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On the minimum wage

    Last week I wrote a piece for CapX which examined ways to help low paid workers. I argued that cutting the tax burden and improving productivity would drive long term real wage growth, allow people to keep more of what they earn and reduce price pressures. I also argued that in some circumstances, increasing the minimum wage to reach a living wage rate with a number of accompanying policies could be achieved without many adverse consequences. Most of the reaction to my piece has been positive although some have criticised it including Philip Booth who has written a blog post for the IEA setting out why he disagrees with me. I’m afraid to say that I don’t find Philip’s blog particularly convincing.

    His first paragraph is a little bit silly. In my opinion, gradual increases in the minimum wage accompanied with tax cuts and various other policies can be achieved without significantly damaging employment. Despite some concerns, David Cameron has suggested that there is a “lot of merit in this idea” and Camilla Cavendish, the new head of the No10 Policy Unit, has also said that “this may be an idea whose time has come”. This does not mean that the Prime Minister or the head of the Policy Unit are Far-Left Greens or Communists.

    The rest of Philip’s blog consists of a few key points; the living wage is a flawed measure of poverty, increasing the minimum wage may damage employment, tax credits are not subsidising low pay and that Right-Wing advocates of the National Minimum Wage are ceding too much intellectual ground.

    As I make abundantly clear in my CapX article, tax cuts, deregulation and other supply-side measures to boost productivity should come before anything else. Further cuts to income tax and national insurance contributions could create a de facto living wage – something which I would hope we all want but unfortunately this section of my article seems to have been ignored.

    Philip complains that I didn’t talk about the benefits of cutting indirect taxes but frankly I thought that was self-evident and have made that point numerous times before. Of course burdensome regulations inflate the cost of living and it is good to see that CPS proposals for simplifying and deregulating the planning system are being taken seriously within Government. Moreover, as I mentioned, there are obviously problems with how the Living Wage is measured and along with many other things it might benefit from being regionalised. In my CapX article, I argue why and how the minimum wage could be increased with the Living Wage rate as a useful benchmark. It is not a defence of how the Living Wage is measured; we agree on the problems inherent in that calculation. This means that quite a lot of Philip’s blog is essentially irrelevant.

    I always oppose unnecessary state intervention but an objective reading of the studies of the impact of the National Minimum Wage can only lead to the conclusion that it has boosted the incomes of the low paid without particularly damaging employment. I am glad that Philip appears to accept this point. This is quite a big deal because it does rather make the traditional argument that the minimum wage would destroy jobs somewhat out-of-date.

    This shows that the Low Pay Commission has done its job well in setting the minimum wage at the right level. It also shows that those who criticised the LPC (and still do) every time it has increased the minimum wage on the grounds that it would damage employment have been completely wrong. There are of course some who lose out from the minimum wage but there are many more who benefit; broadly speaking the minimum wage is a net positive.

    Naturally, as I point out in my CapX article, there is no guarantee that faster increases in the minimum wage would have the same success. This is why I made clear that if the Government was left with this option, it should only do so gradually over a number of years and whilst cutting business taxes using the fiscal boost it would receive from reduced in-work benefits and higher tax revenue. Adding another age band, perhaps for 21 to 23 year olds would ensure that the effects on those most likely to be negatively affected can be mitigated and there are probably also certain other circumstances in which exemptions would be appropriate. Within the context of tax cuts, an extra age band and certain exemptions, there would certainly be scope for larger increases in the minimum wage before it starts to affect employment.

    Philip goes on to cite NIESR research which he claims shows that “300,000 young, low-skilled people could lose their jobs” from implementing my policy. This is terribly misleading. Firstly, as I explained in my CapX article, the NIESR has modelled an immediate move to the Living Wage. This is not my policy. If the Government is going to increase the minimum wage, it must take place over a number of years with tax cuts and age banding etc. Secondly, as the NIESR makes very clear, its work shows the change in labour demand not the change in employment. This means that it doesn’t take into account things like improvements in labour efficiency. Thirdly, even on the NIESR measure, the aggregate reduction in labour demand is actually 160,000 but about 25 times more people would benefit from an average 15% increase in wages. Fourthly, the same model would have predicted a reduction in labour demand of 22,000 following the introduction of the NMW – which of course does not seem to have happened. Etc etc.

    On productivity, Philip makes the obvious point that businesses are largely rational so if they thought they could profit through higher labour productivity from paying higher wages, they would. He also points out that businesses offering higher wages than competitors can attract higher quality staff and thus boost productivity. Both points are clearly true. Yet what Philip fails to mention, is that often some of these productivity gains through eg reduced absenteeism are unanticipated by firms because unsurprisingly, they don’t always have perfect information. More importantly, productivity gains are forced on businesses which are required to pay a minimum wage. The evidence suggests that firms have responded to the minimum wage by raising Total Factor Productivity for example through better training and have not just increased labour to capital substitution.

