28 September 2021

A £15 minimum wage would be way too high

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Minimum wages can raise incomes, but they can also reduce them to zero. As any schoolboy economist knows, if you raise the price of something you reduce the demand for it. Increase the price of labour and you’ll reduce employment. It’s not a difficult insight.

It’s also true that we’re not happy with the idea that some might be thoroughly exploited by employers so the idea of some legal minimum is politically attractive. The question is, therefore, what should the rate be? 

Which brings us to the idea of a £15 per hour minimum recently floated at the Labour Party Conference, and leading to the resignation of the last Corbynite left in the shadow cabinet. Starmer is right to argue against it – £15 is much, much, too high as it would apply to far too many people.

In the early days of the British minimum wage, in 2005, even the Low Pay Commission pointed out that it would have an effect on employment. The effect was small though, perhaps 13,000 jobs, because not that many people were being paid less than that minimal sum anyway. This is also why recent changes in the American minimum wage haven’t had much notable effect. Only some 1%-2% of American workers actually get the Federal minimum anyway and a good half of those also gain tips. 

As the number covered by whatever sum the minimum wage is rises, then the labour of more people is increased in price. Again, this is logically obvious. That also means, equally logically, that employers are going to be looking askance at the costs of employing a greater portion of their workforce. At which point they invest more in automation, try to raise prices, sweat more effort out of fewer workers or even simply declare the game not worth the candle and stop operating. That is, the more the rise in labour costs bites, then the more effort put into not hiring, and so the greater unemployment effects.  

The desire is therefore to find the sweet spot. What level of minimum wage still protects but doesn’t cause – not too much of at least – the ill effects?

The traditional answer here has been in the range of 50-55% of the median wage. There just aren’t that many people who make less than half median wage in any free market society. So this is the number where that backstop against exploitation can be set without causing too much undesired unemployment. More recently the calculation has been refined into what is called the ‘Kaitz Index’ meaning the ratio of minimum to median wage. We also have a significant report for HMG on exactly this point, by one of the major scholars in the field (and very much in favour of minimum wages) Arindrajit Dube, the result is 59%. So the optimal – or perhaps top sensible – level of the minimum wage is 59% of the median wage.

The UK median wage for both and full and part time workers is £13.68. This gives us a maximum sensible minimum wage of £8.07 an hour. Just a little over half what has just been suggested at Labour conference, and well below the minimum wage we currently have.

All of this is based on already having sold the pass about having a minimum wage at all. Some hold the view, as I do, that it’s a damned impertinence to interfere in freely chosen and voluntary contracts, though I admit that’s a minority position. The point is that even if we accept the premise that having a wage floor is desirable, when you follow the calculations a £15 per hour minimum wage is an exceedingly bad idea. For the correct one is that £8.07 an hour, something we might note is rather below the one we’ve already got let alone what some would raise it to. 

One way to encapsulate all of this is that a minimum wage can, at some small unemployment cost, act as a protection against truly low wages. It doesn’t work as a method of increasing the wages of large portions of the workforce precisely because by the time it has an impact on substantial numbers of people it’s already made far too many of them unemployed.

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Tim Worstall works at the Adam Smith Institute and Continental Telegraph.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.