Unemployment and the minimum wage

The UK’s minimum wage began in April 1999, fulfilling a promise of Blair’s new Labour government. Blair was responding to popular demand, since the Conservative government in 1993 had ended the old system of minimum wages. Michael Forsyth, the Employment Minister at the time said: ‘The biggest source of poverty is not low pay; it is having no job. Wages councils destroy employment.’ However, most people, then and now, believe that there is a moral basis for a minimum wage. Certainly, the minimum wage is a popular policy, and the coalition government has not moved close to changing it.

The national minimum wage (NMW) system has some interesting features. Firstly, it is set in a technocratic way by experts who rely on research. Although the Low Pay Commission has both TUC and CBI members, it also has academic members, and an independent chair. Hence, a careful sifting of the evidence on how the NMW bears on business – including business in the regions ‑ plays a large part in the debate. As such, changes in the NMW have responded closely to changes in the health of the economy. The biggest exception to this was in 2001 when the thrusting Stephen Byers saw electoral advantage in pushing the youth rate up considerably prior to the May 2001 election. The important point here is that the NMW is set explicitly to weigh as little on unemployment as possible.

Secondly, the minimum wage is ‘national’, with no regional differentiation. The Low Pay Commission’s terms of reference from the beginning excluded such differentiation. Hence, arguably, the level has always been too high for the north, and too low for the London area. The NMW does, however, have several age categories, with a youth sub-minimum, and an even lower apprentice sub-minimum. Thus, it has been sensibly conceded that young workers and apprentices are less productive. Again, we see an effort to mute the unemployment consequences.

Despite this, the UK labour market is performing poorly for unskilled workers, and the question must arise about the NMW’s role in this. The unemployment rate for the 16-24 group almost doubled from 13.8 per cent in 1999 to 24.7 per cent in 2011. The working age population as a whole have not done nearly as badly as this. In addition, unemployment duration for the young age group has worsened, to the point where 28.2 per cent of the youth unemployed were unemployed for over one year in 2011, compared with only 15.3 per cent in 1999.

Employment effects: UK evidence

The minimum wage has been raised considerably over the period since 1999. Hence, it makes a lot of difference to unskilled workers’ earnings, and one would expect unemployment consequences unless counter-balanced by strong growth. The impact of the minimum wage can be seen in Figure 1, which compares the earnings distributions in both 1997 and 2010. The 2010 distribution has had its lower tail cut off compared with the 1997, and there is also a concentration of workers at the minimum.

The NMW has increased by 72 per cent since 1999, considerably more than the average worker’s wage, which has increased only by 50 per cent, which, in turn, just outpaced price increases of 45 per cent. What effect has this had on job opportunities for the unskilled? There are inherent statistical difficulties of identifying the impacts of a policy that covers the whole of the UK. One way to judge this issue is to examine regional variation, since the NMW has more ‘bite’ in poor than rich areas.

The first person to conduct this type of study was Mark Stewart (2002), who used data for changes in wages and employment in about 150 UK regions for the first year of the NMW. He found no adverse effect, but with only one data point per region he could not allow for region-specific trends or long-run effects. His work has recently been updated (Dolton et al., 2008, 2011), this time experimenting with a lagged minimum wage variable so as to capture long-run effects. Again, while little effect on employment is found, there is a significant increase in claimant unemployment.

An alternative approach is to compare workers who have their wages raised by the NMW with workers paid just above that level (say, up to 10 per cent above the minimum). These workers should have similar skills, and welfare benefit options. This method was also pioneered for the UK by Stewart (2004). He again found no adverse NMW employment effects. However, in more recent work (Stewart and Swaffield, 2008), he has found evidence that the NMW causes a cut in working hours of between 1 and 2 hours per week.

The latest work using this approach is by Dickens, Riley and Wilkinson (2012), using data up to 2010 and encompasses recession years which hit unskilled workers harder. This research finds that the probability of remaining in a job (employment retention) is reduced by about three percentage points by the NMW for part-time women, the group who are most affected by the NMW. This result is important because a 3 point reduction is in fact quite large when measured against an average retention rate (i.e. probability of remaining in employment for one year) of around 70 per cent. About 10 per cent of female part-timers are paid the minimum compared with only 2-3 per cent for male and female full-timers.

