How to introduce a minimum wage without raising unemployment
2 June 2011
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Over at the Adam Smith Institute, Sam Bowman is discussing the minimum wage again. However, as is always the case in minimum wage arguments, supporters of a legal price floor are quick to point out that the introduction of the minimum wage in the UK was not accompanied by rising unemployment, as economic theory would suggest. What explains the labour market’s seeming resilience in the face of what should be a very bad policy?
A quick summary of what theory says should happen might help. In theory, the market price is the price that ‘clears the market’: everybody who would be willing to sell at that price finds a buyer and everyone who would buy at that price can do so. At a price higher than the market price, more sellers would enter the market, while more buyers would be deterred, so ‘the market would not clear’: there would be an excess of supply relative to demand. In labour market terms, that means that there would be more would be more workers and fewer jobs, which means unemployment.
Looking at it from a different perspective, economic theory tells us that wages should equal the marginal product of the worker. If I can produce £6/hour worth of value to your company, it is worth you paying me £5.95/hour to work for you, but not £6.05/hour. Thus, a minimum wage set higher than my marginal productivity does not increase my wages; it just renders me unemployable.
So how come millions of workers with low productivity did not swell the ranks of the unemployed as a result of introducing the minimum wage? There are three possible reasons that come to mind.
The first is the stickiness of labour markets that results from other government intervention. In the short-term, it may be cheaper to increase a person’s wages to a level that is higher than their productivity than to make them redundant. This is particularly true if they have been in the same job for a long time: redundancy payments would be high, while they may be expected to retire or move on soon. So in the short term the impact may be softened.
Secondly, if the minimum price floor is set below the market price, it will not affect supply or demand (or, for that matter, wages!). If, when it was introduced, very few workers in the UK had a marginal productivity of below £3.52/hour, it would not have had a discernable impact: it would, in fact, have been nothing more than a hollow gesture intended to burnish the socialist credentials of the New Labour government (imagine!).
Thirdly, as welfare economics teaches us, what matters to a person considering changing their employment is the next best alternative. In the case of the UK, the real minimum wage is not necessarily the legal minimum, but the amount that one would receive in benefits if one were not working. Housing Benefit alone can be worth around £5 or £6 an hour. Thus, for the poorest and least-skilled in our society, working only ceases to be the next best alternative once the wage they can command rises above the level of out-of-work benefits.
It is not beyond imagination that the Labour government knew this, and deliberately introduced the minimum wage at a low level as a Trojan horse, enabling them to prove that it caused no harm before ramping it up to levels that would impact upon employment. One needs to bear in mind that the Labour government helped create a spectacular economic bubble during their time in government. With the amount of deficit spending and monetary expansion they indulged in, the real question should be why we didn’t have full employment.
Of course, all booms turn to bust. There are now 2.5 million unemployed in the UK, yet the government still refuses to abolish the minimum wage or even to consider less controversial options such scrapping it for under 25s or freezing the rate. Don’t expect those unemployment figures to fall quickly.
A quick summary of what theory says should happen might help. In theory, the market price is the price that ‘clears the market’: everybody who would be willing to sell at that price finds a buyer and everyone who would buy at that price can do so. At a price higher than the market price, more sellers would enter the market, while more buyers would be deterred, so ‘the market would not clear’: there would be an excess of supply relative to demand. In labour market terms, that means that there would be more would be more workers and fewer jobs, which means unemployment.
Looking at it from a different perspective, economic theory tells us that wages should equal the marginal product of the worker. If I can produce £6/hour worth of value to your company, it is worth you paying me £5.95/hour to work for you, but not £6.05/hour. Thus, a minimum wage set higher than my marginal productivity does not increase my wages; it just renders me unemployable.
So how come millions of workers with low productivity did not swell the ranks of the unemployed as a result of introducing the minimum wage? There are three possible reasons that come to mind.
The first is the stickiness of labour markets that results from other government intervention. In the short-term, it may be cheaper to increase a person’s wages to a level that is higher than their productivity than to make them redundant. This is particularly true if they have been in the same job for a long time: redundancy payments would be high, while they may be expected to retire or move on soon. So in the short term the impact may be softened.
Secondly, if the minimum price floor is set below the market price, it will not affect supply or demand (or, for that matter, wages!). If, when it was introduced, very few workers in the UK had a marginal productivity of below £3.52/hour, it would not have had a discernable impact: it would, in fact, have been nothing more than a hollow gesture intended to burnish the socialist credentials of the New Labour government (imagine!).
Thirdly, as welfare economics teaches us, what matters to a person considering changing their employment is the next best alternative. In the case of the UK, the real minimum wage is not necessarily the legal minimum, but the amount that one would receive in benefits if one were not working. Housing Benefit alone can be worth around £5 or £6 an hour. Thus, for the poorest and least-skilled in our society, working only ceases to be the next best alternative once the wage they can command rises above the level of out-of-work benefits.
