2000 words economics essay on wages regulation.

The UK’s minimum wage – not so good after all?

(words 1998)

W S Siebert, Feb 2013

Introduction

There has been a decline in labour market prospects for the most vulnerable groups since the minimum wage was introduced in the UK. There is not sufficient UK evidence yet to pin much of the blame for this on the minimum wage, but the international evidence points in that direction. Proposals for imposing a “living wage” by soft or hard coercion could also be damaging.

Brief history

The UK’s minimum wage began in April 1999, fulfilling a promise of Blair’s new Labour government. Blair was responding to popular demand, since the Conservative government in 1993 had ended the old system of minimum wages. Michael Forsyth, the Employment Minister at the time said: “The biggest source of poverty is not low pay; it is having no job. Wages councils destroy employment”. However, most people, then and now, believe that there is a moral basis for a minimum wage, and the coalition government has not moved close to changing it.

The national minimum wage (NMW) system has some interesting features. Firstly, it is set in a technocratic way by experts who rely on research. Although the Low Pay Commission has both TUC and CBI members, it also has academic members, and an independent chair. Hence, a careful sifting of the evidence on how the NMW bears on business – including business in the regions plays a large part in the debate. As such, changes in the NMW have responded closely to changes in the health of the economy. The biggest exception to this was in 2001 when the thrusting Stephen Byers saw electoral advantage in pushing the youth rate up considerably prior to the May 2001 election. The important point here is that the NMW is set explicitly to weigh as little on unemployment as possible.

Secondly, the minimum wage is “national”, with no regional differentiation. The Low Pay Commission’s terms of reference from the beginning excluded such differentiation. Hence, arguably, the level has always been too high for the north, and too low for the London area. The NMW does, however, have several age categories, with a youth sub-minimum, and an even lower apprentice sub-minimum. Thus, it has been sensibly conceded that young workers and apprentices are less productive. Again, we see an effort to mute the unemployment consequences of the minimum.

Despite this, the UK labour market is performing poorly for unskilled workers, as shown in Table 1, and the question must arise about the NMW’s role in this. We see that the 16-24 group’s unemployment rate has almost doubled to 24.7 per cent over the period since 1999. In addition, as the lower panel shows, their unemployment duration has worsened, with 28.2 per cent unemployed for over one year. In fact, as can be seen, the UK’s youth labour market is now putting in as bad a performance as France, long a youth unemployment blackspot Employment effects

UK evidence. The minimum wage has been raised considerably over the period since 1999. Hence, it makes a lot of difference to unskilled workers’ earnings, and one would expect unemployment consequences unless counter-balanced by strong growth. The impact of the minimum wage can be seen in Figure 1. The 2010 distribution has had its lower tail cut off compared with the 1997. In fact, the NMW has increased by 72 per cent since 1999, considerably more than the 50% of the average worker’s wage.

What effect has this had on job opportunities for the unskilled? There are inherent statistical difficulties of identifying the impacts of a policy that covers the whole of the UK. One way to judge this issue is to examine regional variation, since the NMW has more “bite” in poor than rich areas as shown in Figure 2, which compares the hypothetical effect in a district such as Cambridge with one such as Liverpool. Assume that productivity and the demand for labour is lower in Liverpool. The NMW requirement would move unskilled employment from point d (dictated by the level of welfare benefits) to point c (the demand for labour at the minimum wage). Meanwhile, employment in Cambridge would be barely affected.

The first person to conduct this type of study was Mark Stewart (2002), who used data for changes in wages and employment in about 150 UK regions for the first year of the NMW. He found no adverse effect, but with only one data point per region he could not allow for region-specific trends or long-run effects. His work has recently been updated (Dolton et al 2013, 26) using all data including the recession, and concludes the regions with more NMW bite indeed have lower employment other things equal:

The elasticity is around 0.1 implying that a 10 percent increase in the bite of the minimum wage [relative to the area wage]would lead to a fall of 1 per cent of the employment rate”.

An alternative approach is to compare workers who have their wages raised by the NMW with workers paid just above that level (say, up to 10 per cent above the minimum). These workers should have similar skills, and welfare benefit options. This method was also pioneered for the UK by Stewart (2004). He again found no adverse NMW employment effects, but was only looking at one year of data.

In fact, the latest work using this approach by Dickens and Riley (2012), using data up to 2010, does find unskilled workers are hit harder. In particular, this research finds that the probability of remaining in job (employment retention) is reduced by about three percentage points by the NMW for part-time women, the group who are most affected by the NMW (10% compared to about 2-3% for full-timers). This result is important because a 3 point reduction is large when measured against an average retention rate (i.e. probability of remaining in employment for one year) of around 70 per cent.

So, the UK employment picture for the most vulnerable has deteriorated with the NMW. However, there is not enough data to draw firm conclusions as to the cause as yet. What does the international evidence suggest?

International evidence. Studying a panel of countries or states (for example in the USA) offers a better way of analysing minimum wages since there is more variation in the minimum. An important study of long-run effects is that by Baker at al (1999) for nine Canadian provinces for 1975-93. He found that a 10 per cent increase in the minimum wage reduces teenage employment by 2.5 per cent and that it takes about six years for the full result.

