Future of Work

Do economists think Britain’s ‘living wage’ experiment will work?

Image: A pile of one pound coins is seen, in central London. REUTERS/Toby Melville

Sarah O'Connor
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Future of Work

“I feel as though I have died and gone to heaven,” said Britain’s skills minister in a recent speech, as he prepares to preside over the fastest rise in the minimum wage in the country’s history.

The new policy, which starts on Friday, will see the wages for low-paid workers rise four times faster than average earnings this year.

The world will be watching. Governments in many developed countries are turning to minimum wage policies as they try to deal with inequality and anaemic wage growth.

The stagnation in wages in recent years has been blamed on the rise of global competition, the decline in collective bargaining, a slowdown in productivity growth and the way in which technology has “hollowed out” some middle-skilled jobs.

In response, Germany introduced its first ever minimum wage last year; Japan’s prime minister Shinzo Abe has called for minimum wage increases of 3 per cent a year for the foreseeable future; and some US cities such as Seattle are raising their wage floors to $15 an hour.

Developing countries such as Malaysia are also using minimum wages to try to redistribute growth more fairly and encourage employers to move up the value chain.

As Richard Dickens, an economics professor at Sussex university, concludes: “Minimum wages have never been so popular. The next question is: how far can you push it?”

This is the question that Britain’s new national living wage — which starts at £7.20 an hour and will reach about £9 an hour by 2020 — will put to the test.

Nick Boles, the skills minister, has claimed it will be “one of the biggest increases in the legal minimum wage that any government has done in the western world in living memory”.

But the Conservatives did not always feel this way about the minimum wage. Indeed, the party opposed the UK’s introduction of the policy in 1998, arguing it would destroy jobs. “We bring to it the zeal of converts,” Mr Boles admitted.

Image: Financial Times

Many economists have also changed their views. Economics textbooks used to state that if you raise pay above the value it creates for employers, you reduce demand for labour. In other words, minimum wages cost jobs.

But economists’ opinions are now more nuanced, in large part because of the experience of countries such as the UK, which have so far sustained steady increases in the minimum wage without doing any notable damage to employment.

The early signs from Germany are also positive. In spite of nervousness from businesses about the introduction of a minimum wage of €8.50 an hour last year, the unemployment rate has continued to fall and is now at a record low.

“My view of the history of minimum wages is that we’ve always been surprised about how you seem to be able to push them up without harming job prospects,” says Alan Manning, a professor at the London School of Economics.

“Of course, there would come a point, if you pushed it up too far, that there would be serious adverse effects. We just don’t quite know where that is.”

The UK’s minimum wage is already relatively generous by international standards, according to the Financial Times’ “Big Mac” minimum wage index.

At £6.70 an hour, a minimum wage worker in the UK would have to work 26 minutes to buy a Big Mac. That is better than the US (41 minutes) and Japan (32 minutes), similar to Ireland and Germany, and worse than Australia and Denmark (18 and 16 minutes respectively).

If Britain brought in its £9 an hour target today, a minimum-wage worker could buy a Big Mac after 18 minutes.

There are other ways to measure the level of a minimum wage, such as where it stands relative to average pay. The government plans to increase the national living wage to 60 per cent of median earnings by 2020, which would take the UK from the middle of the OECD pack to the upper end.

The government chose 60 per cent as a target in part because a handful of countries such as France and Australia already sustain minimum wages at that level. France has relatively high unemployment and Australia relatively low unemployment. But it is difficult to make straight comparisons because of differences in how the wages are set and to whom they apply.

Image: Financial Times

In terms of coverage, OECD data analysed by the Low Pay Commission, responsible for recommending minimum wage rates to the government, shows that about 9 per cent of UK workers currently earn within 5 per cent of the minimum wage — a fairly high proportion compared with peers such as Australia, the US and Canada. By 2020, the LPC’s analysis suggests this figure will swell to about 18 per cent — substantially higher than in any other OECD country for which data exists.

“We’re going into uncharted waters and we just don’t really know. In some ways it’s a social experiment,” says Professor Dickens, who is also a member of the LPC.

The big question is whether the UK can maintain its strong employment record, particularly for the lowest-skilled workers, who are about to become more expensive to employ.

Andrew Hilton, director of the Centre for the Study of Financial Innovation, believes the policy will be “devastating” for entry-level and low-skilled jobs.

This debate has emerged in Germany recently, too, after concern that the minimum wage is too high to enable recently arrived refugees to find jobs. Some German politicians have called for exceptions to the minimum wage for low-skilled refugees.

Yet Professor Manning points out that the modelling being done for the minimum wage experiments in US cities like Seattle is encouraging. These analyses suggest low-paid workers will spend more money in the local economy, boosting local demand and creating a virtuous circle for employers and employees.

He says the UK is right to experiment — and disputes the idea that the country is “stumbling towards a cliff edge”.

He adds: “We may be in the dark . . . but it’s much more like we’re on the top of a rounded hill and if you go a little bit too far down, you just walk back up again.

“Nothing here is irreversible.”

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