Introducing the living wage

The government has given some of the poorest workers in the UK a pay boost. Sounds good – but how will it affect the economy generally? Simon Wilson reports.

What’s happened?

As of last Friday, the UK’s statutory minimum wage has risen from £6.70 to £7.20 an hour for those aged 25 and over – and has been rebranded as the National Living Wage. The “National Minimum Wage” does still exist, however, and applies to all workers under 25. (The rates are £6.70 for ages 21 to 24; £5.30 for ages 18 to 20; £3.87 for those aged under 18; and £3.30 for apprentices.)

For the over-25s, the new rate represents a pretty decent boost of about 7%. It means the wages of the lowest-paid will rise this year at four times the rate of average UK earnings. And over the next few years the government has tasked the Low Pay Commission with guiding the rate higher until it equals 60% of median earnings by 2020, which is likely to mean a rate of about £9 an hour.

How does that compare globally?

Currently, the UK is around the middle of the pack – with a similar minimum rate to Canada and Ireland, but paying around 20% less than frontrunners Luxembourg, France and Australia. However, the raise planned for the next four years will lift Britain up the table. Similarly, when national minimum wages are ranked as a proportion of a country’s median wage – probably a more useful indicator – the UK is currently about average.

Our minimum is 48% of our median on 2014 OECD figures, and the new rate bumps it up to 55% (compared to 45% when Labour introduced it in 1999). If the rate does indeed rise to 60% by 2020, it would represent a further step forward in terms of equality of income distribution – and it would take us close to the top of the list, alongside the likes of France, New Zealand and Portugal.

Overall the table is topped by outlier Turkey on 68%, while America is the laggard on 27%, although this ignores US state-level and city-level minimums, which can be far higher than the federal rate.

Is this a good thing?

Broadly speaking, the UK’s economics profession – much like the Conservative party – has become far more warmly disposed towards the minimum wage since its introduction in 1999. Textbook economics tells us that if you raise pay, you will cut demand for labour, and push up unemployment. But economists’ views have become far more nuanced in recent years, not least due to the UK’s experience that a statutory wage floor is entirely compatible with continued strong growth in employment.

“My view of the history of minimum wages is that we’ve always been surprised about how you seem to be able to push them up without harming job prospects,” Professor Alan Manning of the London School of Economics told the Financial Times recently. “Of course, there would be a point, if you pushed it up too far, that there would be serious adverse effects. We just don’t quite know where that is.”

What are the arguments in favour?

MoneyWeek has long argued in favour of a higher minimum wage, principally on the grounds that taxpayers should not be asked to subsidise corporate profits in the form of tax credits for the working poor. The higher the wages, the fewer the benefits that have to be paid out.

The other main arguments in favour involve social justice, protecting capitalism from its tendency to bring forth its own gravediggers, and productivity. Income distribution has become more skewed towards the rich in recent years, increasing inequality and potentially undermining the social solidarity that makes capitalism sustainable in the long run.

Proponents argue that a minimum wage can help to arrest this trend – not just helping those at the bottom, but leading to rises further up the pay scale as employers are obliged to maintain differentials for supervisors, managers, etc.

Many economists also argue that minimum wages boost productivity, especially in the service sector, though the evidence is far from uncontested, and it is hard to disentangle cause and effect. (Do better-paid workers become more motivated and productive, or do higher wages force employers to become more efficient in other ways?)

What are the arguments against?

Plenty of economists fear that such a rapid and significant boost to the minimum wage is a high-risk tactic that will cost jobs, especially in poorer areas, such as the north of England – and especially in retail and catering, for example, where many firms say they will struggle to absorb the costs or pass them on to customers (see below).

“The Office for Budget Responsibility [OBR] estimates 60,000 job losses is much too low given what we know about regional pay differences,” reckons Professor Nick Bosanquet of Imperial College London. “

The rise to over £9 by 2020 will also have differential effects by age group”, discouraging employment of over-25s. Second, many critics argue that minimum wages are a blunt tool for tackling poverty, since (a) the poorest are those without work; and (b) many of those who make the Living Wage will be second earners in well-off households.

Indeed, according to the OBR, “around half the cash gains in household income may accrue to the top half of the household income distribution”. If that proves correct, we can expect the debate on the Living Wage to be far from over.

Do minimum wages cost jobs?

Economists have been grappling with this question for decades, says Buttonwood in The Economist – and handily, a paper by David Neumark of the University of California (available on the IZA World of Labor website) offers an overview of the literature. Most studies show that there is indeed a marginal negative effect on employment.

For a 10% rise in the minimum wage (ie, somewhat greater than last week’s rise) we can expect a 2% drop in employment levels among those workers affected – typically the young and unskilled. Clearly, this is not the same as saying that overall employment will fall by the same amount, but it does suggest that at the margins some people will indeed lose their jobs as the result of the Living Wage.