A few simple questions for Osborne, Labour and the coalition

Allister Heath

IT is a moral imperative for all politicians to seek to help those on low incomes. Poverty is a horrible, depressing, truly heart-breaking condition. But what is the best way to help the working poor?

One approach focuses on policies that promote economic growth, job creation, productivity growth and social mobility, combined with much lower taxes on the working poor. Over time, wages grow hand in hand with productivity; and a tight labour market tends to boost wages. In a dynamic, socially-mobile economy, workers who get a foot in the door at a low entry-level wage then go on to progress and earn more.

Proponents of this view believe that hiking the minimum wage faster than productivity growth (in real terms) reduces total employment over time and compared to what it would otherwise have been, especially among the young, immigrants and low-skilled. The reason? No employer will ever hire somebody whose cost is greater than the monetary value of their output; so somebody who produces £7.01 an hour would still be worth employing at a total cost of £7 an hour; somebody who produces £6.99 wouldn’t.

A recent paper by Jonathan Meer and Jeremy West by the National Bureau of Economic Research concludes that “the minimum wage reduces net job growth, primarily through its effect on job creation by expanding establishments. These effects are most pronounced for younger workers and in industries with a higher proportion of low-wage workers.”

In stark contrast, the alternative approach – the consensus in Britain– is that low pay can be fixed by political intervention by mandating significantly higher minimum wages, with negligible side-effects. I hope George Osborne is right and that a sharp rise in the minimum wage will have zero effect on employment. Perhaps the rise will be spread over two years; inflation may erode it further. If it coincides with higher productivity, unit labour costs would go up even less, and the effect on jobs may truly be negligible.

But let’s instead assume that the rise is significant; there is now a race in Westminster to be as generous as possible with other people’s money, so this could be just the start of even sharper increases. So here are a few questions for the Tories, Labour and the rest.

What other goods or service can cope with an 11 per cent price hike, with no impact on demand at all? How large do you think the reduction in demand for labour will be, compared with what would otherwise be the case, over a multi-year horizon? Perhaps you think that higher wages will force employers to make workers more productive. But why wouldn’t employers do this anyway? Or perhaps you believe that employers will cut down on other costs: reduce training, introduce unpaid overtime and so on. Presumably, you believe that there are lots of “monopsonies” in the labour market and that employers often pay workers below the value of their output, so higher wages would merely reduce profits but not cut jobs. But what will the consequence of these reduced profits be? Or do you believe that profits are irrelevant to investment and GDP growth? And what effect will higher wages have on the rush to automation? Will shops, petrol stations, fast food outlets and others accelerate their quest to replace people with machines? If not, why not? Maximising profits means minimising costs. Perhaps the politicians believe that the costs in terms of reduced jobs or worsened conditions is a price worth paying to boost the pay of a much larger number of people. If so, they should make this clear.

As to me, I worry and worry some more. It is desperately important to help the poor, but it would have made far more sense to take minimum wage earners out of income tax altogether than to meddle with market forces. Let’s just hope the unintended consequences aren’t too large.

Follow me on Twitter: @allisterheath

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