It is not beyond imagination that the Labour government knew this, and deliberately introduced the minimum wage at a low level as a Trojan horse, enabling them to prove that it caused no harm before ramping it up to levels that would impact upon employment. One needs to bear in mind that the Labour government helped create a spectacular economic bubble during their time in government. With the amount of deficit spending and monetary expansion they indulged in, the real question should be why we didn’t have full employment.
Of course, all booms turn to bust. There are now 2.5 million unemployed in the UK, yet the government still refuses to abolish the minimum wage or even to consider less controversial options such scrapping it for under 25s or freezing the rate. Don’t expect those unemployment figures to fall quickly.
24 thoughts on “How to introduce a minimum wage without raising unemployment”
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The answer to your question of why unemployment remained so high is obvious – I’m sure you’re aware of the structural problem but let’s spell it out. On the demand side high levels of unemployment benefit and ‘incapacity’ benefit as you point out. On the supply side – very poor (state) education system meaning potential employees are inadequate for the jobs offered, high levels of job-destroying taxation (so-called National Insurance, Income Tax, Corporation Tax, VAT) and extremely high levels of job-destroying regulation in the labour market and in specific sectors.
Given this situation, however, it’s unlikely that reducing the minimum wage would significantly reduce unemployment without supply-side reforms and reduction of transer payments. That’s not to say, of course, that the national minimum wage ought not be scrapped forthwith. At the very least there should be greater flexibility – the absurdity of the ‘national’ aspect are manifest given the huge differentials in the labour market between London and the South East and other regions. The minimum wage is probably encouraging migration between regions – something that would not be reflected in national employment statistics either.
As to wage rates, you make an excellent point – like other socialistic measures this is indeed a Trojan Horse. Let’s try an experiment – set the minimum wage at £20/hour and see the impact on unemployment then!
Clearly there will be a level where minimum wage levels really do affect employment but the current levels are way short of this.
It is the perpetual feeling in an employer’s mind that he can actually get an employee to work for nothing, or thereabouts: “lucky to have a job my lad”. Yet when buying his new Mercedes, he knows the opportunities to negotiate the price down are limited, but still buys one.
The last Government skirted round the problem by the system of tax credits – the taxpayer funds the minimum amount needed. An amount that’s increasing rapidly with so many for-profit companies running public services.
The flexible working practices, weaker unions, less job security etc have not actually benefited the UK economy on the labour side. It has been easier to move production and jobs to the Far East, easier to get rid of employees, easier to keep wages flat.
Often these are the same companies whose acumen extends to elaborate tax avoidance schemes as well to enhance the shareholder value that is so revered.
A (much) higher minimum wage, coupled with more job security would at the very least keep some of the profits in the UK, in the hands of those who help create them, taxable in addition and with the multiplier effect (if we can still quote Keynes these days).
Paying a minimum living wage takes away at a stroke many of the benefits issues that many find so distressing.
Der Krosben, I’m afraid I must agree with your imagined employer’s attitude of “lucky to have a job my lad”, especially at the minimum wage rate as it now exists.
I have mainly worked at smaller concerns and I can assure you that I would not have held those jobs if my employer had been required to pay me even a slightly higher minimum wage. Indeed, I have even agreed to work for below minimum wage in the past in order to secure employment. I do not feel that I was exploited in this. I would have been extremely stupid of me to hold out for what someone else may consider to be “fair” or “just” or “reasonable” remuneration for my services; I would have had a very empty CV indeed and my employment prospects would have seen no improvement.
Although I agree that the minimum wage as it now exists has probably not affected a significant proportion of the working population as a whole, it will have affected a much higher proportion of exactly the kind of person it was designed (purportedly) to benefit; the lower-skilled and less experienced worker. Judged by this, meaningful, benchmark it is hard to see how minimum wage laws can do any good at all.
I would add a fourth explanation: minimum wage is largely ignored where it is effective. I remember about a year ago some US social agency found out that the labour laws are generally not being followed in low-paying occupations. When the state introduces the minimum wage, the employer will:
– lower alternate means of compensation
– worse working conditions
– require higher productivity
– require unpaid overtime
These means are good enough to mitigate quite a lot of government interference. The theory stands; introducing minimum wage doesn’t create (as much) unemployment, because the state is unable to enforce it.
A solution that would not require the abolition of the minimum wage would be to make it compulsory for the tax allowance to be at least twice the minimum wage at 40 hours a week.
This way the government would see that the minimum wage would hit them in the pocket as well as employers and the low paid, suddenly they would pay a bit more attention to the impact.
