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Don’t rely on the minimum wage in the fight against poverty

The Economist

The National Minimum Wage is 20 years old today. Despite the controversy surrounding its inception, it is now widely accepted across the political spectrum. As I noted recently, it looks as though Philip Hammond wants to increase it significantly in the coming years. Certainly the Labour Party wants to do so.

When the minimum wage was first introduced, there were just two rates: an adult rate for those 22 and over, and a ‘development rate’ for those aged 18-21. Now there are five different rates, plus a range of complex rules to cover piece rates, bonuses, night work, accommodation offsets and so on. We could probably do with restructuring this system, now one of the most complicated in the world, and reducing the number of different rates.

Currently 15 per cent of those in employment have their pay determined by minimum wage legislation, and this proportion is projected to rise as the National Living Wage (the highest NMW rate) reaches 60 per cent of median hourly earnings (the target for next year). This ratio will put it at the high end of such rates internationally.

The minimum wage is argued to be a success, as it is said to have raised real pay at the bottom of the wage distribution. How far this is correct is difficult to say, as it depends on an unknowable counterfactual – what would have happened over the last two decades in the absence of a state-enforced minimum. Ultimately wages in a free market depend on productivity, and that has risen (albeit slowly) since 1999.

But certainly, wages have risen and dire blackboard-based predictions of employment losses at the time of the introduction of the minimum wage have been confounded. Economists now take a more nuanced view of the workings of the labour market. Dynamic models stress that people are entering and leaving the labour market all the time. Most of the time, even with a constant demand for labour, employers are simultaneously losing workers (through leaving for new jobs, retirement, education, childcare, illness or death) and taking on new employees.

This means that even if the demand for labour falls as minimum wages rise, firms may still be taking on workers if outflow has increased. And because firing people is costly (redundancy pay, stress on managers, loss of skills), firms may try to reduce intake rather than dismiss people and allow numbers to fall through ‘natural wastage’. So you don’t see firms sacking large numbers of workers when minimum wages rise.

Some businesses can of course pass higher wage costs on to the consumer (or, in the case of the public sector, the taxpayer). But more commonly they may try to contain cost increases by adjusting hours instead of numbers employed. One means by which they may do this is through greater use of zero-hours contracts for low-paid work.

Another possibility is altering other elements of the job package – cutting overtime rates, reducing or scrapping staff discounts, limiting training opportunities and so on.

So modest increases in minimum wages may have little short-term effect on employment, though they could lead to a deterioration in the perceived quality of employment on offer to job-seekers.

But the short-term effect is only part of the picture. One study of the restaurant sector suggests that a ten per cent increase in minimum wages would only lead to a 1 per cent fall in employment within the first year. However over the longer term there would be a 4 per cent fall as less efficient businesses drop out and more capital-intensive businesses enter the market.

Fear that many low paid-jobs may be vulnerable to automation and a switch to capital-intensive production has led the Institute for Fiscal Studies to warn against a ‘bidding war’ amongst politicians to increase minimum wages. As an Office for National Statistics release again showed last week, minimum wage workers tend to be concentrated in sectors and occupations where automation seems most likely to take hold.






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