1 October 2019

The risk of playing politics with the minimum wage


The details of Sajid Javid’s conference pledges to boost the National Minimum Wage, aka the National Living Wage (NLW), look more sensible than those of Labour’s John McDonnell, but that’s not a high bar. Indeed, this could be another political bidding war that any responsible party should be happy to lose.

To recap, Javid has promised to adopt the proposal floated by Phillip Hammond earlier this year, which was to raise the NLW to two-thirds of median earnings, within five years. Based on current forecasts for inflation and wages, this implies a target figure of around £10.50. The NLW is currently £8.21 for those aged 25 or more, so the new plan would require annual increases of about 5%. This is not completely unrealistic.

However, setting a minimum wage at 66% of median earnings would mean that the UK has the highest minimum wage (relative to average earnings) of any major OECD country. It would be even higher than France (where the comparable figure was 62% in 2018, based on OECD data). And no, that’s not a good thing – just look at French unemployment. In most of our competitors, such as Germany, the Netherlands and Ireland, the figures are in the high 40s.

Javid has also promised to lower the age threshold for those who qualify for the top rate of NLW from 25 to 21. The rate for this age group is currently £7.70, so it is not much lower than for those aged 25 plus, but this would imply average annual increases for this group of about 6-7%. That’s pushing it a bit more.

Both these proposals are at least more sensible than Labour’s plan to go straight to £10 as soon as 2020, and to apply this rate to everyone from 16 upwards. It does seem right that people are paid the same for the same work, regardless of their age. But there are good economic reason why minimum wages should be lower for younger workers, because they are likely to be less productive and require more training and supervision. The minimum wage is also only a floor; it does not prevent an employer from paying a younger person a higher rate if they are contributing at a higher level.

Again, even France allows less experienced 16 and 17 year olds to be paid 80% of the national minimum wage, with much lower rates for most apprentices. Unfortunately, the French national minimum wage itself is set at such a high level that this system has still contributed to the very high youth unemployment there. It is worth noting too that countries that make no age distinction tend to set lower national minimum wage rates for all workers, hence minimising the additional risks to young people.

As the independent Low Pay Commission has explained, ‘the existing age structure of the minimum wage was designed by the Government in light of evidence that younger workers are more at risk of being priced out of jobs than older workers, with worse consequences if they end up unemployed.’ Labour has chosen to ignore this advice completely and instead more than double the cost of employing someone aged 16 or 17.

It would therefore be good to see the costings of the Tory proposals (if they are any). It would also be good to hear more from Professor Arindrajit Dube, who was commissioned by the Treasury earlier this year to produce an independent review of the latest international evidence on the effects of minimum wages on pay and employment. He has apparently advised that the government could be more ambitious, which would be useful backing for the new policy. However, Professor Dube has argued previously in favour of keeping minimum wages at close to half the median, describing this as ‘a well-balanced policy option’.

To be clear, the introduction of the national minimum wage and subsequent increases have made a significant contribution to the growth of household incomes, without the job losses that some had feared. Given that the conclusions of academic studies are never likely to be completely unequivocal, it’s not unreasonable to take a political decision to push the envelope a little further (as Javid appears to have done). But I’d still argue that the UK system has worked well because the NLW has been set at sensible levels, based on evidence and advice provided by the Low Pay Commission. In other words, the policy has been successful precisely because it has not been too ambitious.

Indeed, the Office for Budget Responsibility has already estimated (in October 2018) that ‘a rise in the NLW to two-thirds of median earnings would raise the unemployment rate by 0.4 percentage points in the ‘target’ year. In today’s terms that corresponds to a rise in unemployment of around 140,000, plus an equivalent reduction in hours for those remaining in employment. Average hours would be 0.4% lower and real GDP 0.2% lower than they otherwise would have been’.

What’s more, enthusiasts for higher minimum wages rarely say where the money is going to come from. Companies are no more than legal entities and cannot bear the economic cost themselves. Part of the burden of an increase in wages for the lower paid will be borne by shareholders, but it will also fall on employees, on consumers (as higher prices) and on taxpayers (many of those earning the NLW work in the public sector). If none of these concerns are valid, why stop at £10, or £10.50? Why not raise the NLW to £20, or higher?

Some supporters of a higher minimum wage have suggested that smaller companies and their employees could be protected by some form of targeted subsidy, paid for by savings from in-work benefits. But this would simply layer one government intervention on top of another. What is the point of forcing an employer to pay a higher wage, then giving them a subsidy so they can afford it, rather than just making the same payment direct to the employee?

Overall, Javid’s proposal is risky both in terms of its economic impact but also the politics, given that Labour is already offering more. The lack of supporting evidence also adds to the sense of election promises that have not been properly thought through. But his plans are at least much more responsible than those from John McDonnell, which would be far too big a leap into the unknown.

CapX depends on the generosity of its readers. If you value what we do, please consider making a donation.

Julian Jessop is an independent economist