So, the UK employment picture for the most vulnerable has deteriorated rapidly since the introduction of the minimum wage. However, there is not enough data to draw firm conclusions as to the cause as yet. What does the international evidence suggest?

International evidence

Studying a panel of countries or states (for example in the USA) offers a better way of analysing minimum wages since there is more variation in the minimum wage and more sophisticated statistical techniques can be used. An important study of long-run effects is that by Baker et al. (1999) for nine Canadian provinces for 1975-93. He found that a 10 per cent increase in the minimum wage reduces teenage employment by 2.5 per cent and that it takes about six years for this result to be revealed.

There have been several further international panel studies, all finding serious adverse employment effects. Neumark and Wascher’s (2004) analysis of 17 OECD countries for the period 1975-2000 finds that a 10 per cent increase in the minimum wage leads to a two per cent reduction in the employment rate for younger people (aged 15-24). More recent work by Dolton and Bondiabene (2012) confirms these estimates and also suggests that the impact of minimum wages tends to double during a recession.

Finally, the work by Addison and Ozturk (2012) on a similar sample concentrates on employment outcomes for adult women. They estimate that a 10 per cent increase in the minimum wage will reduce employment by 1.5 per cent.

In sum, while the UK evidence is thinner due to statistical problems, the research overall points to the minimum wage reducing employment as conventional economic theory predicts. In other words, the minimum wage undermines employment for the least productive whilst raising wages for others. The research also suggests that the workers who benefit are the better-off: where there is high unemployment there is heightened competition for jobs, with the better connected workers rather than the poor finding them. Thus, Ahn et al.’s (2011) research shows that, as the minimum wage increases, there is a shift in employment towards teenagers in families with highly educated heads and away from poorer groups.

Morality and new proposals for a ‘living wage’

Going beyond the NMW, the Joseph Rowntree Foundation and others are calling for a ‘living wage’ of £7.45 an hour. This would be achieved by moral persuasion and possibly implicit and explicit government pressure. We are told that ‘the moral pressures are winning out over the economic pressures’. Yet what moral virtue is there in a policy that causes the loss of jobs for low-wage, low-skill workers or which causes the lengthening of unemployment terms? Countries with high minimum wages and/or high social costs – such as France – have high long-term unemployment (nearly half the unemployed have been jobless for longer than a year in France). As unemployment terms lengthen, productivity declines and it becomes ever more difficult for people to find work once priced out by a high minimum wage.

The living wage would be tied only to living costs and median incomes and not to labour market conditions. As we have seen, the unemployment effect of the UK minimum wage has been reduced because of the pragmatism of those setting the rate. The imposition of the living wage – regardless of labour market conditions – would be a recipe for increased long-term unemployment.

A functioning market would have much lower wages in, say, Liverpool than in Cambridge, which would attract business, and relieve poor unemployed people. If the market were allowed to work – which would require lower benefits as well as lower wages, since benefits form a floor under wages – then businesses would move north. Of course, it is difficult to take on the benefit system, but even tax breaks for businesses in development areas would be better than a living wage. The living wage is simply the worst solution to an admitedly serious problem – the high levels of unemployment in the UK.

Pushing wages up for favoured workers in large firms and in government would do nothing for those trapped within our dysfunctional ‘permanent’ welfare system. In fact there are other policies, such as reduced regulation and taxes, that could widen job opportunities and enable unskilled workers to become independent and earn their their own ‘living wages’.

The full version of this article was published in EA magazine.

Member of the Advisory Council

Professor W Stanley Siebert is a member of the Advisory Council at the Institute of Economic Affairs and is a professor in the Department of Business and Labour Economics at the University of Birmingham.

5 thoughts on “Unemployment and the minimum wage”

  1. Posted 14/09/2013 at 15:16 | Permalink

    It really does not matter what method is used; they are all irrelevant as they do not deal with the more fundamental issue of how much a business is able to pay whilst keeping its product internationally competetive.

    It is no more than a government stealth tax on all employers. If government really want to look after the poor old worker, how much better to do so through the welfare system and to properly fund it with taxes.

    Taxes are also a cost of production but far better we see clearly the now immense direct cost of government and its spending habits rather than have them hide the cost by passing them on to the private sector dressed up as something else.

