The effects of a higher minimum wage: social justice or unemployment?

Contando_Dinheiro_(8228640)The putative ‘National Living Wage’ was introduced in the UK last week. That it is so-called is purely political, since the National Minimum Wage was introduced by the last Labour government in 1999. This version is significantly higher than the NMW, and its introduction has by-passed the independent Low Pay Commission and taken the name of the higher still ‘Living Wage’ which campaigners claim is a truer reflection of the minimum cost of living in the UK. True to form, the Chancellor George Osborne has turned it in to something more intensely political. It is notable that the Conservatives opposed the introduction of the NMW when in opposition, amid claims that it would cost millions of jobs. It has been a remarkable turnaround!

The NLW will apply only to employees over 25. It is being introduced gradually and is expected to rise to around 60% of median earnings by 2020, or £9 an hour.

What might the effects of a higher floor to wages be? There are likely to be consequences for social justice in the form of changes in inequality and poverty, for the level and structure of employment, for firm and economy-level efficiency, for demand and for relative prices. But when considering these factors, it should be born in mind that any NMW or NLW should be part of a package of government policies which aid the inevitable adjustments in the economy, even if the effects are found to be positive overall.

The effects on inequality depend on the narrowing of wage differentials at the bottom of the labour market. With a floor to wages for the lowest paid, there will tend to be some pressure for wages paying slightly more than the NMW to increase. It is hard to know how far this extends up the distribution, but the impact is likely to be less for higher paid workers than for the relatively low paid.

If there is no negative employment effect, the effect of higher wages for the lowest paid is to unambiguously increase their standard of living. Some commentators have suggested that many of the lowest paid are second earners in households which are not poor at all. If the household is the unit of analysis this may be true. But this ignores the effect on individuals within households, who may achieve some greater degree of independence once earning a higher wage. This idea moves us beyond economics into the realms of sociology. Whether or not such effects are a good thing becomes far more subjective.

Any disemployment effect of the NMW has been the subject of many studies. A classic is Card and Krueger, who looked at data in the US and found small increases in employment after the minimum wage was increased. In the UK, the Conservatives, now in government, have long-since dropped their opposition. In fact, UK unemployment continued to fall after the NMW was introduced. Theoretically, there may be some fall in employment, other things being equal, but there may be other more important factors operating when they are not equal, such as economic growth. The latter will tend to increase labour demand if overall output increases faster than productivity. Thus analyses which ignore the dynamics of macroeconomic trends and broader developmental processes will be found wanting.

The NMW may play a role in increasing productive efficiency in a number of ways. If, as some authors claim, low pay is often the result of workers being undervalued rather than the consequence of their being unskilled or unproductive, then low pay has a social component and will be caused by low firm productivity rather than the usual reverse causation cited in orthodox economic theory. Higher wages for the lowest paid should help to counteract this problem.

In addition, if low wages are a means by which less efficient firms compete on price rather than quality and service, then higher wages may increase efficiency by forcing all such firms to change their competitive strategies. The degree to which competition on price remains important will vary between firms and industries, but preventing wage cutting as a route to lower prices might encourage investment in new technologies as a more viable route to lowering costs and prices in the longer term.

There may be a degree of structural change in the size distribution of firms if the NMW increases unit costs in small firms compared with larger firms. What matters to national prosperity in the long term is growth in productivity, so a particular change in this distribution may not matter in economic terms. The key factors to examine at the firm level will be the proportion of wages in overall costs and their ability to pass on cost increases in higher prices. Some structural change is therefore inevitable and the government could play a role in assisting firms and workers to adapt as part of their labour market and industrial policies.

Low pay can also cause high worker turnover and reduced job satisfaction and effort, so that higher wages, so-called ‘efficiency wages’, can reduce these effects and encourage firms to invest in training if they know that workers are likely to be more committed to the job.

Depending on the tax and benefit system, NMWs can reduce the need for income support or wage subsidies provided by the state. In this way, poverty reduction and redistribution is to some extent reduced by regulation, and the size of the state in terms of income and expenditure might be reduced.

Higher wages will also have some effect on demand for goods and services. Studies have shown that the poorest workers tend to spend more locally and on products with a lower import content. Such effects may only be small but can still provide a boost to the economy. On the other hand, if firms paying higher wages are forced to pass on the increased costs in higher prices, these effects can be muted.

One obstacle to higher NMWs can be the highest paid and wealthiest in the economy who often benefit from cheap goods and services provided by the lowest paid. When wages increase for the latter, prices of such products may well increase. An interesting example of this can be found in Norway and Sweden, where although there is no NMW, trade unions play a relatively strong role in society and wages and working conditions are more regulated than the UK or US. Visitors to the Nordics often complain about the high prices in these countries. This may well be an effect of greater regulation, but their societies and economies remain prosperous, and in some way their citizens have accepted that more expensive goods and services are a price worth paying for a greater degree of social justice.

Thus there a number of effects that higher wages for the lowest paid can have, many of them positive. In the end they should be part of a package of policies that encompass labour market, social welfare and industrial policies, which can help firms adjust to paying more, improving efficiency and valuing their workers more highly.


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