Labour Market

The risks of lifting the minimum wage

In a recent article on CapX, Adam Memon made the case for the minimum wage to be increased to the living wage. In other words, he wishes to see the Green Party’s policies on this matter to be adopted – certainly, what he proposed was well to the left of anything that has been proposed by the Labour Party or any mainstream left-leaning think tank. Raising the minimum wage in this way is becoming an increasingly popular policy amongst Conservatives and others who could be described as being broadly on the “free-market right”. It is something of a puzzle. If such people believe that labour markets don’t work, why do they think that any markets work? Why not have the government set all prices?

Minimum wage = maximum risk

When it comes to minimum wage policies, the stakes are high. If an increase in the minimum wage increases unemployment, the results can be devastating for the individuals concerned; they can affect the individual for life; and it can be difficult to reverse the policy. On the other hand, alternative policies to reduce poverty such as the provision of in-work benefits may or may not work, but can easily be adjusted if they don’t work and, other than being a waste of money, don’t have many side effects. Those who believe in a higher minimum wage should be very, very certain that they are right. If they are wrong, and minimum wages cause more unemployment, it will be the most vulnerable who will suffer: those with the lowest productivity; those with the fewest skills; those with disabilities; the long-term unemployed; people who live in low-productivity regions; and so on. If the minimum wage causes unemployment, one of the most pernicious effects will be that it lengthens unemployment terms. When people become unemployed, their productivity and the wage they can command tends to fall, thus making it even more difficult to obtain a job at the wage floor and condemning people to long periods on the dole.

A poor poverty alleviation policy

As it happens, even if the supporters of a higher minimum wage are right, the policy will do little for the most vulnerable. Nearly half of those (44 per cent) who earn the national minimum wage live in households in the top half of the income distribution and 60 per cent of those who earn less than the living wage do not work full time. If these people are poor, the main problem is that they work too few hours and increases in the minimum wage are likely to lead to a decrease in hours worked. And those who do live in poor households have their income topped up by the government through means-tested benefits (tax credits).

Means-tested benefits do not subsidise employers

However, Adam Memon argues that the payment of tax credits involves the government “subsidising” firms that take on low-paid workers. This is a bizarre argument. If a worker’s productivity does not justify a higher wage (and, if it does, why does the worker not move to a higher-paying job?) the government is not subsidising the firm, it is helping the worker. Quite why those who propose higher minimum wages cite the growth in tax credits to people in work as evidence of the need for a rise in minimum wages is difficult to understand. The Blair/Brown governments introduced this huge programme of in-work benefits and it has been accompanied by a substantial rise in employment. Since when did this become the fault of the enterprises that employ the people in receipt of these benefits?

It is not a moral imperative for firms to adjust wages to compensate for bad policy

Adam Memon’s also invokes an ethical argument. Echoing Churchill, he says that nobody should earn insufficient to keep themselves. Memon accepts that high taxation may be one reason why people struggle on their net earnings, though he does not mention indirect taxation which (especially when taxes on cigarettes, alcohol and petrol are considered) bear down particularly heavily on the poor. Restrictive planning policies  also affect the poor disproportionately: they both raise the amount the government has to pay in benefits and thus levy in taxes and also raise the level of the “living wage”.

This should lead us to ask a simple question: why is it a moral imperative for employers to pay whatever the living wage happens to be when the level of the living wage is largely controlled by government policy? If the government decides to be more liberal with planning policies and reduce alcohol taxes, the living wage might fall to £5.50 an hour. If it decides to be still less liberal with regard to planning policies and to increase alcohol taxes, the living wage might rise to £9 an hour. What moral principle is it that determines that an employer must adjust its wage levels to compensate for the effects of these policies?

