The Minimum Wage: Silver Bullet or Poisoned Chalice?

As the economic debate has shifted away from macroeconomic outcomes to living standards, politicians across all parties have become increasingly interested in pay, particularly for those on low incomes. This has manifested itself in calls for a significant increase for the UK’s National Minimum Wage (NMW). Prior to the Low Pay Commission’s recommendation to the government (subsequently accepted) to raise the minimum wage from £6.31 to £6.50, the Chancellor was calling for a rise to £7 by 2015, for example. Other politicians and pressure groups have pressed for even more significant increases, perhaps up to the level of the campaigners’ Living Wage – currently estimated at £8.80 in London and £7.65 outside of London.

Underlining all of these suggestions is an assumption that setting a higher NMW without considering the productivity of workers is costless. In other words, there won’t be any effect on unemployment or any significant unintended consequences from the minimum wage increase. On top of that, advocates of higher minimum wages often claim other happy side-effects of minimum wage increases, such as reduced poverty, improvements to the public finances and reducing ‘tax credit subsidies to employers’.

In the first of a series of new, short IEA publications (‘Briefings’), Len Shackleton and I today publish a paper entitled The Minimum Wage: Silver Bullet or Poisoned Chalice? to assess these claims.

The key points are these:

- The NMW has risen significantly relative to average earnings since its introduction in April 1999 – by 75 per cent vs. 61 per cent, and significantly higher than the rate of inflation. Even since 2008, when the NMW has fallen in real terms, it has increased compared to average earnings (14 per cent growth since 2008 vs. 10 per cent), which is a better reflection of its bite in the labour market.

- The consensus view is that though overall the NMW has not had a particularly significant impact on unemployment since its introduction in April 1999, the level of the NMW still matters. Both the Treasury and the US Congressional Budget Office think minimum wage increases from here cost net jobs.

- Employment impacts of increases in the minimum wage disproportionately affect the young, the unskilled, and the long-term unemployed. Since the introduction of the minimum wage in 1999, youth unemployment in the UK has increased significantly. The number of 18-24 year olds out of work for more than one year has also increased markedly. The UK’s youth unemployment rate advantage relative to France has worsened considerably, and Germany – which does not have a minimum wage – has a very low youth unemployment rate. The proportion of students working has fallen significantly both over time and relative to Germany too.

- The minimum wage, due to its uniformity across the whole of the UK, has significantly different levels of bite by region. It is 70 per cent of median hourly earnings in the Welsh private sector, for example, but just 42 per cent in London.

- There is sketchy evidence of firms getting around paying the minimum wage, or finding new ways of dealing with the cost pressures, in the form of unpaid internships, zero hours contracts, reducing funding for training and shorter working hours.

- An increase in the minimum wage is not a particularly effective poverty reduction tool. Many of the poorest are out of work, and a minimum wage increase can do nothing to help them. Furthermore, many on low pay are not from poor households, and may be second earners and young people living with parents.

- There is little evidence minimum wage increases improve the public finances to any significant extent. When all effects are considered, the Treasury estimated overall savings to government to be as small as £30 million from an increase in the minimum wage to £7 per hour.

- The argument that tax credits subsidise low wages is exaggerated. 1.4 million of the 4.6 million households in receipt of tax credits have no adult in paid employment. 1 million of the 3.2 million recipients of in-work tax credits work less than a 30-hour week. Tax credits are therefore subsidising a short working week for these groups, not low wages. For the rest, tax credit reform could ameliorate the subsidy effect to make tax credits a wage supplement rather than substitute.

- A significant new role for the Low Pay Commission, including more politician input and a wider remit, would jeopardise the emphasis on not causing unemployment and lead to more political inference.

Given the evidence, we conclude that in the absence of abolishing the minimum wage, the government should seek to negate the worst effects of it – on young people and on the regions. This should include abolition of both the apprentice and under-18s rates, as well as a new proposal to suspend the minimum wage for one year for any under 24-year-old who has been out of work for more than 12 months. It should also instruct the LPC to set the minimum wage regionally, according to local productivity and firms’ ability to pay, with the main emphasis on maximising private sector employment.

 

Ryan Bourne is the co-author, with J. R. Shackleton, of The Minimum Wage: Silver Bullet or Poisoned Chalice?

Abolishing the under-18 minimum wage rate won't have much effect because soon every under-18 will have to be in full-time education.
I started typing out a response, but it ended up at over 500 words, which I thought was too much. So I put those 500 words as a post on my own blog: http://ralphanomics.blogspot.co.uk/2014/04/abolish-minimum-wage-laws.html
Interesting comments and in general I agree, especially that the Government now needs to think about the impact to business of increases in minimum wage rather than utopian or esoteric ideas like a living wage...but your conclusions seem a bit off. Does an hourly rate of either £3.72 or £2.68 really act as a disincentive to employ either the under 18s or Apprentices? I think not and I suggest that your conclusion on this is erroneous. On the other hand, I applaud the idea of a reduction in cost to a business of employing someone who is currently on the unemployed register - however reducing the hourly rate payable is not going to make it work for the employee - they have no incentive to come off state benefits unless they are going to receive a reasonably high wage. Why not have something like a cash back for the employer via the tax system. It must be cheaper and more effective for the State to pay a proportion of the job-seekers allowance to the employer and get tax paid by the employee on their wage than having an unemployed person claiming benefits.

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