May 20, 2014 by Paul Goldsmith
Ed Miliband’s announcement yesterday of the intention of a Labour government to set a statutory minimum wage target linked to average earnings was not a surprise – as he and his party have been particularly consistent on their intention to combat in-work poverty, and this policy is coherent with that. What was also not a surprise was the warning from business groups that the policy would drive up costs and affect international competitiveness. The right-wing newspapers worried that it would cause unemployment. In among the conflicting messages from all sides of the ideological question is one cold stark fact – there are five million people in this country who work – but cannot make ends meet. This country spends more money on benefits to people IN work than out of it. What type of country do we want to live in?
The economics of raising the minimum wage seem simple, but evidence suggests that the consequences of it are not simple at all. For instance, basic economics would suggest that if a wage is set above the equilibrium wage (where demand for workers meets supply for an industry), then the supply of that labour will be greater than the demand, as more workers will be prepared to work for that wage than the jobs available from firms at that wage. Therefore, a minimum wage will cause an ‘excess supply’ of workers – otherwise known as ‘unemployment’. This was what drove the Conservative Party to oppose the minimum wage for many years – commonly regarded by those that run the party now as a colossal mistake.
That’s because there are some serious flaws in that argument – and Ed Miliband’s announcement spots both of them quite well. The CBI (Confederation of British Industry) pointed out that they think that the Low Pay Commission (who independently research and then set the minimum wage) is “doing very well” – which may mean that it is “doing very well” in serving the interests of the business community. Whatever, Miliband said that he wants to set out a new framework for the Low Pay Commission with a five-year target and a strengthened role in tackling poverty and raising productivity. This is the point – if the Low Pay Commission are setting a minimum wage which keeps many workers in poverty, is it actually doing it’s job. But also – shouldn’t the influence of higher minimum pay on a worker’s productivity be taken into account?
Back to basic economics – a worker’s contribution to the firm they are working for can be split into two – one aspect is the actual productivity that they add when they work – how many units of a product they make or how much of a product they sell, and the other aspect is the price that those units they make or sell actually sell for. A firm looking to hire a worker will only hire them if the wage they would have to pay them at least equals but (if they want to make a profit) is lower than the worker’s productivity multiplied by the value of what they produce or sell. (This is their marginal revenue productivity if you are an A-level economics student and want to know)
Miliband is suggesting, and this is perfectly logical economically, that if the minimum wage is raised – it might incentivise workers to raise their productivity. Furthermore, and bear in mind people on a low income are more likely to spend extra income they get as opposed to save it – paying them more could increase consumption in the economy, and some of this will go to UK firms who will need to hire more workers to meet that demand….my point being that essentially a minimum wage might not produce excess supply – even in a competitive market – as demand for labour may end up increasing too so we may end up at a new, higher equilibrium wage – with a higher employment too. (This is not the place for me to go into the effect of a minimum wage in markets with a dominant employer – called a ‘monopsony’ – apart from to say that normally employment and wages will rise).
But let’s go back to the other benefit of raising the minimum wage. The government at the moment tops up wages with tax credits, which costs them a huge amount of money, and they are essentially subsidising companies who underpay their workers. So this policy could also reduce the budget deficit, something which even those on the right-wing of politics should be pleased about.
Sounds like a no-brainer? Anything that increases our costs relative to our trading partners is not going to be received by businesses well. But businesses aren’t people. People in full-time work are in poverty. That – and I understand this is a value judgement – is wrong.