There have been other international panel studies, all finding adverse effects. Neumark and Wascher’s (2004) analysis of 17 OECD countries for the period 1975-2000 finds that a 10 per cent increase in the minimum wage leads to a two per cent reduction in the employment rate for younger people (15-24). Recent work by Dolton and Bondiabene (2012) confirms these estimates and also suggests that the impact of minimum wages tends to double during a recession.

Finally, the work by Addison and Ozturk (2012) concentrates on employment outcomes for adult women. They estimate that a 10 per cent increase in the minimum wage will reduce employment by 1.5 per cent.

In sum, while the UK evidence is thinner due to statistical problems, the research overall points to the minimum wage reducing employment as conventional economic theory predicts. In other words, the minimum wage undermines employment for the least productive whilst raising wages for others. The research also suggests that the workers who benefit are the better-off. Thus, where there is high unemployment there is heightened competition for jobs, with the better connected workers – teenagers from better educated families rather than the poor finding them (see Ahn et al. 2011).

Morality and new proposals for a “living wage”

Going beyond the NMW, the Joseph Rowntree Foundation and others are calling for a “living wage” of £7.45 an hour. We are told that “the moral pressures are winning out over the economic pressures” (Hirsh 2012). Yet what moral virtue is there in a policy that causes the loss of jobs for low-wage, low-skill workers or which causes the lengthening of unemployment duration? Countries with high minimum wages and/or high social costs - such as France - have high long-term unemployment (where nearly half the unemployed have been jobless for longer than a year).

The living wage would be tied only to living costs and median incomes and not to labour market conditions. As we have seen, the unemployment effect of the UK minimum wage has been reduced because of the pragmatism of those setting the rate. The imposition of the living wage – regardless of labour market conditions - would be a recipe for increased long-term unemployment.

A functioning market would have much lower wages in Liverpool than in Cambridge, which would attract business, and relieve poor unemployed people. If the market were allowed to work – which would require lower benefits as well as lower wages since benefits form a floor under wages - then businesses would move north. Of course, it is difficult to take on the benefit system, but even tax breaks for businesses in development areas would be better than a living wage. The living wage would push wages up for favoured workers in large firms and in government, but would do nothing for those trapped within our dysfunctional “permanent” welfare system.In fact, there are other policies, such as better schooling (and reduced teacher union power), reduced regulation and taxes, that could enable unskilled workers to become independent and earn their their own “living wages”.

References

Addison John and Orgul Ozturk (2012). “Minimum Wages, Labor Market Institutions, and Female Employment: A Cross-Country Analysis”, Industrial and Labor Relations Review, 65: 779-809.

Ahn, Tom, Peter Arcidiacono and Walter Wessels (2011). “The Distributional Impacts of Minimum Wage Increases when both Labor Supply and Labor Demand are Endogenous”, 29: 12-23.

Baker, Michael, Dwayne Benjamin and Shuchita Stanger (1999). “The Highs and Lows of the Minimum Wage Effect: A Time-Series Cross-Section Study of the Canadian Law”, Journal of Labor Economics, 17: 318-50.

Commission (2012). National Minimum Wage - Report 2012, Cm 8302, London: Low Pay Commission.

Dickens, Richard, Rebecca Riley and David Wilkinson (2012), “Re-examining the Impact of the National Minimum Wage on Earnings, Employment and Hours: the Importance of Recession and Firm Size”, Research Report Commissioned for the 2012 Report, http://www.lowpay.gov.uk/lowpay/research/pdf/

Dolton, Peter and Chiara Bondibene (2012). “The International Experience of Minimum Wages in an Economic Downturn”, Economic Policy, 27: 99-142.

Dolton, Peter, Chiara Bondibene and Michael Stops, 2013. “Identifying the Employment Effect of Invoking and Changing the Minimum Wage: A Spatial Analysis of the UK”, unpublished working paper, University of Sussex.

Hirsch, Donald (2012), “The Living Wage: Where Morality and Economics Meet”, Joseph Rowntree Foundation, www.jrf.org.uk/focus-issue/minimum-income-standards

Stewart, Mark (2002), “Estimating the Impact of the Minimum Wage Using Geographic Wage Variation”, Oxford Bulletin of Economics and Statistics, 64: 583-606.

Stewart, Mark (2004), The impact of the introduction of the UK minimum wage on the employment probabilities of low wage workers. Journal of the European Economic Association, 2: 67–97.

Figure 1: Changes in the Earnings Distribution due to the NMW

Source: Commission (2011), Figure 2.9

( Supply D C ambridge wage a Welfare Labour hours D L iverpool NMW b c d )

Figure 2: Assessment of NMW Effects

Table 1: Adverse Changes in Employment for Unskilled Workers

		All, 16-65	No qualifications	16-24	France, 15-24
Unemployment rate (%)	1999	6.3	12.1	13.8	24.2
	2011	8.1	17.0	24.7	22.1
	Change 1999-2011 (% points)	1.8	7.9	10.9	-2.1
Unemployment duration (% of unemployed > 12 months)	1999	28.7	NA	15.3	France, total 40.3
	2011	33.3	NA	28.2	41.4
	Change 1999-2011 (% points)	4.6	NA	12.9	1.1

Sources: Commission (2012, Table 2.10), ONS (2012) and OECD (2000, 2012)

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