The UK’s job seeker’s allowance for those who lose their job is much lower than the OECD average. Aadya Bahl argues that improving unemployment support is key not just for protecting workers but also for unlocking economic dynamism and productivity.

Enjoying this post? Then sign up to our newsletter and receive a weekly roundup of all our articles.

The ongoing welfare debate in the UK has focused on disability benefits and getting those signed off sick back into work, but there has been little discussion about the broader issue of unemployment support. While risk of job loss in the UK is relatively low, the consequences for those who experience it are severe.

Unemployed workers in the UK experience a greater income loss than those in other OECD countries. Two-in-five workers experience a large income shock when becoming unemployed in the UK, 10 percentage points more than that experienced Germany, Netherlands and Iceland, as shown by research carried out for the Economy 2030 Inquiry, a joint initiative between the LSE’s Centre for Economic Performance and the Resolution Foundation, funded by the Nuffield Foundation.

Further, the UK’s unemployment support system provides a weak safety net. The income “replacement rate” – hypothetical entitlement of workers to taxes and benefits in the event of unemployment – in the UK is low by international standards. For instance, a single worker without children earning the average wage would receive just 40 per cent of their previous income in benefits if they were to become unemployed, compared to the OECD average of 59 per cent.

The unemployment benefit was worth only 14 per cent of the average weekly earnings in 2023-24.

The low rates can be traced back to policy decisions made in the 1980s. The UK has a flat-rate unemployment benefit system where benefits are unrelated to a worker’s previous earnings. Additionally, unemployment benefits have only been uprated in line with price inflation rather than earnings growth. As a result, the unemployment benefit was worth only 14 per cent of the average weekly earnings in 2023-24.

A barrier to economic dynamism

Beyond the financial hardship faced by individuals, having an inadequate safety net holds back economic dynamism. A dynamic business environment is one in which workers and firms respond to opportunities and challenges by adapting and innovating. One way in which this happens is through reorganisation of the workforce. It is worrying then, that in the UK, the rate at which workers move between firms, due to jobs being cut in some firms and appearing in new and growing firms, has fallen by 4 percentage points between 2009 and 2019.

Low unemployment benefits incentivise unemployed workers to take the first job that comes along, rather than continuing to search for roles that better match their skills and contribute to higher productivity.

In addition to the macroeconomic consequences, this lack of dynamism can also be an issue for individual workers. In the absence of adequate safety nets, workers are less likely to take risks and change jobs. But moving jobs is important for pay and career progression, with job movers typically experiencing a 4.1 percentage-point growth in pay compared to those who stay in the same job.

And even if a worker is forced to move jobs, low unemployment benefits incentivise unemployed workers to take the first job that comes along, rather than continuing to search for roles that better match their skills and contribute to higher productivity. Better job matching could yield significant productivity gains for the UK. At a sectoral level, the contribution of worker reallocation to productivity growth has fallen from 0.4 percentage points per year between 1997 and 2007, to zero between 2008 and 2019. Had this source of growth remained constant, wages would be £1,400 higher today.

Stronger unemployment benefits could help unlock greater job market dynamism, boost productivity, and improve living standards.

Unemployment benefits as a tool for growth

The UK’s stagnant productivity is a key contributor to the cost-of-living crisis and rising inequality. Productivity in the UK lags behind other OECD countries growing at only 0.4 per cent per year between 2007 and 2019. Since worker reallocation plays a crucial role in driving productivity, any policy focused on delivering growth must take this into account.

Stronger unemployment benefits could help unlock greater job market dynamism, boost productivity, and improve living standards. As we have argued, more generous unemployment benefits have been linked to workers finding better-paid and longer-lasting jobs. Reduced financial anxiety enables workers to feel more confident taking risky job moves and gives them more time to find positions that are better aligned with their abilities. This not only benefits workers through higher wages and increased job satisfaction, but also improves firm efficiency.

The UK’s current flat-rate payments fail to reflect a worker’s previous earnings.

A new unemployment insurance

The government’s recent Get Britain Working Green Paper proposes a major overhaul of the welfare system, with a focus on helping people get back into work. It acknowledges the importance of a “non-means tested, time-limited financial award” that gives people the space to find the right job, rather than pushing them into immediate employment. The consultation on Unemployment Insurance leaves key design questions, like those on generosity and duration, open.

The UK’s current flat-rate payments fail to reflect a worker’s previous earnings. The Economy 2030 Inquiry suggests that the unemployment insurance could change this by offering payments based on previous earnings, like the method used by other European countries and in the calculation of Statutory Maternity Pay in the UK.

The inquiry recommends a model that provides 65 per cent of a worker’s previous earnings for up to three months, with extensions during periods of economic crises. This support would be available to anyone who had been in employment for at least a year. It also proposes that for the first three months of unemployment, workers should be allowed to only look for a job that is of a similar nature, level or pay as their previous job, rather than being pushed into any available job.

While unemployment is an economic issue, it also affects people’s sense of security and wellbeing. As the government itself states in the green paper, employment support should be about supporting people “to find the right work for them, fulfilling their potential, and using the skills they have.”

All articles posted on this blog give the views of the author(s), and not the position of LSE British Politics and Policy, nor of the London School of Economics and Political Science.

Image credit: Marmalade Photos in Shutterstock

Enjoyed this post? Then sign up to our newsletter and receive a weekly roundup of all our articles.