The impact of the minimum wage on employment

Adam Memon does not believe that the rise in the minimum wage he proposes will affect employment to any great degree. Authors from the National Institute of Economic and Social Research beg to differ: research published by that organisation suggested that 300,000 young, low-skilled people could lose their jobs from implementing Adam’s policy. But, as I have indicated above, one should be very sure that there is no impact on employment before proposing a big hike in the minimum wage. He is correct to say that there have been few employment effects of the minimum wage in the UK so far. This is perhaps not surprising. The remit of the Low Pay Commission is to fulfil the “aim of having NMW [National Minimum Wage] rates that help as many low-paid workers as possible, while making sure that we do not damage their employment prospects.” In other words, Adam Memon is merely confirming that the Commission is doing the job it was asked to do. The problem is that Adam is now asking the Commission to do a different job – to raise the minimum wage to the level of the “living wage” which is not determined at all by labour market conditions but by government policy and the costs of buying a basket of goods and services. It cannot be assumed that the consequences of decoupling the minimum wage from employment conditions will be benign. Indeed, if the consequences of a much bigger rise in the minimum wage were benign, the Commission, following its own mandate, would already have raised the minimum wage further.

Perhaps the most dangerous and seductive argument is that a higher minimum wage will raise productivity and therefore pay for itself. By arguing this, Adam Memon is, in effect, arguing that he knows better than employers when it comes to wage determination. The world is (apparently) full of employers who could, if only they were a bit smarter, raise wages, raise productivity and not damage profitability. This point has been “retweeted” and presumably obtained some traction in debate. Unfortunately, it is based on a very elementary fallacy (as is quite clear from the majority of the studies to which Adam refers). An individual employer can, of course, raise wages and, in doing so, will attract the more productive workers from a given category (cleaners, bar tenders etc). This is a case of positioning in the labour market: Manchester United pays more than Leicester and gets better players. It does not follow that, if all employers increase wages, workers magically become more productive. In the same way, if every top flight club in Europe were to increase player wages by 25 per cent, their players would not suddenly become better footballers.

Conservatives must stop outbidding socialists on the minimum wage – they will get applause but could destroy lives

By his own admission, there are a lot of “ifs, buts and maybes” in Adam Memon’s article. Perhaps they are summed up by the sentence: “and if the employment effects do appear significant, the minimum wage rise can simply be frozen.” I am afraid that is simply not good enough. We are talking about people’s lives, not mere numbers represented by a monthly statistic. Unemployment is a personal disaster for people. Unemployment in a high minimum wage environment, may turn into long-term and, ultimately, permanent unemployment. We cannot take risks with unemployment. Politically, rises in the minimum wage would also be difficult to reverse.

Beveridge would never have believed that, except in very unusual circumstances, a working man (as it would invariably have been) in a single-earner family could not support his whole family. How have we reached the position today where so many people seem not to be able to afford the basics? The answer is simple. The regulation of energy markets, increases in indirect and direct taxes and, most of all, an illiberal planning regime have put living costs out of reach of many low paid. There is a low-risk response and a high-risk response to this. The low-risk response is to reverse the policies that raise living costs. The high-risk policy is to raise the cost of employing those with the lowest skill levels.

Prof Philip Booth is the IEA’s Editorial and Programme Director.

Academic and Research Director, IEA

Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs. He is also Director of the Vinson Centre and Professor of Economics at the University of Buckingham and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham. He also holds the position of (interim) Director of Catholic Mission at St. Mary’s having previously been Director of Research and Public Engagement and Dean of the Faculty of Education, Humanities and Social Sciences. From 2002-2016, Philip was Academic and Research Director (previously, Editorial and Programme Director) at the IEA. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. He is a Senior Research Fellow in the Centre for Federal Studies at the University of Kent and Adjunct Professor in the School of Law, University of Notre Dame, Australia. Previously, Philip Booth worked for the Bank of England as an adviser on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.

2 thoughts on “The risks of lifting the minimum wage”

  1. Posted 28/05/2015 at 15:27 | Permalink

    If ‘minimum wage’ levels could be raised to ‘living wage’ levels with no harmful effects
    (except on employers, who don’t seem to matter!) why not advocate requiring every employer
    to pay double the living wage, so that the standard of living of those affected could be given
    a really big boost?

  2. Posted 19/12/2015 at 19:19 | Permalink

    The business proprietor has to be persuaded as well as urged to take actions that he or she has actually previously disregarded or

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