Ryan Bourne

No, it is not a good idea for the Tories to raise the minimum wage

No, it is not a good idea for the Tories to raise the minimum wage
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There’s so much to disagree with in Rupert Myers' piece arguing that the Tories should raise the minimum wage that it’s difficult to know where to begin. Raising the minimum wage will be bad for the most vulnerable in the workforce and will lead to less employment. The question of whether it would win support for the Conservative party is another matter.

This is really basic economics. Raising the price of labour by dictat will reduce the demand for it, other things given. Or as Paul Krugman put it back in 1998:  'The higher wage reduces the quantity of labor demanded, and hence leads to unemployment.' 

It might not necessarily lead to a fall in the actual number of people employed, because firms also have the option of cutting back the hours of workers as well. But there will be less overall employment than before. Add to this the fact that raising the minimum wage will lead to an increase in the supply of workers (think more young people than otherwise dropping out of education to enter work, more home-makers deciding that it is worth their while to go back to work, or even more immigration), and you can see there’s a double hit for the very low skilled workers, who will be crowded out of finding jobs by their more skilled peers.

Evidence from America, for example, finds that a 10 per cent increase in the minimum wage depresses teenage employment between 1 and 3 per cent. Of course, this all depends on where the wage is set. Canadian research has suggested that so long as minimum wages are set below 40 per cent of average earnings of the group, the effects on employment are small. But unfortunately for the young here (the age group most likely to be scarred by the effects of long-term unemployment) 2011 figures for the UK youth minimum wage as a proportion of the average wage were 65 per cent for 18-21 year-olds, and as high as 76 per cent for 16-18 year olds.

Rupert essentially claims that because employment kept rising even after the minimum wage was introduced, this is evidence that Tory warnings about it causing unemployment were wrong. But this misses the point. What the Tories meant, correctly, was that there would be less employment than in a world in which there was no minimum wage. The general growth of the economy could lead to employment continuing to rise after the minimum wage’s introduction, but this doesn’t mean employment wouldn’t be higher still without one.

Though the numbers are small enough to not really affect the macroeconomic picture, consider Appendix 3 from this 2005 Low Pay Commission report. In its survey of employers from 9 low-wage sectors it found that 37 per cent had cut staffing levels in response to the national minimum wage increase in 2003, whilst only 4 per cent raised them; 31 per cent cut basic hours worked whilst 3 per cent raised them; 28 per cent cut overtime hours; 81 per cent said their profits fell; and 63 per cent said they raised prices. This direct evidence suggests that increasing the minimum wage further would lead to more unemployment than there otherwise would be.

To be fair to Rupert, he is not the only person to have made the claim that minimum wages don’t appear to have effects on employment levels. The intellectual ammunition came from Card and Krueger’s study which compared two neighbouring US states and found that employment in the fast-food industry was unaffected by one state raising the minimum wage. Yet this was only examining one industry at one specific point in time, and its conclusions have since been cast in to doubt because the payroll evidence gave the opposite conclusion to their surveys. In fact a 2007 review of the state of the literature more generally found:

'The oft-stated assertion that recent research fails to support the traditional view that the minimum wage reduces the employment of low-wage workers is clearly incorrect. A sizable majority of the studies surveyed in this monograph give a relatively consistent (although not always statistically significant) indication of negative employment effects of minimum wages. In addition, among the papers we view as providing the most credible evidence, almost all point to negative employment effects, both for the United States as well as for many other countries.'

There appear to be three broad theoretical arguments which, even if the data shows they do not exist, could justify increased minimum wages not leading to less employment, all of which seem implausible. First, if firms hiring these workers with low skills are monopolies – evidently not true when you look at the sorts of industries which pay the minimum wage. Second, if all of the increase in cost is absorbed as lower profits – which in itself will have consequences of deterring innovative new start-ups, or force firms with thin profit margins out of business (as Chris Dillow has said, if you don’t believe this, you don’t believe in capitalism). Third, if higher minimum wages reduce turnover of staff and so lead to an overall cost saving – but if this was true, wouldn’t rational firms be doing it already and not require it to be imposed?

None of this is to claim that some low-paid people won’t benefit from an increase (though evidence suggests that those with low household incomes – the real measure of poverty -  won’t benefit most). And it may well be good for the deficit, as it would act much like a tax by stealth given the higher marginal tax rates low income workers face.

But there is little merit in Rupert’s claim that this would stimulate growth. The Keynesian view that increasing the pay of low wages increases demand is tempered by the effect on employment, the effect on profits and investment and the fact consumers are deleveraging. And, crucially, there is little theory or evidence to dismiss the concerns of those of us who believe the minimum wage will increase unemployment and crowd out the lowest skilled and young. The Conservative instincts on this aspect were right in the 1990s. Raising the minimum wage further, as Rupert suggests, may well win the Tories votes – but it will sacrifice working lives.

Ryan Bourne is Head of Economic Research at the Centre for Policy Studies.