Reaction’s distinguished correspondent Maggie Pagano, in an otherwise favourable review of the Growth Commission’s Growth Budget, suggests that it contains one bad policy – that of reducing the minimum wage from its proposed rate of 66% of the median wage to 61%.
Since I normally agree with pretty well everything that Maggie says, I thought I owed it to her, because as well as writing for Reaction, I am also a Co-Chairman of the Growth Commission, to explain why we have included this policy in our Growth Budget.
When the minimum wage was about to be introduced I was consulted by Labour on whether I thought it would do significant economic damage. My reply was that it would not, provided that the rate at which it was set wasn’t too high. It was introduced at a rate of 46% of the median wage in 1999 and stayed below or around 50% until 2010. When Michael Portillo as Shadow Chancellor was preparing to change the Tory position from opposing to supporting the minimum wage and phoned me to ask whether it would do economic damage I gave him the same advice – that at the proposed rate it would do minimal economic damage and would do some good, preventing extremes of exploitation in the labour market.
What has changed is that the minimum wage has risen dramatically as a percentage of the median wage from the initial 46% in 1999 and its proposed rate for 2024 of 66% of the median wage will be the highest in the advanced economies and well above the OECD average of 54%.
The case for a minimum wage is to prevent exploitation when employers have too much control in the labour market; the case against it is that it increases employers’ cost base. In some circumstances this is unaffordable and jobs are destroyed – often those of the most marginal members of the labour force with physical or mental disabilities or new migrants. In other circumstances the costs are passed on and lead to higher inflation which requires higher unemployment to squeeze it out.
Where a minimum wage can have a positive effect is if it is paid for by higher productivity. But productivity performance in the UK has deteriorated since the minimum wage started rising sharply so there seems to be scant evidence of this potentially favourable outcome occurring. I must admit that the idea of higher wages causing a rise in productivity has always seemed like wishful thinking to me despite its popularity with people as diverse as hard line trade unionists and died in the wool Brexiteers and there is little evidence of it working anywhere. Had the theory had much plausibility, Britain in the 1970s with its aggressive trade unions and high wage inflation would have been the most productive country in the world – in reality it was one of the least productive of the major economies.
The most comprehensive academic research on the impacts of a minimum wage, an international study in 2019, concludes, “Recent work helped identify how this impact may vary by the level of the minimum wage. Across US states, the best evidence suggests that the employment effects are small up to around 59% of the median wage.”
The Growth Commission has two econometrically estimated models which it uses to analyse an issue like this. Its micro model suggests that scrapping the minimum wage would add 1.36-1.49% in GDP per capita. Its macro model suggests that reducing the minimum wage from 66% of the median wage to 61% would in 20 years time add 0.8% to GDP per capita. This reduction to 61% is what the Growth Commission has proposed, which would leave the minimum wage higher than the 60% proposed for the EU and the rate of 55-60% proposed by the trade union advisory committee to the OECD.
Obviously at the moment with employers still struggling to get workers, one suspects that the number of jobs directly priced out in the UK by the minimum wage is low though those who are priced out are likely already to be those suffering disadvantage. But what is more likely is that in the current inflationary climate there will be upward wage inflation pressure as workers try to restore their differentials. Already UK wage inflation remains stubbornly high at 7.9% compared with 4.4% in the eurozone and 4.1% in the US. The minimum wage rises that have taken place and those that are planned are likely to force UK wage inflation to stay higher for longer.
Although the sharply rising minimum wage isn’t the only factor keeping up wage inflation, it is almost certainly a contributor. The higher the rate of underlying wage inflation, the more unemployment will have to rise to bring price inflation under control.
Looking back, I think I could have provided better advice to Michael Portillo. I didn’t at the time dare advise him on politics but I think I ought to have. The problem with the minimum wage was that once the government got into the business of setting people’s pay, the pressures on it would be asymmetric. There would always be more voters wanting a pay increase than employers warning against. While the minimum wage might work economically in the short term, it would always be under upward pressure. Oddly the Labour governments, who introduced the minimum wage, were fairly cautious about raising it. The coalition and Tory governments have seemed to have no such reservations and have pushed the policy to a point where it does real damage.
The problems that successive governments have had in resisting rises to the minimum wage have important consequences for any government thinking of introducing a Basic Income. It would be surprising if this can be done without unleashing political pressures to raise any initial level of basic income to a level that fairly quickly becomes economically damaging.
I accept that undoing the damage caused by an excessively high minimum wage is not easy. The first step (as in the Denis Healey advice that when you are in a hole the first thing is to stop digging) will be to stop the ratio of the minimum wage to average earnings rising further. Then it will be necessary to find a way of edging it down. The Growth Commission proposed a freeze until it had fallen to 61% of median earnings. But it may be that this task has to be completed in stages.
The Growth Commission exists to inform people of the consequences of the choices that their elected representatives make. We would be failing in our duty, if, with our modelling pointing out the negative consequences of an excessively high minimum wage, we had avoided pointing out this damage.
Douglas McWilliams is Co-Chairman of the Growth Commission which reported its Growth Budget last week.
