Labour Market

Should the low paid get a ‘living wage’?

We often hear when a group of lower-paid workers goes on strike that they ‘deserve more’, that they ‘need a living wage’. There is now something called the ‘London Living Wage’, above the minimum wage set by central government and supported on the grounds that the cost of living is higher in London than in the rest of the country. Although certainly well-meant, these ideas would end up making most people – particularly the low-paid – worse off.

It is useful to make the starting point of the discussion clear. Suppose that at the existing wage rate there are coming forward for work just the number of workers required, and that they work normal hours (that is, neither overtime nor short time on an average week) to meet demand for the product. These workers get together, and thinking that they are not paid a ‘living wage’, go on strike.

It is possible the employers could increase their wages; the employers might be monopolists, or they might be receiving a subsidy from the taxpayer to cover their costs. In any event, as a result of the increase in wages employers do not want to employ any fewer workers.

So the same number of workers is wanted, but higher wages are being paid. As this will lead to more workers applying, some – the least able – will be rejected. (It must be emphasised that this argument does not assume that people work only for money – what it assumes is that pay is one of the factors people are interested in.)

As a result of the wage increase some of the people who were previously in jobs are unemployed; and some of the people who have taken their place have come from other jobs where they are worth more, but are paid less because their employer is neither a monopolist nor subsidised to pay them more than the value they contribute to output.

This second effect, the diversion of more skilled workers, lowers the output of the economy. So we have more unemployment and less output as a result of ‘paying a living wage’. This may seem a harsh conclusion. It is not. What it does is remind us that there are foolish ways as well as sensible ways to solve a problem.

In this case, the problem is that there are some jobs which are worth having done only at wages which society regards as too low – they provide too poor a standard of living. But paying more for these jobs makes things worse.

It is also worth looking at the case where the employer decides to pay the workers more, but cannot pass on this cost increase to either his customers or the general body of taxpayers.

The increased labour costs cannot be absorbed without increasing prices due to the implications for the other factors of production. The employer could not just cut back what he paid for raw materials; if he did, no one would sell to him. And capital would end up earning less than it could elsewhere. This would lead to it being employed elsewhere. His only course is to charge more for his products, sell less, and employ fewer workers. Again unemployment rises.

What should, then, be done? What to do is to pay people money from general taxes. The people who receive this money can then go out and earn more without losing what they have already received.

If we simply decide to pay people more for their work without regard to what they produce, we will end up unable to pay them at all. Pay should be separate from social provisions – otherwise resources are wasted, and when that happens the poor are the first to suffer.

This article appears in the Second Edition of Fifty Economic Fallacies Exposed, which was published on 19 September 2014 and is available as a free download.

Member of the Advisory Council

Professor Geoffrey Wood is a member of the Advisory Council for the Institute of Economic Affairs as well as a professor of monetary economics at the university of Buckingham. Geoffrey has previously worked at the Bank of England as an Economist, and later as Special Adviser on Financial Stability.

1 thought on “Should the low paid get a ‘living wage’?”

  1. Posted 24/09/2014 at 21:13 | Permalink

    If the government got housing benefit right,with a significantly lower cap than the £26,000 they are proposing, the cost of housing for people who want to work would come down significantly, so that the living wage would be significantly lower in London especially.

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