Whether the next prime minister is Theresa May or Jeremy Corbyn, one thing looks certain—the National Minimum Wage (or the National Living Wage as George Osborne rather cheekily rebranded it) is set to rise. The Conservatives have pledged to raise the wage floor up to 60 per cent of median earnings by 2020, equating to a minimum wage of around £9 an hour, whilst Labour has gone further by offering £10 over the same time frame. Both offers are substantial increases from the current level of £7.50 for the over 25s.
The politics of the minimum wage have shifted rapidly since its introduction in 1999. A measure once opposed by the Conservatives has been embraced by both main parties who are now fighting a bidding war in terms of offering the most to the low paid. Despite this, there are still some who argue the minimum wage does more harm than good to the workforce and the wider economy. They are mistaken; it has been a UK success story, and future rises in it are welcome.
Dire warnings initially that imposing a legal minimum would lead to a substantial increase in unemployment have been proved incorrect. Today Britain’s employment rate stands at a record and the pressing problem facing the labour market is not a lack of jobs but a lack of decent earnings. The real wage (wages after adjusting for the change in prices) squeeze of 2008 to 2014 was the longest since Victorian times and with inflation picking up following Sterling’s post-Brexit slide, real wage growth has once again turned negative. Even with sub-5 per cent unemployment, Britain’s flexible labour market appears unable to generate pressure for higher wages.
Of course, a higher minimum wage is not a panacea for this problem. It’s debatable to what extent a higher wage floor pushes up wages for the median—or middle—earner, rather than simply compressing the distribution of pay.
"No party’s minimum wage pledge has reached a level which would be a headwind for jobs growth"And it should be acknowledged that the process for setting the minimum wage has changed in recent years, which may have implications for employment growth. From its introduction in 1999 until the Budget of 2015, the wage floor was set in a technocratic manner by the Low Pay Commission (LPC)—an independent body made up of experts, employer and employee representatives. Its remit was to raise the wage by as much as possible without having a negative impact on employment.
George Osborne’s new National Living Wage (which only applies to the over 25s) saw a major change in approach—with the LPC being given an explicit target of 60 per cent of median earnings by 2020. This brought the politics back into the minimum wage and opened the door to the political bidding war we have seen this in election.
There are of course those who worry that such an approach will lead to outlandish promises and a wage floor so high it starts to hamper employment growth. But so far there is little evidence of this. No pay is a worse problem than low pay, but no party’s pledge has yet reached the level at which the wage floor would be a serious headwind for jobs growth.
There may even be an (almost) intended economic upside to a higher minimum wage. The major long-term problem facing the British economy is a serious lack of productivity growth. Productivity growth—the ability to get more economic output for any level of input—is the key to increasing living standards in the long-term. Since 2008 the UK’s performance on this front has been abysmal. Slowing productivity growth is a worldwide phenomenon but in the UK the issue is particularly acute.
In the long-run most economists would agree that the wage level and productivity are intrinsically linked. Higher output per hour allows firms to raise their employees’ wages without taking a hit to their profit margins. To give a simple example: if an employee produces 5 per cent more in any given year without working any additional hours, then a pay rise of up to 5 per cent has no impact on underlying profits.
"The major long-term problem facing the British economy is a serious lack of productivity growth"But whilst the link between productivity and wages is clear, the exact relationship is murky. The usual argument is that faster productivity growth leads to more rapid wage growth as firms have room to increase their payroll bills. But there may well be circumstances in which the relationship is reversed.
One reason for weak productivity growth in the UK in recent years has been low levels of investment by business. To use a favourite phrase of economists, all things being equal, higher capital spending on new equipment, new machinery and new software should lead to higher productivity. A worker with more capital should be able to produce more output than a worker with less capital.
But when labour is cheap—as it has been in the UK in recent years, firms have few incentives to invest. Why spend money on expensive machinery which may sit idle to increase output when instead you can hire cheap workers who can be laid off in a downturn?
It may—and this is still a “may”—be the case that a higher legal minimum wage forces firms to invest in getting more out of their existing workforce. Historically and internationally, there are plenty of examples of higher labour costs encouraging firms to invest in labour saving technology and increase their productivity.
If a higher wage floor helps raise UK productivity, then the winners won’t just be the low paid but the economy as a whole.
