Let’s try to keep politics out of setting minimum wages

The auction continues. One week, Chancellor Philip Hammond is said to be contemplating a large increase in the national minimum wage in an attempt to ‘end low pay’. Next, Labour has responded by extending its plans for a higher £10-an-hour minimum wage to include workers under the age of 18. These might sound like great ideas, but they are full of dangers.

The government already sets a minimum hourly rate for most workers aged 25 or over, the National Living Wage (NLW), which is currently £8.21. There are lower rates for younger people and apprentices, explained here and summarised below:

NLW

The 2017 Conservative Manifesto pledged to raise the NLW to 60% of median earnings by 2020 and then by the growth rate of median earnings thereafter.

However, the Chancellor is thinking of setting a higher target of two-thirds of median earnings, or 66%, which is the OECD’s threshold for defining ‘low pay’. According to 2017 data from the OECD, this would take the UK above France (62% of median earnings) and New Zealand (60%), and well ahead of other competitors such as Germany, the Netherlands and Ireland (all in the high 40s).

We can only make an educated guess at what this policy would mean for pay in terms of pounds and pence, as this depends on how the baseline of median earnings evolve. But if the 66% target were adopted now, the NLW would probably increase to around £9.60 in 2020, compared to around £8.70 under the current plan. A decent pay rise for many, so what’s not to like?

For a start, this isn’t great politics. Labour had already promised to raise the NLW to £10 per hour by 2020, as well as lower the starting age to 18. Now, Labour plans to go further and extend this to under 18s. It is therefore easy to paint the Chancellor’s plan as less ambitious and the Conservatives as Labour-lite. This is a political bidding war that no responsible government should want to win.

More importantly, the economics is even worse. There is a strong case for a basic minimum wage to protect the most vulnerable from exploitation. However, ever-larger increases will surely come at the costs of higher unemployment, lower hours, and cuts in non-wage benefits and pensions.

The knock-on effects on the earnings of workers higher up the pay scale can go either way too: some might see bigger pay increases than otherwise to maintain pay differentials, but others might find that their pay rises more slowly as employers look to find savings to pay a higher minimum wage.

Similarly, some firms might invest more to increase productivity, but this is most likely to take the form of the automation of lower-paid jobs, again increasing unemployment.

To be clear, the introduction of the national minimum wage and subsequent increases have not led to the job losses that some had feared. Indeed, the UK employment rate is now the highest on record. But this is because the NLW has been set at sensible levels, based on evidence and advice provided by the independent Low Pay Commission. In other words, the policy has been successful precisely because it has not been too ambitious – a message seemingly lost on today’s cheerleaders for further big increases.

It goes without saying that you can find economists on both sides of this argument. Nonetheless, the balance of the evidence reviewed by Len Shackleton and Ben Ramanauskas is that minimum wages usually have a small but significant negative impact on employment. For example, this NBER paper concludes that the ‘best evidence points to job loss from minimum wages for very low-skilled workers – in particular, for teens’. And this study of the phased introduction of the Seattle Minimum Wage Ordinance found that it actually lowered earnings overall, because job losses and reduced hours offset the increase in pay for those still in work.

Indeed, the Office for Budget Responsibility has already estimated (in October 2018) that ‘a rise in the NLW to two-thirds of median earnings would raise the unemployment rate by 0.4 percentage points in the ‘target’ year. In today’s terms that corresponds to a rise in unemployment of around 140,000, plus an equivalent reduction in hours for those remaining in employment. Average hours would be 0.4 per cent lower and real GDP 0.2 per cent lower than they otherwise would have been’.

It is also surely no coincidence that France, the major developed economy with the highest minimum wage relative to median earnings, has some of the highest rates of unemployment, particularly among young people. In France, high minimum wages have compounded the problems of high employment taxes and excessive labour market regulation.

What’s more, campaigners rarely answer the question of where the money is going to come from. Companies are no more than legal entities and cannot bear the economic cost themselves. Part of the burden of an increase in wages for the lower paid will be borne by shareholders, who may well be better off than the population as a whole. But the burden will also fall on employees, on consumers (as higher prices) and on taxpayers (many of those earning the NLW work in the public sector). If none of these concerns are valid, why stop at £10? Why not raise the NLW to £20, or higher?

Some supporters of a higher minimum wage have suggested that smaller companies and their employees could be protected by some form of targeted subsidy, paid for by savings from in-work benefits. But this would simply layer one government intervention on top of another. What is the point of forcing an employer to pay a higher wage, then giving them a subsidy so they can afford it, rather than just making the same payment direct to the employee?

Labour’s latest proposal – extending a £10 NLW to workers aged under 18 – is especially dangerous. The minimum wage for a 17 year old is currently £4.35. Raising that to £10 in 2020 would therefore more than double the minimum cost of employing a young person. You do not have to be an economist to see the problem here…

This might not matter if you believe that only ‘bad employers‘ pay lower wages. It certainly makes sense that a young person doing the same job to the same standard as an older worker should usually be paid the same too. But this isn’t the killer argument against age differentiation in minimum wages that many seem to think, for two main reasons.

First, the reality is that young people tend to earn less than those with more experience and responsibility for good economic reasons, because they are likely to be less productive and require more training and supervision. This would be true even in the absence of any differentiation in minimum wages.

Second, the minimum wage is only a floor; it does not prevent an employer from paying a younger person a higher rate if they are contributing at a higher level. Indeed, basic economics suggests that a relatively productive young person can expect to earn more.

For example, in 2018 the median hourly earnings for workers aged 18 to 21 was £8.45, compared to the current NMW of £6.15 for 18 to 20 year olds and £7.70 for those aged 21 to 24. Admittedly, the figure for those aged 16 to 17 was a relatively low £4.98, but even this was higher than the under-18 NMW of £4.35 and the apprentice minimum of £3.90. And again, these differences are not solely due to the structure of minimum wages.

What’s more, the economic case for some form of age differentiation in minimum wages is widely recognised. Even France allows less experienced 16 and 17 year olds to be paid 80% of the national minimum wage, with much lower rates for most apprentices. Unfortunately, the French national minimum wage itself is set at such a high level that this system has still contributed to the very high youth unemployment there. It is worth noting too that countries that make no age distinction tend to set lower national minimum wage rates for all workers, hence minimising the additional risks to young people.

The UK Treasury at least appears to be aware of these points and has commissioned a review of the latest international evidence on the effects of minimum wages on pay and employment. This review will be led by Professor Arindrajit Dube, whose own work is relatively sanguine about the negative impacts.

My own preference would be to regard minimum wages as no more than a basic safety net, rather than a tool to influence incomes or tackle poverty more widely. Real wages should continue to recover anyway as the UK approaches full employment and productivity starts to pick up again. But if we are going to go further, let’s at least try to keep political showboating out of it.

Returning more power to set minimum wage rates to the Low Pay Commission would be a good start. And in case you missed it, here is what the Commission itself has said on the case for age differentiation:

LPC

Labour would not be doing young people any favours by ignoring that advice.

 

This is an extended and updated version of an article first published by The Telegraph.

 

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