What kind of labour market policy is best at improving living standards for the poorest workers? Both of the major parties now argue that at least part of the answer lies in significantly raising the national minimum wage. Indeed, the government has proposed increasing the current top rate of £6.70 per hour by 50p from this April.
Policies like this are good news for current workers, but they may not protect the interests of the poor in the long-run. Most people are familiar with the argument that a high minimum wage can raise the unemployment rate. All other things being equal, as the price of a product increases, the quantity demanded falls; this applies to labour as much as it does to anything else.
The empirical evidence tends to support this. A 2007 review of the international economics literature, carried out by the Institute for the Study of Labour in Bonn, found that a “fairly overwhelming” majority suggested minimum wages had at least a mildly negative employment effect on the lowest-skilled workers. The burden does not fall equally across generations: a raised minimum wage may incentivise older workers to remain in employment for longer, but at the same time cause youth unemployment to rise.
A common misconception – often stated by the Conservatives in the 1990s – is that we should expect to see a dramatic fall in employment immediately after a minimum wage is introduced. Few economists would now accept this view, but the long-run effects can still be severe. In a 2013 paper from MIT, it was found that for every 10% increase in the minimum wage, once adjusted for inflation, the rate of employment growth fell by 0.3% each year. This effect will compound over time, eventually becoming very substantial.
A large part of the reason for this lies with technology. A higher minimum wage may lead employers to mechanise their production processes instead of taking on new workers; this can take years, or even decades, to become apparent. Labour-intensive companies, with higher costs, will also be more likely to fail: their replacements often choose a different trade off between labour and technology. Isaac Sorkin gives the example of small restaurants – often family-run – giving way to larger chains, which tend to be more reliant on machines.
High minimum wages can also have more subtle negative effects. For example, in a recent paper from the Centre d’Economie de la Sorbonne, it was found that immigrants in France had a serious negative effect both on native employment – and, for those with short-term contracts, on wages. A very inflexible labour market was among the main causes identified, resulting in part from a relatively high minimum wage. Given that a large migrant intake remains one of the best ways to combat the ageing populations of many advanced democracies, their effect on native workers is likely to become an even more inflammatory issue in the coming years.
Where does the UK fall in all of this? Most studies suggest that the employment effect of our minimum wage has been less severe than in many other countries; immigration here also seems to have a close-to-neutral effect on both native employment and wages. This is partly because our labour market is more flexible in other ways, but we can also thank the Low Pay Commission: first established in 1997, it advises the government on increases to the minimum wage, with a specific remit to have regard for any potential effects on employment.
The Chancellor now proposes to override the Commission’s recommendation – not to mention the warnings in the literature – with effects for the poorest that may not become fully apparent for many years. If we are serious about improving living standards for the poor, the liberal solution is not to tighten controls on wages: we should consider simply topping up incomes instead, through policies such as a Negative Income Tax (NIT). Proponents of steep increases in the minimum wage no doubt have noble intentions, but they are mistaken.