I am well aware of someone who does the evening shift in a local newsagent and gets no money, only credit to spend in the shop, it pays for her bread and milk not much more, but no tax either. I doubt this is a rare occurrence.
There’s more to Tom’s third paragraph than meets the eye.
Given that there can be added value in a product or a service that is beyond that of the cost of provision, the choice of the employer can be to a) make a little less profit than before, or b) no profit because of a decision to stop employing people.
There is also one other thing to mention about a minimum wage – it can act to limit the extent in which inefficient, badly-run companies subsidise themselves literally at the expense of their employees. But that’s a topic for another time (and a topic you’ll never see discussed at the ASI).
There are so many errors in this blog-post that it is difficult to know where to start, so let’s start here:
(i) “Looking at it from a different perspective, economic theory tells us that wages should equal the marginal product of the worker.”
Is this always true? NO! This is only ever true if there is full employment, or for employment sectors where high skills are in short supply. In which case employers will indeed bid against each other for the available talent, so pushing up the price until the point is reached where the cost of labour exceeds the marginal product of the worker. It certainly doesn’t apply to the low paid, many of whom do work for which the marginal product greatly exceeds their wage. Their wages are bid down because the supply of low skilled labour always exceeds demand unless there is full employment. Low pay then falls to subsistence levels (as predicted by the Iron Law of Wages), or below.
(ii) “If, when it was introduced, very few workers in the UK had a marginal productivity of below £3.52/hour, it would not have had a discernable impact…”
Except that when it was introduced many of the advertised jobs were paying as little as £2.50, so how does that fit into your theory? In fact a number of academic papers and reports have concluded that about 6% of workers (i.e. two million) saw their pay rise when the minimum wage was introduced.
(iii) “So how come millions of workers with low productivity did not swell the ranks of the unemployed as a result of introducing the minimum wage? There are three possible reasons that come to mind.”
No, there is a fourth. Many of these businesses were able to pass their costs on to customers, or absorb them out of their excessive profits. This is because the wages of the low paid are often significantly less than the marginal product of their work as outlined in point (i). So many employers had inflated profits from which they were able to find some of the additional money. Moreover, most of these jobs are in the service sector, and so they are also unaffected by international competition. The net result is that service costs often rise as customers are forced to pay the real economic cost of the services they require, rather than have such services partially subsidised by the state via the benefits system. This adds to the amount of redistribution in society as the rich are forced to pay the real price for the services they require (rather than having them subsidised by the state) and their excess wealth is transferred to the poor.
(iv) “With the amount of deficit spending and monetary expansion they indulged in, the real question should be why we didn’t have full employment.”
No the real question is: how is it that some people at the IEA and elsewhere seem to have failed to notice that unemployment in the five years before 2007 was the lowest since the 1970s even though the minimum wage had already been introduced?
(v) “One needs to bear in mind that the Labour government helped create a spectacular economic bubble during their time in government. With the amount of deficit spending and monetary expansion they indulged in…”
This is just a reiteration of your erroneous comment of three months ago where you stated: The recession was the result of bad economic policy by the Labour government: notably, running a deficit since 2000 while stoking a credit crisis. (I assume it is the same Tom Papworth, yes?) Firstly the deficit had nothing to do with the recession. A government with both total debt and income equal to 40% of GDP (as was the case prior to 2008) can sustainably run a 2% annual deficit when inflation is at 2.5% and growth is at a similar level (as was also the case). Under those circumstances the ratio of debt to GDP and/or government income will remain unchanged. Nor can a small budget deficit cause a major recession. If it did we would always be in recession, and once in we would never get out. Moreover, as J.K. Galbraith and others have noted, recessions are caused in part by inequality. As for the credit expansion, that was and is a Tory policy.
It was a Tory government that abolished reserve requirements in 1980.
It was a Tory government that allowed retail banks to buy investment banks and brokerages after Big Bang.
It was a Tory government that deregulated the mortgage market and allowed banks to enter the market, thereby providing cheap capital for housing and inflating the housing market prior to 1990, and again afterwards.
It was a Tory government that allowed building societies to demutualise.
It was a Tory government that sold off social housing and failed to replace it, thereby stoking the housing market further.
It was a Tory government that deregulated the credit card industry thereby creating a massive consumer credit bubble.
It was a Tory government that oversaw the largest rise in inequality in this country since WWII.
If the Labour government is responsible for anything, it is in not reversing these policies, policies that many at the IEA and the Adam Smith Institute (ASI) I suspect supported and possibly even proposed.
