Labour Market

Why a compulsory living wage is not the best way to help society’s poorest

The Living Wage Foundation – which lobbies employers to pay £9.15 an hour in London and £7.85 elsewhere – has never called for statutory implementation of its cause. It considers itself to be a pragmatic civil society movement, encouraging firms to pay their low-paid workers enough to live comfortably.

But the campaign has been hijacked by politicos calling for state enforcement. Surprisingly, it’s Conservatives – Steve Hilton, the Centre for Policy Studies, Welsh MP Andrew Davies – who are among the worst offenders. In effect, they demand a much higher minimum wage set in accordance with perceived basic living costs.

The three main arguments for such a policy are dubious. The first is a non-sequitur: that opponents of the introduction of the minimum wage wrongly predicted highly negative effects on employment, so those fearing a compulsory living wage are wrong too.

This is daft. The Low Pay Commission’s current remit takes into account likely employment effects when recommending minimum wage rates. Whoever sets a living wage cannot do so. Empirical evidence overwhelmingly shows the level of minimum wages matters – set it too high and unemployment, fewer hours or fewer perks result. Pegging minimum wages somewhat arbitrarily to living costs without considering productivity is therefore highly risky, particularly for the young and unskilled. There was already a pre-crash relative deterioration in the UK’s youth unemployment rate with the existing minimum wage set-up. If a living wage were enforced, NIESR estimates up to 300,000 fewer young people would find jobs.

Another argument is that firms could easily improve productivity if forced to pay more: KPMG and Costco are lauded as evidence of what can be achieved. But while individual firms sometimes see productivity improvements from paying more – through improved morale, lower turnover, reduced absenteeism and attracting better job applicants – it is naïve to assume this can work for all firms and sectors. Economists who should know better regularly invoke this “efficiency wage hypothesis” to explain why workers being paid more is good for business – forgetting that this hypothesis was developed to explain how unemployment arises! That firms with few low-paid employees have found the living wage easy to implement does little to reassure companies in such competitive industries as retail and pubs.

Perhaps the worst argument is the claim a living wage is required to obviate the need for tax credits, which “subsidise employers”. This is bizarre. If housing costs rise because of tight planning laws, this has little impact on supply and demand in the labour market. To legislate that a firm should compensate workers for bad policies through a living wage is perverse – as is claiming that tax credits to offset bad policies are a “subsidy” to employers. Firms pay people for what they do, not the living standards politicos think they should have.

Moreover, people earning less than the living wage and those receiving tax credits are often very different groups. Over 40 per cent of those earning less than the living wage are in households in the top half of the income distribution, because many are second earners or youngsters living at home. Tax credits, however, are more highly targeted to poorer households.

We all share the aspiration that those working full time should be able to live comfortably and independently, but arguments for a compulsory living wage are weak: most beneficiaries would be part-time workers. Rather than focusing on hourly wage rates, politicians should ask themselves why the cost of living is so high for poor households in the first place and hence why many people working full time still struggle. If they did so, they’d find that, from housing to energy, childcare to food, and of course the tax burden, the blame lies much closer to home.

Ryan Bourne is the IEA’s Head of Public Policy. This article first appeared in City AM

Head of Public Policy and Director, Paragon Initiative

Ryan Bourne is Head of Public Policy at the IEA and Director of The Paragon Initiative. Ryan was educated at Magdalene College, Cambridge where he achieved a double-first in Economics at undergraduate level and later an MPhil qualification. Prior to joining the IEA, Ryan worked for a year at the economic consultancy firm Frontier Economics on competition and public policy issues. After leaving Frontier in 2010, Ryan joined the Centre for Policy Studies think tank in Westminster, first as an Economics Researcher and subsequently as Head of Economic Research. There, he was responsible for writing, editing and commissioning economic reports across a broad range of areas, as well as organisation of economic-themed events and roundtables. Ryan appears regularly in the national media, including writing for The Times, the Daily Telegraph, ConservativeHome and Spectator Coffee House, and appearing on broadcast, including BBC News, Newsnight, Sky News, Jeff Randall Live, Reuters and LBC radio. He is currently a weekly columnist for CityAM.