Living Wage likely to destroy jobs and increase poverty
11 September 2012
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10 September 2012
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12 September 2012
Economic Theory
Last week Ed Miliband suggested that a new Labour government could introduce a requirement for all government contractors to pay a ‘living wage’ well in excess of the national minimum wage. This is part of his approach to what he calls ‘pre-distribution’ – higher pay for poorer workers before tax – rather that redistribution through the tax and benefit system
Mr Miliband was endorsing, not for the first time, the aims of the Living Wage Campaign, dating back to 2001 in this country but also having equivalents in other countries – for instance the USA, where New York mayor Michael Bloomberg recently incurred campaigners’ venom by vetoing a city council proposal to implement a living wage scheme.
In the UK the proposal is for a Living Wage currently set at £8.30 per hour in London and £7.20 outside the capital. This contrasts with a national minimum wage which is currently £6.08, rising next month to £6.19.
Where do these figures come from? The London and national living wages are calculated by two different bodies – GLA Economics, a hangover from Ken Livingstone’s day, and the grandly-named Centre for Research in Social Policy, in reality a small congregation of sociologists at Loughborough University.
The London figure has attracted most attention as a result of Boris Johnson’s continuing support, the endorsement of some leading financial service companies such as J P Morgan, Goldman Sachs and KPMG, and a rather unpleasant campaign by students which forced University College London and some other London universities to sign up.
The figure, if not exactly plucked out of the air, is reached by an arcane process. First, the GLA Economics team estimate a ‘Low Cost but Acceptable’ budget for four stylised households with different working patterns and family commitments. The wage which academic experts say suffices for ‘an adequate level of warmth and shelter, a healthy palatable diet, social integration and avoidance of chronic stress for earners and their dependents’ differs between households, so a weighted average is taken. This gives the ‘Basic Living Cost’.
The second – ‘Income Distribution’ – approach takes a figure which represents 60 per cent of the median income for London for each household type. These are again weighted.
In London the Basic Living Costs approach gives a figure of £6.85 per hour and the Income Distribution approach gives a figure of £7.65 per hour.
The average of these two figures (now called the ‘poverty threshold wage’) is £7.25. In order to protect against unforeseen events a margin of 15 per cent is added to the poverty threshold wage. Thus we have the figure of £8.30.
Numerous criticisms could be made of this arbitrary methodology. However I prefer to concentrate on the implications of trying to implement this up-till-now voluntary approach more widely.
For one thing, the whole approach is based on ‘needs’ and makes no concessions to the affordability of the rates set. In this it contrasts sharply with the relatively cautious approach of the Low Pay Commission, which for all its faults has recognised that pay does affect the demand for labour. Its most recent report, based on good-quality research from some of the UK’s best labour market economists, recommended an increase in the adult national minimum wage (NMW) which is well below the rate of inflation – and no increase at all for youth employees. By contrast the Living Wage methodology virtually guarantees that the wage will increase over time in real terms whatever the state of the labour market.
Paying these higher wages to workers on government contracts would mean higher costs directly to the taxpayer. Moreover, the Living Wage is so much higher (more than a third) than the national minimum that it would almost certainly trigger higher pay for other workers as well. The NMW is paid to those who, for various reasons, display low productivity. Those who are currently paid £8.30 an hour are more productive, perhaps because they are more experienced, or work in more difficult environments. They need to be paid more than NMW people to compensate for this, and the implementation of the Living Wage would ultimately shift their wages up as well.
These substantial pay hikes, particularly in a recession, would almost certainly lead to job losses.
They would also privilege those who kept their jobs at the expense of ‘outsiders’ who would be forced into parts of the economy where the Living Wage would presumably not apply – small businesses, self-employment and the black economy. This would force down pay in these areas.
They would be a blunt instrument in tackling poverty even on their own terms. The GLA Economics methodology, with its stylised examples and simple weighting cannot provide the sort of sophisticated microsimulation modelling which the Institute for Fiscal Studies, for example, might bring to this issue. The GLA people really do not know what the consequences of the Living Wage would be. Hazarding an informed guess, I expect the main beneficiaries of the £8.30 an hour, assuming that they kept their jobs, would be part-time workers and young people. These are the major groups (they overlap of course) which currently earn less than the proposed Living Wage. Part-time workers usually have some other source of income or financial support (such as other family members, while the needs of young people are rather less than those of prime-age workers).
The real poverty in our society lies with those who are not in work at all, and the implementation of the Living Wage will do nothing to improve their chances of a job – rather the reverse. Mr Miliband (and Mr Johnson) really need to think about this more carefully.
Mr Miliband was endorsing, not for the first time, the aims of the Living Wage Campaign, dating back to 2001 in this country but also having equivalents in other countries – for instance the USA, where New York mayor Michael Bloomberg recently incurred campaigners’ venom by vetoing a city council proposal to implement a living wage scheme.
In the UK the proposal is for a Living Wage currently set at £8.30 per hour in London and £7.20 outside the capital. This contrasts with a national minimum wage which is currently £6.08, rising next month to £6.19.
Where do these figures come from? The London and national living wages are calculated by two different bodies – GLA Economics, a hangover from Ken Livingstone’s day, and the grandly-named Centre for Research in Social Policy, in reality a small congregation of sociologists at Loughborough University.
The London figure has attracted most attention as a result of Boris Johnson’s continuing support, the endorsement of some leading financial service companies such as J P Morgan, Goldman Sachs and KPMG, and a rather unpleasant campaign by students which forced University College London and some other London universities to sign up.
