Welfare Myth Four - Welfare Caused the Crisis

17/06/2013 14:41 | Updated 14 August 2013

The next instalment in my intermittent series on welfare myths is the claim that welfare created the current economic crisis.

The myth most often used by politicians to justify their attack on the welfare state is that welfare spending is somehow unaffordable and is to blame for the current crisis. Nothing could be further from the truth.

For better or worse government expenditure has hardly changed as a percentage of GDP in over 40 years. The average percentage is 43% and the two major peaks in expenditure were in 1977 and 1982 (but even then it did not exceed 50%).


The real cause of the current economic crisis is over-borrowing - in particular by home owners. Of course we can also rightly blame the banks for lending to us and governments for letting them do so. But it is important to recognise the role that many of us have unwittingly played in the current crisis.

Over the past 18 years we have borrowed increasingly large amounts of money to buy houses. After we adjust for inflation, the average house price at the end of 1995 was £83,900. At the peak of the housing bubble in 2007 it was £219,843. That is an increase of 260%. Real economic growth for the same period was only 46%.

Our homes seemed to magically grow in value, while we did nothing. Buying houses seemed like the best investment in the world. What could go wrong?

History teaches us that when people think they can make money just by spending money, then you will get a bubble - an unsustainable price increase. Most bubbles just burst - causing ruin and disaster to those who didn't get out in time. But in a democratic welfare state like ours it is natural for the people to expect the politicians to get them out of this mess.

We can see the reality of this in another graph which represents the UK interest rate over the past 50 years. For the last four years the base interest rate has been held at 0.5% - whereas the average rate for the last 50 years is 7.5%.


What this means in practice is that an excessive mortgage, secured against an inflated price, is now more affordable - because the price of the mortgage has been kept artificially low.

This impacts on different families in different ways. First of all it is only a subsidy to home owners, and of course the percentage of home owners increases with income. Second it is a subsidy in proportion to the size of the debt, which also increases with income. So the impact of lowering the cost of borrowing is a hidden subsidy to wealthy homeowners.

The wealthiest 10% of families have an average income of £114,800 per year. On average they pay £4,500 on their mortgage - but if the base rate was 7.5% they would be paying £8,600. This means that they now receive a subsidy of about £4,100 per year. This figure would be even higher if we excluded the wealthy who did not have mortgages from the calculation.

Unsurprisingly the figure for the poorest 10% of families is very different. The poorest 10% of families have an average income of £7,900 per year and they pay an average of £6 per year on their mortgage - but if the base rate were 7.5% they would be paying £11. (Of course very many in this group have no mortgage, but pay inflated rents in order to pay other people's mortgages.)

So this means that the hidden subsidy to home owners of an artificially lowered interest rate is a distribution of money to the wealthy. For average families of different incomes this distribution is as follows:


We can go further and calculate the total cost of the subsidy for the whole economy. This figure turns out to be £34.1 billion. Interestingly this annual figure is very close to the total amount that the government intends to cut from benefits and social care by 2015.

So, when you hear politicians blaming welfare for the current crisis - pause. Think about what really caused the current crisis. Think about why politicians might want to blame the groups who couldn't have possibly caused the crisis. Think about whose interests are served by this rhetoric. Yes, it is the wealthy; but it is also many more of us who borrowed too much and then expect politicians to bail us out when things went wrong.

If you want to do something about this you could join the Campaign for a Fair Society and sign the WOW Petition.