  2. Posted 15/09/2013 at 17:41 | Permalink

    Waramess has a point when he says “If government really wants to look after the poor old worker, how much better to do so through the welfare system and to properly fund it with taxes.”

    In other words if an employer who thought an employee who was worth 50p/hr was able to actually pay them that amount, with the state bringing the employees take home pay up to the socially acceptable minimum, the result would be a huge increase in employment for youths, the unskilled, etc.

    But the problem would be that employers would put far more employees onto 50p/hr (or even 1p/hr) that they should, because employer and employee would know full well that the state would pay the bulk of the wage.

    However there is actually a solution to the latter problem, and as follows: let employers pay employees whatever they want, but where the state is subsidising an employee, give the state the right to call the employer’s bluff. That is, give the state the right to say to employers: “OK, you’ve had this employee on a subsidised basis for six weeks (or whatever). Now it’s make your mind up time. Either admitt the employee is in fact viable without any subsidy, in which case you can keep the employee, but you fund the whole wage (minimum wage / union wage, etc). Otherwise it’s henceforth illegal for you to continue employing the individual concerned, and we’ll try to find the employee an alternative job where he/she might be better suited, i.e. less unproductive.”

    The latter system would result in a quick labour turnover for those concerned, but that wouldn’t be entirely undesirable: it’s a good idea for those who cannot find jobs at which they are productive to try several jobs till they find something that suits them.

  3. Posted 17/09/2013 at 07:25 | Permalink

    The problem with Ralph Musgrave’s suggestion here is that it would require an enormous bureaucratic body to “police” and manage and introduces new problems into the variable – what if the worker is happy in the job and is learning valuable skills there but the government decides to “move them” to something they hate?

    Those who think that employers will pay people “much less than they are worth” are showing a lack of faith in markets. In fact, with many more jobs becoming available the worker will be in a position of strength as the employers will be competing for them – which drives wages up. Quite the opposite of the situation we have now where sixty people might apply for a single basic job putting all the power into the hands of the employers.

    The determinant of what somebody is worth is the agreement between the employer and the employee. Both parties are able to view their arrangement to decide if it suits them. The potential employee can look at perks, training, career progression, wages, terms and conditions, whatever else they value. The employer does the same. As in any other trade, both sides must feel this is a deal which benefits them or they wouldn’t do it.

    The only fly in the ointment is if a worker is negotiating a contract and does not know the value of their work in the current market. Perhaps because they are not good at negotiation for one reason or another and therefore can be taken advantage of. This is easily solved by unionisation where workers can trade information and support one another in such negotiations.

  4. Posted 17/09/2013 at 10:52 | Permalink


    I agree the bureaucratic costs involved could make my idea a non-starter.

    On the other hand I worked for a temporary employment agency a long time ago, and those agencies “create” very short term jobs (sometimes just “one day” jobs) without any problem. And the costs can’t have been excessive, because the relevant employers were happy to fund “one day jobs”.

    As regards what happens when a worker is “happy” at an existing job, my answer is: “tough”. The rule of the game is: employees move when they’re told to move. Moreover, while an employee may be “happy” in job X, if the job is not commercially viable, there is not a good excuse for it staying in existence too long.

    Re your point that market forces (possibly assisted by trade unions) ensures reasonable pay and that employers are not tempted to pay anyone 50p/hr, I agree that is the case with about 95% of jobs. However, my basic point is that the marginal product of labour declines as numbers employed rises. That is, the fewer unemployed there are, the more difficult it is to match members of the dole queue to vacancies. And that matching problem becomes near impossible when unemployment falls to 5% or so of the workforce – unless employers are allowed to take on relatively unsuitable labour at an ultra-low price that compensates for the unsuitability.

    So the system I’m advocating would take unemployment below the supposed “irreducible minimum” 5% or so.

  5. Posted 20/09/2013 at 15:19 | Permalink

    Ralph, just seen your responses. A bit late for a reply however better late..

    Im not suggesting the government make up wages to the minimum wage, simply that if they wish to achieve a higher take home pay for the lesser paid they should raise the tax band accordingly.

    This and the tax credit system should accommodate the issue though I personally believe the miinimum wage was yet another of Blairs opportunistic attempts to grab the headlines.

    Far better to reduce taxes to the less well off and shrink the size of government. Now, thats the way to get the economy moving not to print money and make the poor poorer.

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