    Philip argues that wages match productivity and if they didn’t then people would change job which means that the in-work benefits help workers rather than subsidise firms. This is true for some but if businesses were rational, others would surely pay their lower paid workers less than justified by their productivity safe in the knowledge that the Government will top it up with in-work benefits. Workers would have less need to change jobs because the shortfall between their wages and their productivity is made up by the taxpayer. Families and businesses are paying taxes to fund the tax credit and housing benefit bills both of which have grown significantly in recent years. If the negative employment effects can be reduced, increasing the minimum wage would alleviate the burden on taxpayers by giving an income boost to low paid workers which would cut the demand for in-work benefits.

    The minimum wage is now established as a form of protection from exploitation and in Britain it has on balance been a success. Repeating the same arguments from two decades ago is not useful in the face of what is a formidable evidence base. This is especially the case because many of the people who now say that the benign effects of the minimum wage just show that the LPC has done its job properly are the very same people who criticised the LPC every time it raised it on the basis that it would damage employment.

    A programme of tax cuts, deregulation and education reform is necessary to raise living standards and equip young people with sufficient skills to become productive workers. Other measures should of course be examined but if the Government did decide to increase the minimum wage, it could be done in a way which provides a significant income boost to the low paid without particularly damaging employment. 

    Adam joined the Centre for Policy Studies as Head of Economic Research in January 2014. 

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    Comments

    Anonymous - About 1456 days ago

    Philip Booth:

    I am sorry if you find the beginning of my post silly and most of the rest irrelevant: it is in fact quite sensible and relevant.

    There were two main arguments used by those opposing a minimum wage in 1997. One was that it was a poor way to help the poor. And this remains so. Minimum wage recipients are not especially concentrated in low income households. The second was the employment effect. Of course, if you set up a commission with the objective of minimising the employment effects, you would expect the employment effects to be small. That does not make the argument wrong, it merely means that the government implemented the policy in the knowledge that employment effects were a problem and did a good job. We should also bear in mind that those people who do lose their jobs are likely to be socity's most vulnerable and also the young - it is always tempting to think of unemployment as an aggregate statistic and not look at the stories behind it. Maybe the rise in self employment and zero hours contracts has something to do with the minimum wage but I accept there is no evidence for that.

    You are, of course, completely right to say that there is common ground between us on all the complementary policies and you are trying to argue that I am ignoring that. I am not ignoring that. I am just ensuring that we are clear that there is ultimately one difference between us. The position I was arguing for was the status quo. The position you were arguing for was that, whatever living costs should happen to be, the minimum wage should be set at that level (if not immediately, eventually). There was nothing in your blog to suggest that if planning policy were not liberalised and alcohol taxes not reduced etc you would not go ahead with your policy or that there was a limit to it. There was nothing to suggest that if, for example, there were another commodity price shock which reduced productivity and raised the cost of living you would not keep the minimum wage and the living wage together.

    So, there are three positions here. One is not to have a minimum wage at all. The second is to set it to minimise employment effects. The third is to tie it to an arbitrary variable dependent on all sorts of things including government policy. You were arguing for this third position though I accept (and noted in my blog) that you were also arguing for policies that would lower the living wage.

    The tax credits argument is a comlpete red herring. This is an anti-poverty policy. As you will know, I have argued against the huge marginal tax and benefit withdrawal rates these create right up the income scale (to nearly £40K). However, these no more subsidise an employer paying £6 an hour to not pay £7 an hour than they do an employer to pay £12 rather than £13. In both cases, the employee gains from a pay increase (by about 30p in the pound) and it is not clear why you think that employers are able to keep wages down "subsidised" by tax credits. I agree, incentives (including to train) etc are all skewed by the tax credits system but they are skewed for a family with children until you are earning about three times the minimum wage.

    The key fact is, I am afraid, that large numbers of people have found themselves stuck at the minimum wage level - but this mirrors low real wage growth in the economy as a whole.

    As it happens, by the way phasing it in might exacerbate the employment effects because businesses will be able to plan with greater certainty to substitute labour for other things.

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    Harold Ewing - About 1444 days ago

    First class Trot nonsense!

    If you are not willing to accept that a significant amount of jobs will be lost then you are a danger - you will not be happy until jobs ARE lost, and will raise the level until the damage is happening.

    Also, why not just have complete central planning of business and be done with it?

    Did you vote for Ed?

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