Why raising the minimum wage is not the best way to help Britain’s poorest

It is widely rumoured that the government is moving towards a commitment to increase the national minimum wage (NMW) well above levels suggested by the – usually fairly sensible – Low Pay Commission.

This may be good news for some workers, but I’m not convinced that it is sensible policy. Temporarily recognising the constraints on the public finances, politicians are trying to pass on to business the costs of helping the poorest-paid. But business does not ultimately bear the cost of government-mandated wage hikes. That falls on consumers, to the extent that cost increases are passed on, and more importantly on certain employees or potential employees – some of the very people the policy is meant to help.

While we must recognise the difficulties they face, low-paid workers are paid badly largely because their productivity is very low. If their wage rate rises arbitrarily, employers look for ways of substituting overseas workers for UK employees if output can be produced elsewhere (mostly manufacturing), using capital equipment instead of people (think self-check-outs in supermarkets), or reducing coverage in service fields (early closing in pubs and restaurants on slack nights).

The result is that fewer hours of work are offered by profit-seeking businesses – but also by revenue-constrained public and voluntary sector employers. This may not mean existing low-paid workers lose their jobs: there is not much evidence of that happening as a result of minimum wage increases either here or in the US. But hours may be reduced, employees may find their workload increased, or non-pay benefits (such as training or subsidised accommodation) may be trimmed.

The real impact falls on those seeking jobs. Rather than sacking existing workers (which can be costly and distressing), employers prefer to reduce new hiring and ask for more experience and qualifications. As a result, young people find it harder to get a toehold in the labour market. Among them, ethnic minorities typically get the toughest deal. Thomas Sowell, the prominent African-American economist, has argued against minimum wages in the US because any negative employment effects fall disproportionately on young black workers; the same is almost certainly true here.

Bear in mind, too, that the minimum wage is national, which means it has very different effects across the UK. In London, the NMW is only around 35 per cent of the median hourly wage; in regions like Wales, Northern Ireland, the North East and the North West, it is over 50 per cent. So following a significant increase in the minimum wage, you would not want to be a young job-seeker with few qualifications in Newcastle or Swansea.

The poorest-paid are also not necessarily in poverty. Well over half of minimum wage workers are part-time. Many are students, others are secondary earners in otherwise reasonably well-off households. So as an anti-poverty policy, it is poorly directed. Nor is it likely that the government will save much on in-work benefits like tax credits. Most of those on minimum wages do not access them. Those on housing benefit are likely to stay on it. And if job-seekers spend longer finding work as a consequence, other benefit spending is likely to increase.

This article originally appeared in City AM here.

Editorial and Research Fellow

Len Shackleton is an Editorial and Research Fellow at the IEA and Professor of Economics at the University of Buckingham. He was previously Dean of the Royal Docks Business School at the University of East London and prior to that was Dean of the Westminster Business School. He has also taught at Queen Mary, University of London and worked as an economist in the Civil Service. His research interests are primarily in the economics of labour markets. He has worked with many think tanks, most closely with the Institute of Economic Affairs, where he is an Economics Fellow. He edits the journal Economic Affairs, which is co-published by the IEA and the University of Buckingham.

4 thoughts on “Why raising the minimum wage is not the best way to help Britain’s poorest”

  1. Posted 09/01/2014 at 14:12 | Permalink

    In my opinion there should no minimum wage (MW) anywhere let alone the UK.

    My area of expertise is recruitment and the current legislation has unintended consequences and more holes in it than gruyere cheese.

    The most obvious way of getting round the MW is to make the staff 3rd party contractors, through limited liability companies or more likely ScheduleD Self Employed. One example would be to get the contractor to do a job to a fixed price. Take the example of a quote £1000 to clean 100 hotel rooms. It may take the person 200 hours of work to achieve it working out at £5 per hour, below MW. However legal.

    Proving or disproving self employment is very hard and extremely bureaucratic and is under Directive IR35. The HMRC does not have the resources to investigate anyone. Secondly if a worker was challenged by the HMRC it is quite easy to fight them.

    If you can prove some or all of the following the HMRC have lost: Right of substitution (employ or nominate someone else to do your job), mutuality of obligations (a fixed term contract, with no de jure right of continued work), supply your own equipment and/or do not work fixed hours, there are many others, but you are home and dry if this applies.

    Gordon Brown tried to do this in 2000 with computer contractors and soon after the courts were clogged up with cases. Out of 1,000 hearings Brown lost 993.

    The Conservative Party are not being very bright and comes across as an expensive, employment shedding, “eye catching” initiative. The net beneficiaries will be European migrants on which I am agnostic.

    Enjoyed the article of course.

  2. Posted 09/01/2014 at 17:36 | Permalink

    Not very sensible to get caught up in an argument where someone else has set the agenda. You got it right when you pointed out that the minimum wage is the act of government passing on the cost.

    The fact is that if the government wish for the poorest to receive a minimum wage or indeed a living wage then it can do so quite easily through the tax system. The effect will be the same but the process would be more transparent.

    One way or another the cost will end up with the consumer but we will be able to see more clearly who the bad guys are.

    The only reason why there are people on low wages is not that they are necesarily less productive but more to do with the fact that there are more of them available; supply and demand.

    This constant stream of stealth taxes, for that is what the minimum wage represents simply serves to further drive down competitive production to the benefit of our competitors. Far better tto let wages sink to a level that might reduce unemployment, but then of course the government get caught up in their own net of benefits payments.

  3. Posted 16/01/2014 at 20:14 | Permalink

    Characteristically strong article.

    One aspect in this debate should be pushed further: what is the impact of the national minimum wage on different regions?

    Note that private-sector job creation in large parts of northern England, Wales and Northern Ireland was far from impressive even before the financial crisis.

    When the minimum wage was introduced in 1999 at £3.70 or whatever it was, there was no real argument that this would create unemployment in London and the South East. But that cannot be the whole story.

    It seems deeply irrational to make low-income workers earn the same in London as in Londonderry.

  4. Posted 22/01/2014 at 11:59 | Permalink

    Thanks. A really useful article summarising the issues – particularly the regional ones.

    Although the main motivation is probably to appear to be helping the lower paid, there is another benefit to the government that few have mentioned so far. This is yet another example of a government “inflation-friendly” initiative that will nudge up the rate of inflation, because as you say, employers will probably just pass on the price rise.

    With government debt currently increasing exponentially, they need to follow as many “inflation-friendly” policies as they can to help reduce the real value of that debt. Expect more ideas like this to follow.

    Pete Comley
    Author: Inflation Tax: The Plan To Deal With The Debts.

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