Perhaps the greatest error you make, though Tom, is at the start of your analysis. You cannot apply the principles of classical economics and market clearing to the field of employment without disastrous consequences. People are not like commodities. They cannot be brought into existence in an instant and removed from the supply chain when they are too numerous. Human capital cannot be simply mothballed or put into cold storage when it is not needed in the way that factories or production lines can. Nor can human capital be reallocated as easily as goods or finance. A dentist cannot become a footballer at will, and a footballer cannot become a dentist. Each person has his own natural talents and there is a finite limit to the extent to which education and retraining can expand his capabilities.
Ultimately, though, the question of the minimum wage is one of morality and human dignity. To claim therefore that the lowest paid and poorest are actually overpaid is something that most civilised people should consider distasteful. But if the IEA and ASI truly do desire the abolition of both the minimum wage and the benefits system, then I suppose the question both need to answer is this: how low would you like to see the wages and living standards of the poor fall?
why is it than when people do not agree with Cantab83’s reasoning they are in error – just as when they produce contributions to the debate on housing that do not share his opinions they are not constructive contributions? There is a puzzle that recorded unemployment (and I stress recorded unemployment because some of the lowest productivity groups do not necessarily form part of recorded unemployment when they are not employed) did not rise after the introduction of the minimum wage. There are many possible reasons for this and it is reasonable to try to resolve the puzzle. Your last point indicates some of the difficulties in your reasoning. The very rigidities you point to are a reason why, when the government rapidly expands one sector of the economy (as happened in the run up to 2008 when government spending rose at very rapid levels), in the short term more resources in total might be employed – those who are being taxed to finance the increased levels of spending do not necessarily lay off workers immediately – total employment might rise in the short term. As it happens, my understanding is that Tom is not a “Tory”
Reply to Philip (on Sat, 04/06/2011 – 18:55)
I have never claimed that Tom was a Tory. I was merely pointing out which party should be held most culpable for the current economic mess.
“why is it than when people do not agree with Cantab83’s reasoning they are in error…”
So are you suggesting that if I can find flaws in IEA policy proposals then I shouldn’t point them out? Or am I in error? In which case, where exactly are the flaws in my arguments? I’d love to know.
The point is that you were not pointing our flaws in reasoning you were pointing out were your opinions and interpretation of evidence differed. And I never said you are in error – I would not want to fall into the same trap! If economics was like providing that the earth were round the number of socialists (or, in your view, the number of believers in markets) would be similar to the number of people who believe that the earth was flat. Just on a previous point, let’s assume that the evidence did point to the marginal product of many people being below the minimum wage and that theory and evidence suggested that they would be unemployed in the face of a minimum wage above their level of productivity. It is insufficient to say that because people need a certain wage to have a living standard that is regarded as non-distasteful we should therefore have a minimum wage. There are worse things than earning a low wage – such as not earning a wage at all. There are other ways of waging the living standards of the very poor. One is through the benefits system (you suggest that the IEA is in favour of abolishing that, could you point to the relevant publication – the most recent ones by Niemietz certainly do not take that approach?) another one is through supply side measures (housing, fuel and food costs are all artificially inflated by government intervention.
So Cantab83 (oh dear):
“It was a Tory government that abolished reserve requirements in 1980”
And signed up to the Basel Accord in 1988. And a Tory/Liberal coalition now that continues to have capital requirements and has liquidity requirements before there is international agreement on them.
Or did that slip by? Did you feel you had achieved some kind of omniscience in 1983 and decided to close your mind to all new information?
The rest of your post is also laughable but that one in particular stuck out.
@Cantab – the point you don’t seem to recognise is that it is the minimum wage which drives down the living standards of the poorest! However much you may wish the reverse to be true, government intervention harms the poorest the most. I sympathise with a critique of (neo) classical economics and equilibrium theories – however, such a position does not encourage me to support the minimum wage, the opposite, in fact.
This point made me laugh:
“No, there is a fourth. Many of these businesses were able to pass their costs on to customers, or absorb them out of their excessive profits. This is because the wages of the low paid are often significantly less than the marginal product of their work as outlined in point (i). So many employers had inflated profits from which they were able to find some of the additional money. Moreover, most of these jobs are in the service sector, and so they are also unaffected by international competition. The net result is that service costs often rise as customers are forced to pay the real economic cost of the services they require, rather than have such services partially subsidised by the state via the benefits system. This adds to the amount of redistribution in society as the rich are forced to pay the real price for the services they require (rather than having them subsidised by the state) and their excess wealth is transferred to the poor.”