The figure, if not exactly plucked out of the air, is reached by an arcane process. First, the GLA Economics team estimate a ‘Low Cost but Acceptable’ budget for four stylised households with different working patterns and family commitments. The wage which academic experts say suffices for ‘an adequate level of warmth and shelter, a healthy palatable diet, social integration and avoidance of chronic stress for earners and their dependents’ differs between households, so a weighted average is taken. This gives the ‘Basic Living Cost’.
The second – ‘Income Distribution’ – approach takes a figure which represents 60 per cent of the median income for London for each household type. These are again weighted.
In London the Basic Living Costs approach gives a figure of £6.85 per hour and the Income Distribution approach gives a figure of £7.65 per hour.
The average of these two figures (now called the ‘poverty threshold wage’) is £7.25. In order to protect against unforeseen events a margin of 15 per cent is added to the poverty threshold wage. Thus we have the figure of £8.30.
Numerous criticisms could be made of this arbitrary methodology. However I prefer to concentrate on the implications of trying to implement this up-till-now voluntary approach more widely.
For one thing, the whole approach is based on ‘needs’ and makes no concessions to the affordability of the rates set. In this it contrasts sharply with the relatively cautious approach of the Low Pay Commission, which for all its faults has recognised that pay does affect the demand for labour. Its most recent report, based on good-quality research from some of the UK’s best labour market economists, recommended an increase in the adult national minimum wage (NMW) which is well below the rate of inflation – and no increase at all for youth employees. By contrast the Living Wage methodology virtually guarantees that the wage will increase over time in real terms whatever the state of the labour market.
Paying these higher wages to workers on government contracts would mean higher costs directly to the taxpayer. Moreover, the Living Wage is so much higher (more than a third) than the national minimum that it would almost certainly trigger higher pay for other workers as well. The NMW is paid to those who, for various reasons, display low productivity. Those who are currently paid £8.30 an hour are more productive, perhaps because they are more experienced, or work in more difficult environments. They need to be paid more than NMW people to compensate for this, and the implementation of the Living Wage would ultimately shift their wages up as well.
These substantial pay hikes, particularly in a recession, would almost certainly lead to job losses.
They would also privilege those who kept their jobs at the expense of ‘outsiders’ who would be forced into parts of the economy where the Living Wage would presumably not apply – small businesses, self-employment and the black economy. This would force down pay in these areas.
They would be a blunt instrument in tackling poverty even on their own terms. The GLA Economics methodology, with its stylised examples and simple weighting cannot provide the sort of sophisticated microsimulation modelling which the Institute for Fiscal Studies, for example, might bring to this issue. The GLA people really do not know what the consequences of the Living Wage would be. Hazarding an informed guess, I expect the main beneficiaries of the £8.30 an hour, assuming that they kept their jobs, would be part-time workers and young people. These are the major groups (they overlap of course) which currently earn less than the proposed Living Wage. Part-time workers usually have some other source of income or financial support (such as other family members, while the needs of young people are rather less than those of prime-age workers).
The real poverty in our society lies with those who are not in work at all, and the implementation of the Living Wage will do nothing to improve their chances of a job – rather the reverse. Mr Miliband (and Mr Johnson) really need to think about this more carefully.
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Any increase in costs to a government contractor is the same as a tax increase on the population. In effect more pay means more revenue for the government in a short term method as the costs will increase across the board to absorbe the net effect ie inflation!
The problem is that the solutions for the unemployed are different from those for low-paid jobs, so a single measure cannot help both groups – and indeed risks harming one at the expense of the other.
The majority of benefits are paid to people who are in work but not earning enough to pay their existing expenses. Now, they could try going to their landlord and negotiating a rent reduction on that basis. With utilities it would be a case of not using them so much (i.e turning down the heating, cooking less, eating more cheaply, making fewer phone calls). Some of these are achievable with little impact, some would noticeably diminish the quality of life and some are virtually impossible.
Some economists would argue that if enough people did challenge their landlords rents would be forced down. Maybe so, but it would be a slow and painful process with no certain or even vaguely predictable outcome. In any case, it’s a very unequal power relationship: at the moment average rents are actually rising: landlords would probably bullishly accept people moving, expecting to to find another tenant willing to pay the desired amount. If rents are unaffordable people will leave those areas, causing a degree of havoc since they could probably no longer afford to commute either leaving, at best, companies having the headache of rising staff turnover and at worst certain low-paid but essential jobs unfilled (which may force wages up in any case as employers have to offer more to attract staff back!)
Some have argued that the government, rather than looking at how much money it raises and thinking about what to do with it, should look at what it needs to do and only raise the money for that. That is exactly what many low-paid do at the moment: there is no way they can escape or change their housing commitments [what they need to do] so there is an externally enforced salary floor. If they don’t even meet that, the benefits system brings them up to it.
But it is a phenomenally inefficient way of organising things (the fact that the “minimum wage” is taxed, further locking people into the benefits spiral is a logical insanity). It essentially boils down to: companies pay small wages and high taxes; the government uses those taxes to supplement to the low wages.
In short, the benefits system is a massive (and massively inefficient) short-term subsidy to employers which they end up paying for it in the long-term.
Surely it would be better for companies to pay higher wages and for the benefits system to be much smaller, requiring smaller taxes? What is patently impossible is to pay low wages, low taxes and no benefits.
The question is how to get there in a reasonably efficient and humane manner. Perhaps an even higher level of “Recommended Wage” with companies that offer it getting a tax break?