it is increasingly clear that our new Prime Minister must respond also to emerging questions about the specific challenges facing younger people in Britain.

Just like families, states and societies are underpinned by a social contract between the generations – collectively supporting each of us through the stages of our lives, and crucially doing so fairly. But this contract looks at risk of fraying. Even before the EU referendum result highlighted big differences between the generations, with the under 45s voting to remain and the over 45s to leave, issues of intergenerational fairness were rising up the agenda.

These concerns have been driven by some visible problems. Young people have experienced the biggest pay squeeze in the aftermath of the financial crisis, seen their dreams of home ownership drift out of sight and witnessed a welfare state in retreat. No doubt some of these strains on the intergenerational contract are short-term in their nature and will unwind naturally over time, but there is a sense that many of them run deeper.

In this document, which marks the launch of the Intergenerational Commission, we dig deeper into some of the experiences of younger generations to identify both reasons for optimism and causes for concern. In doing so, we establish a framework for thinking about intergenerational issues and highlight the scope for policy to make a difference.

Millennials are at risk of becoming the first ever generation to record lower lifetime earnings than their predecessors

In contrast to the taken-for-granted promise that each generation will do better than the last, today’s 27 year olds (born in 1988) are earning the same amount that 27 year olds did a quarter of a century ago. Indeed, a typical millennial has actually earned £8,000 less during their twenties than those in the preceding generation – generation X.

While it is the financial crisis that is responsible for much of this, with more than a 10 per cent gap still existing between young people’s earnings today compared to their peak in 2009, there are signs that problems preceded the recent crisis. Those millennials who were 25 years old before the financial crisis hit were already seeing no pay progress on preceding cohorts. And we know that there were problems developing before the crash including a lack of productivity-boosting training for young people and declining job switching – both trends posing risks to younger generations’ earnings.

Of particular relevance to questions of intergenerational fairness is evidence that the pay of today’s workers has been suppressed by firms filling deficits in defined benefit pension schemes that provide for older or retired workers. Some estimates suggest that as much as £35 billion is being diverted to this effort each year by businesses.

No one knows what the future will bring, but even on optimistic scenarios it looks likely that the millennials will record much lower generational pay progress than their predecessor generations did. And under the pessimistic but plausible scenario in which factors including Brexit and the structural productivity slowdown weigh down on earnings growth over the longer term, millennials face becoming the first generation on record to achieve lower lifetime earnings than their predecessors.

This idea that progress over time might be grinding to a halt matters not just for individuals, but for how Britain feels as a country.

Lower levels of asset building, and home ownership in particular, generate short-term disappointment and longer-term living standards challenges

Wealth matters both in the near- and the longer-term. Asset ownership – in cash savings or possessions – provides a source of stability that helps individuals to deal with the inevitable challenges life throws up, and creates a platform for risk-taking and entrepreneurialism. Crucially, wealth also makes a big difference to living standards in retirement, with implications for individuals and for the state.

The fact that those aged 65-74 now hold more wealth than the entire population aged under 45 (a group more than twice their size) is therefore a matter of concern.

This generational concentration of wealth is being driven in no small part by the closure of access to generous defined benefit occupational pension schemes to younger workers. Such schemes have average contribution rates of 21 per cent, with 16 per cent coming from the employer. But the number of active members has dropped from 4.6 million to just 1.6 million since the turn of the century, with very few newer workers included.

Instead, younger workers must make do with defined contribution pensions. The introduction of auto enrolment is providing an important boost to coverage, with active membership rising from around 1 million in 2000 to 3.2 million by 2014. But average contributions are below 5 per cent, with just 2.9 per cent coming from employers. In the absence of significant improvement in these figures, millennials face much more uncertain retirements than the baby boomers currently entering this phase.

Important though this pension question is, the more visible source of discontent among younger groups is the lack access to home ownership. Indeed, it is housing which sits at the heart of much contemporary anxiety about fairness between the generations. Given a baby boomer at age 30 was 50 per cent more likely to own their own home than a millennial at the same age, such concern is understandable.

The corresponding sharp increase in private renting among younger groups brings with it issues around quality, security and stability. And the financial impact is clear. With more people in such accommodation and renting costs rising over time, millennials are spending an average of £44,000 more on rent in their 20s than baby boomers did. That figure is greater than the average first time buyer deposit today and primarily represents a transfer from young to old.

The good news is that families themselves often step in, using private intergenerational transfers to ameliorate the worst effects of housing scarcity. The Council of Mortgage Lenders estimates that while only 30 per cent of first time buyers had help from family in 2005, that figure had risen to 50 per cent in 2015. But this brings with it serious questions both of equity and social mobility, and of how long we can rely on the bank of mum and dad.

With little sign that ‘generation rent’ can just age its way to home ownership, a renewed focus on house building is likely to sit at the heart of a renegotiation of the social contract between the generations.

The redistributive welfare state is key, but too little consideration is given to how this plays out across generations

It is the welfare state in its 20th century incarnation that has developed most clearly society’s intergenerational role, by directly providing transfers between life stages in both cash and services. It is the embodiment of our national intergenerational contract.

In principle, everyone pays in during their working life, drawing down in early years and retirement for a broadly-neutral lifetime result. But the generosity of transfers and services changes over time – as do tax rates and the size of generations that are contributing or withdrawing. As a result, different generations can end up with net gains or losses. It is estimated that the average baby boomer will have a net gain more than twice as large as the average member of the much smaller ‘silent’ generation born before the boom.

But perhaps more concerning than trends that are partly driven by demography – and that are hard to witness year by year – is the failure to give due consideration to the generational impact of tax and welfare policy changes.

Relative protection of pensioner benefits in recent years, alongside restrictions on working age benefits, have already created a divergence in what younger and older generations can expect from the state when they fall on hard times. And looking at the tax and benefit plans the new Prime Minister and Chancellor have inherited shows that policies to be implemented over the next four years will take £1.7 billion from millennials while giving away £1.2 billion to the baby boomers.

These may be legitimate choices, but too little debate in this area means we are blind to the generational fairness or otherwise of such decisions. To the extent that younger generations will benefit from these same priority shifts in later life, this might be considered a short-term rather than a long-term problem. But settlements have a tendency of changing over time, potentially benefiting some generations more than others. At a minimum we need to ensure policy makers and the public understand the intergenerational implications of the choices they make much better than they do now.

Rewriting the intergenerational contract

While by no means exhaustive, the issues raised in this report are undeniably big. And they are ones that we too often fail to understand fully, let alone have answers to. If we want to strengthen rather than further undermine our social contract it is vital that we do better on this score.

Yes, there is much for younger generations to celebrate: from greater freedoms than their grandparents could ever have dreamed of, to technology and global connectedness enriching their lives. But that does not take away from very real living standards pressures we see developing, pressures we can and should do something about.

Yes, some of these developments are determined by demography and the experience of differently-sized generations ageing through life stages. But others reflect choices we have made that exacerbate rather than close generational divides, and policy failures – from skills to housing – that have been allowed to endure.

Yes, these things are difficult, but there are reasons for optimism. For all the talk of generational war, people whatever their age share concerns for the fate of the next generation – for their children and grandchildren. That might explain why we’re starting to see big increases in support for house building right across the generations.

And that’s why we’re confident that renewing the intergenerational social contract is both necessary and achievable. That is the task set for this Intergenerational Commission.