Of course, it is not just the ‘rich’ who use buy goods and services. Even the poorest in society must buy goods and services so increasing the price they pay via wage floors imposes the penalty of increased costs, which must also represent a greater portion of their lower incomes, with no means of discrimination. How do you figure that to be ‘moral’??? The means to avoid having ‘such servies subsidised by the state via the benefits system’ is, of course, to abolish the benefits system, although frankly I’m at a loss to understand what you’re talking about here – how is the state subsidising the services the ‘rich’ (i.e. everyone who pays tax) use? And given the deadweight loss of such a subsidy via the tax system, most taxpayers are certainly paying more in tax than they receive in beneficial subsidy.
The ‘Iron Law of Wages’ went out with the ark. What are they teaching you at Cambridge!?! Even Marx (with whom you seem to have some sympathy?) rejected it.
Unemployment may have been falling when the minimum wage was introduced, but as the post observes, the initial rate was low and the unemployment figures do not reflect the distortions which resulted.
I’d also suggest that (as far as I can see) everyone at the IEA and ASI is concerned with ‘human dignity’ and ‘morality’ and this is why they support the liberal policies which, they believe, would favour the furthering of these goals. To accuse them of aiming to undermine the living standards of the poorest is malign and I think grossly unfair – just because they believe that this can be achieved in a different manner to that which you do does not make them immoral, and your (misplaced) moral outrage does nothing to bolster your argument, even if it were correct, which it is not!
A few further points – JK Galbraith et al did not ‘note’ that inequality helps cause recessions, they argued this; it is contentious.
It’s all very well throwing mud at the Tories, this is not a party political post. The point is that both parties have continued statist policies to greater or lesser degress which have caused unemployment. To blame ‘deregulation’ of the credit market (it is still heavily regulated) for the financial bubble and crash is to fail to see the wood (state control of interest rates) for the trees.
The deficit did not cause the recession – that was, indeed, the credit bubble stoked by (state-controlled)low interest rates. The deficit, however, has other malign effects and it is quite clear the level of deficit being run was far higher than was sustainable, let alone desireable. Your predictions of what is a ‘sustainable debt’ are predicated on continued GDP growth which is not guaranteed especially under so much government intervention. Moreover, I would argue that the current rate of national debt is deeply unsustainable. Inflating it at 2.5% is merely destructive of savings and will have a hugely deleterious impact on the long term economic growth prospects. However, these points have no real bearing on the minimum wage.
Human capital is not infinitely transferable but state intervention has the effect of making it less transferable and creates exactly the sort of unemployment which you lament.
Reply to Whig (on Wed, 08/06/2011 – 17:03)
Quote 1: “…the point you don’t seem to recognise is that it is the minimum wage which drives down the living standards of the poorest!”
Quote 2: ” Of course, it is not just the ‘rich’ who use buy goods and services. Even the poorest in society must buy goods and services so increasing the price they pay via wage floors imposes the penalty of increased costs, which must also represent a greater portion of their lower incomes, with no means of discrimination. How do you figure that to be ‘moral’???”
So how exactly does setting a minimum wage above what the lowest paid are currently earning make them poorer? What is the argument here? That the minimum wage makes the poor poorer by increasing their costs faster than their earnings? Or that it increases inequality? Or both? The reality is that it does neither (provided the rise is not too steep or the level insanely high).
The poor may spend disproportionately more on the very services that they themselves provide, although that is highly debatable. After all most of the relevant minimum wage jobs are in sectors like hotels, catering, leisure, child care, and retail that are mainly funded by people with high levels of disposable income. Either way, it is unimportant because the important mathematical measure is not the RATIO of their earnings to the costs that they incur from purchasing the very services that they provide, but the DIFFERENCE. It is their net income that counts, and that clearly increases as the minimum wage increases. For the top earners the difference goes down. So inequality also reduces in addition to the poor becoming richer in real terms.
Never forget that private sector job creation between 2000 and 2007 was far from impressive in large parts of the UK. In places like Wales, Northern Ireland and many northern counties it was only unsustainable levels of public sector spending that kept a lid on unemployment. In those areas, the minimum wage most definitely had a negative impact on private sector (“real”) jobs.
The Welsh Assembly Government boasts that it has,throughProAct, kept 12,000 people at work who otherwise would have been unemployed. So, it is the taxpayer who is paying the minimum wage to keep others in work and so has less to spend,thus causing unemployment elsewhere.
GDM
Reply #2 to Whig (on Wed, 08/06/2011 – 17:03).
“The means to avoid having ‘such servies subsidised by the state via the benefits system’ is, of course, to abolish the benefits system, although frankly I’m at a loss to understand what you’re talking about here – how is the state subsidising the services the ‘rich’ (i.e. everyone who pays tax) use? And given the deadweight loss of such a subsidy via the tax system, most taxpayers are certainly paying more in tax than they receive in beneficial subsidy.”
If a job is economically viable then it should be capable of paying a wage that is sufficient to support the worker employed in that job (a living wage). If there is no minimum wage, or that minimum wage is set too low, then wages of the unskilled will inevitably fall below subsistence level with the difference being met by the State via the benefits system. Without that subsidy those jobs would not be filled and the firm would go out of business. That firm therefore only exists because its workers are supported at the tax-payers’ expense. The jobs it provides are therefore uneconomic. Now how is that any different from the way the State used to subsidise the operations of uneconomic nationalised industries? At least in the case of nationalised industries there weren’t any rentier shareholders profiteering at the expense of the tax-payer.
Moreover, allowing one firm to operate at wage levels below the economic minimum merely ends up driving down the wages in competitor firms that had previously been operating above that threshold. It ends up in a race to the bottom that increases inequality (wages go down, profits go up), reduces overall demand and GDP, and gradually turns the country into a low-wage economy with ever lower levels of consumer demand, particularly from those with earnings below the mean, that then impact on future profits, investment and growth. The economy performs best if the number of middle-class consumers is increased, not decreased.
There are only two solutions to this hypocritical situation of the State indirectly supporting uneconomic jobs. Either you have a minimum wage that is consistent with the benefits system, or you abolish the benefits system. The former requires a minimum wage that is set at a level that makes work pay, whilst the latter leads to mass starvation amongst the unemployed who have no means of support. The moral choice should therefore be obvious.
Cantab83, you said: “If a job is economically viable then it should be capable of paying a wage that is sufficient to support the worker employed in that job (a living wage).” This “living wage” is going to depend heavily on the circumstances of the individual. Someone living at home, having all of their food supplied for them etc. would therefore have a wage requirement of zero. What you seem to be getting at is that each adult (I assume adult) is entitled to a “living wage” that would enable them to live in their own (or, presumably, shared) accomodation, supply their own food (or again, share), provide their own transport etc. The thing is, these requirements do not reflect the actual needs of many people (especially young people) looking for work. Indeed, some people may prefer (for whatever reasons) a job paying below an arbitrary “subsistence” level to one paying that level or slightly above. If we had the higher minimum wage you want you would be shutting off employment (to an even greater degree than currently) that certain people would actually want to take in any circsumtances, as well as employment that people would want (in the sense that they had to take it) in the absence of a welfare state. I think it would therefore be helpful if you could clarify what you think a standard of subsistence living involves and whether the minimum wage should be tailored to individual circumstances or whether it should make some common assumptions (i.e. living conditions, food bills etc)?
Without the distortions of minimum pay rates and welfare payments people would not be able to live on a wage below their subsitence (i.e. survival) needs. That much is a truism. It could therefore never be in the interests of an employer to offer such a wage; his employees would all die. However, even this is a compositional fallacy because different employers would be pursuing different agendas and would probably be bidding up wage rates through an attempt to attract good workers away from such businesses (which probably wouldn’t be hard). One of the easiest ways to put a competitor out of business is surely just to deny them a workforce. Even if we could accept a great degree of what you are saying; that there would be businesses “exploiting” their employees to the degree you suggest, don’t you think that there would be a consumer reaction at some point? Some people in this country visibly adjust their spending habits based on how people in various places in the supply chain are treated, even in foreign countries many thousands of miles away (Fair Trade etc). If that is true do you not think it is possible that people would stop buying a product domestically produced (be it a good or a service) where the employees were being (literally) starved? One could imagine producers bragging about the fact that their employees had a life expectancy of plus one month of employment and so on as a marketting ploy.
Ironic that unemployment fell sharply 2 weeks after this post! Everything Tom’s argument hinges upon crumbles to dust, and yet he’ll probably continue to believe this nonsense regardless.
Some people just can’t help having religious convictions about factual, measurable concepts. If you can’t adapt, you’re left in Tom’s position, scratching your head wondering why reality doesn’t match your far superior mental model of the world.
LOL!!
@ Dave T – So of course, when unemployment was increasing Tom was definitely correct?
Reply to Alan (on Tue, 14/06/2011 – 14:07)
(i) “Without the distortions of minimum pay rates and welfare payments people would not be able to live on a wage below their subsitence (i.e. survival) needs. That much is a truism. It could therefore never be in the interests of an employer to offer such a wage; his employees would all die.”
And what about those who aren’t employed? They are surplus to requirements. What happens to them? And what about workers who are employed on short-term contracts? How is that consistent with employers looking after the long-term interests of their employees?
Your argument seems to be a standard counter-argument to the Iron Law of Wages. It may also explain why a number of 19th century industrialists did indeed invest in their workers through higher wages and decent housing (although some of this was driven by religious conviction, not economics). At the same time, though, many millions in the Victorian era were unemployed, unsupported by the State, and living in abject poverty. Some may want to see this country return to that state of affairs – I don’t! Therefore we need a welfare state, irrespective of the level of “distortion” you say that it brings. If that “distortion” arises by keeping people alive who would otherwise have died, how is that bad? A minimum wage is then just part of the overall package of “distortion”.
Moreover, I regard your argument that some people may prefer (for whatever reasons) a job paying below an arbitrary “subsistence” level to one paying that level or slightly above as very weak for this reason. Removing the minimum wage may increase job opportunities for a few, but it would lower the wages of many more. The net benefit would be massively negative. A minimum wage is not perfect, and will never deliver the optimum outcome for everyone, but it is much better than the alternative.
(ii) “However, even this is a compositional fallacy because different employers would be pursuing different agendas and would probably be bidding up wage rates through an attempt to attract good workers away from such businesses (which probably wouldn’t be hard). One of the easiest ways to put a competitor out of business is surely just to deny them a workforce.”
As I pointed out previously, that explains why some people are paid more than others. It doesn’t explain why many exist, or would exist, at subsistence levels or below. It is about supply and demand. High skills are in short supply, low skills are not. At the bottom end of the employment scale bidding up wages will never put a competitor out of business by denying them a workforce because there is no shortage of labour, and the skills and training are low.
(iii) “Even if we could accept a great degree of what you are saying; that there would be businesses “exploiting” their employees to the degree you suggest, don’t you think that there would be a consumer reaction at some point?”
On a scale large enough to make those employers change their business models? No! For a start, any firm that did try and change would be undercut and put out of business by one that didn’t. Your argument depends on collective action by the entire market simultaneously. How likely is that?
@ Cantab 83
I’m sorry if this response isn’t 100% clear but I’m currently at work. I’ll try to take your responses in turn:
“(1) And what about those who aren’t employed? They are surplus to requirements. What happens to them? And what about workers who are employed on short-term contracts? How is that consistent with employers looking after the long-term interests of their employees?”
It seems strange to defend a minimum wage on the basis of the people who are not employed given that the minimum wage will, ceteris paribus, increase unemployment. I realise that this point is the very basis of the article but I haven’t heard a convincing argument to the contrary. Again, and this is crucial if you are to understand my perspective, you are assuming the need for a much higher “living wage” than is probably the case. It is perfectly possible that somebody between the ages of 16 and 22 (to take an arbitrary range) could “survive” on an incredibly low wage rate, say £1 per hour, or even zero. This is because their circumstances may not (in an extreme case selected for clarity), “require” any wage at all; they are supported by others. This opens up scope for more people to be employed and more economic activity to be undertaken, especially legally. This situation, which looks at first glance to be exploitation by the employer, is only temporary; the employee will be gaining skills and, if the business is successful, the employer will be benefiting from a lower risk business environment encouraging expansion and promoting competition. It seems that this would have benefits for society as a whole. Would you rather that the young person simply took their £40 or so from the state (Job Seeker’s Allowance) with only “on state benefits” to report on their CV? There is no exploitation in this situation (certainly not necessarily) and if there is any it is as much the employee exploiting the employer as the other way around; he will be “stealing” skills, knowledge and employability that he could have gained no other way. In the medium to long term at least, the employee “wins” by accepting the low initial rate.
Concerning short-term employees, I never made any comment on them. I believe that a short term employee should understand the risks associated with their contract of employment and either make an attempt to bid up their wage in order to cover fluctuations in income or else change their spending/living habits whilst looking for more secure sources of income. Don’t forget that the whole point of the exchange is that it is voluntary. If the employee is not happy with it he is perfectly free to mitigate any perceived risks as he sees fit. Don’t forget that employers have huge regulatory risks associated with employing somebody (which I believe should be abolished). If you were employing somebody with no experience wouldn’t you want to mitigate the risk of them being very bad and costing you money by employing them on a short term basis? The shift towards “temping” in probably at least partly a result of high employment law regulation. Your “solution” causes the disease you complain of.
Your point regarding “religious conviction” reveals, with respect, a misunderstanding of the nature of the problem being discussed. If people invest in other people, or act altruistically generally, that is part of economic analysis, not external to it. I believe this has been well put in the recent IEA publication dealing with so-called Fair Trade. Subjective value preferences (e.g. treating employees “well”, giving to charity), whether or not rational, and whether or not expressible on a balance sheet, are all part of the study of economics. It is, after all, a study of human behaviour.
Your comments regarding the Victorian era are simply false, as well as the suggestion that anybody could sensibly want a return to “that state of affairs”; maybe in terms of our institutional arrangements but that is distinct from the conditions of poverty that people typically associate with that era. We could instigate genuine liberal reform and it’s more likely as a result that I’ll be driving around in a better quality car (and eventually its successor), not a horse and carriage! You are failing to take account of the temporal aspect of the problem. You are making the fundamental mistake of failing to recognise the improvement that even the worst Victorian working conditions represented compared to conditions that existed only shortly before. The fact that industrialising Britain was dirty and dangerous had nothing to do with liberal policies but instead was a direct result of the limited technology available at the time. No doubt in a few hundred years people will look at things we regard as an unavoidable fact of life and be appalled that we had to endure such hardship. That’s progress! As to your claim that people lived in abject poverty, it’s a trite point but define poverty. Would you not consider living as a serf, your subsistence dependent directly on submission to your landlord, as greater “poverty” than living in dirty conditions (by standards drawn up hundreds of years later) but with equality before the law and success being far less dependent on submission to a legal superior? The figures I have seen also show that mass unemployment in this country was something that did not exist until the welfare state really started to develop. There have been varying degrees of state provision for the poor for hundreds of years, and it certainly existed during Victorian times but was nothing compared with private charitable provision. People simply did not starve in the absence of the miracle of the modern welfare state. From memory, the poor design of the Poor Laws was recognised during that time as creating problems overall, and not through want of provision but because of moral hazard. This indicates that human beings, whether modren or Victorian, tend to react to incentives in the same way, something that you would expect.
If we are facing two simplistic alternatives, as you suggest, it is hard to see why more people having a higher wage (if lucky enough to be employed) is a better result than more people being in employment in the first place, even if this does lead to some people taking a pay cut in the short term (which I don’t think would necessarily follow anyway). It is more likely that the division of labour would be more efficient if lower paid workers could legitimately enter the workforce at lower rates of pay which would have serious productivity implications. Even if it would be hard to demonstrate that the individual worker would benefit in his capacity of employee (which I doubt, I’m sure any competent economist could provide a theoretical framework backed up by real world examples), it is much easier to see that most people would benefit in their role of consumer.
(2) “As I pointed out previously, that explains why some people are paid more than others. It doesn’t explain why many exist, or would exist, at subsistence levels or below. It is about supply and demand. High skills are in short supply, low skills are not. At the bottom end of the employment scale bidding up wages will never put a competitor out of business by denying them a workforce because there is no shortage of labour, and the skills and training are low.”
First of all, low skills do not have to be in short supply in order for prices to be bid up; they simply have to be in shorter supply than the current demand for low skilled work. Minimum wages distort this by making illegal a large amount of work that a large section of the workforce would be able to do. In effect, minimum wages decrease the demand for low skilled work because it cannot be paid for, thus reducing the chance that somebody will be employed (as it would be an act of charity probably beyond most employers’ ability in a competitive market) and increasing the chances that such work will be outsourced abroad or mechanised.
Regarding the second point, all that is important is that the better employees can be tempted away. I disagree that there is little difference between low skilled employees. Concerning people at the lower end of the pay scale, the biggest factor from a productivity perspective are likely to be things such as employee reliability and attitude, at least in the short term. A bad low paid employee is not just “bad”, they tend to be a liability, i.e. actually hurt the business. Even if they are not so bad that they cost the business money, the fact that the rival firm is more productive on a similar investment will enable to reduce their costs and the net effect is the same.
(3) “On a scale large enough to make those employers change their business models? No! For a start, any firm that did try and change would be undercut and put out of business by one that didn’t. Your argument depends on collective action by the entire market simultaneously. How likely is that?”
My argument depends on nothing of the sort because it is not an argument concerning our political process. One of the greatest virtues of the market is precisely that it does not require large-scale collective action of the type you are suggesting. Loss in sales of a few percentage points (which, in a paradigm example for our purposes would translate into a few percentage points increase shared between competitors) could be enough to drive a firm out of business. It would certainly be enough for management to come under serious scrutiny.
I really do not see how you can have so little confidence in individual market actors and yet so much confidence that they will be able to understand your arguments and vote for them (as your desired outcomes can only be achieved through collective action of a political nature and, therefore, force). In effect, you think human beings act altruistically in the political sphere, but would gladly buy a product they knew to have been made by somebody being starved by their employer. I don’t understand this double standard.
What B chooses to pay C is none of my business. I don’t have the right to use force to make B pay more, and I don’t have the right to employ government agents to do so either.
Stop the government hubris, and stop the government force.
This topic has arisen on another forum today, and I find myself returning to this post. I am particularly struck by my last paragraph:
“There are now 2.5 million unemployed in the UK, yet the government still refuses to abolish the minimum wage or even to consider less controversial options such scrapping it for under 25s or freezing the rate. Don’t expect those unemployment figures to fall quickly.”
A year later, and they haven’t budged at all (2.56m in June 2012 according to the ONS).