There has been no discernible impact on employment despite early scaremongeringby Jonathan Portes / March 31, 2019 / Leave a comment
“How do employers in a low-wage labour market respond to an increase in the minimum wage? The prediction from conventional economic theory is unambiguous: a rise in the minimum wage leads profit-maximising employers to cut employment.” The first two sentences in perhaps the most famous, and certainly the most influential, paper in modern labour economics. This position was very much in line with the Economics 101 model of the world that I’d picked up, almost by osmosis, in my first few years at the Treasury. But having paraphrased the theory this paper was about to overhaul it.
When I read it, in 1993, I’d just arrived at Princeton, where the author, Alan Krueger, taught labour economics. The paper was still an early draft, but it was already making waves. New Jersey had just raised the minimum wage by 20 per cent; neighbouring Pennsylvania had not. Yet Alan’s painstaking research (involving a survey of more than 400 fast-food outlets) showed that the job losses that theory would have predicted simply didn’t materialise. For a young economist, still thinking on Treasury tramlines, it was a revelation. As the anniversary of the introduction of the UK national minimum wage approaches it is worth remembering the lessons.
Astonishingly for an economics paper, the impact was immediate. Other research followed, generally reaching similar conclusions, including that by Alan Manning and others in the UK. There was a backlash from the ultra-orthodox wing of the economics profession, who believed that when the facts contradicted the theory, there must be something wrong with the facts. In the Wall Street Journal, Nobel Laureate James Buchanan wrote:
“Just as no physicist would claim that ‘water runs uphill,’ no self-respecting economist would claim that increases in the minimum wage increase employment. Fortunately, only a handful of economists are willing to throw over the teaching of two centuries; we have not yet become a bevy of camp-following whores.”
In fact, Buchanan was precisely wrong: many economists did follow Alan, and not just on this specific topic. The paper signalled the beginning of a revolution in microeconomics—especially in labour and development economics—with detailed empirical research, often involving actually going out and collecting new data, taking priority over elegant theoretical modelling.
Meanwhile, in the UK, a minimum wage was Labour Party policy, but one that had been comprehensively rubbished during the 1992 election campaign. Along with many others seen as driven by old-fashioned social ideology, it appeared ripe for the scrapheap under Tony Blair and Gordon Brown. But the changing intellectual climate saved it, and the 1997 manifesto promised a “sensibly set national minimum wage (NMW)… decided according to the economic circumstances of the time… and with the advice of an independent low pay commission.”
Still nervous, the incoming Labour government took a very cautious approach. The Low Pay Commission (LPC) had representatives from both trades unions and business, as well as labour market experts, and had a strong steer to proceed slowly and by consensus. So, when it was introduced in April 1999, the NMW was set at a very low level, £3.60 an hour. That didn’t stop the Conservatives and some economists predicting disaster. Professor Patrick Minford (now a laughing stock for his Brexit fantasising, but then a credible voice for free-market economists) claimed that the introduction of the minimum wage, even at this low level, would cost more than 200,000 jobs.
The success of the LPC, both as an institution and in policy terms, is now well-known. It still operates by consensus and is led by empirical evidence. Supported by a small, but very competent, team of civil servants, every year it commissions a number of studies on the impacts of the NMW. Consistently, they have shown that the NMW has had little or no impact on employment, while boosting earnings for the lowest paid. By 2015, the NMW had risen gradually but significantly (relative to average earnings), so instead of being at the bottom we were approaching the EU average.
But George Osborne broke with this approach. Not, as previous Conservative chancellors might have, by ignoring the LPC and abolishing or reducing the NMW, but by setting a new, more ambitious, target rate (for those over 25) of 60 per cent of median earnings, which would put the UK well ahead of most other European countries.
Many economists were sceptical. While there’s a consensus that the NMW has cost few if any jobs, and that the predictions of naïve economic theory were wrong, hardly anyone would dispute that at some point too high an NMW will damage employment and the labour market. And having the chancellor set the NMW based on an arbitrary, politically driven target, rather than the LPC, seemed an unnecessary risk.
So far these fears have not been vindicated. With employment in the UK at record highs, there’s still no evidence that the NMW is damaging job prospects. And, while earnings inequality overall is rising—with the top 0.1 per cent doing particularly well—rises in the NMW have protected the position of the lowest paid. On 1stApril—the 20thanniversary of its introduction—it will rise again, to £8.21 an hour.
So where next? Many thought that, after Osborne’s burst of radicalism, the chancellor would be content to leave well enough alone. But instead, in the spring statement, he invited another US-based economist, Arindrajit Dube, from one of the most left-wing economics departments in the US, UMass Amherst, to advise on the future development of minimum wage policy. The US academic debate has been reinvigorated by sharp rises in minimum wages not at national but at local levels, with a number of cities introducing a $15/hour rate, more than double the national floor, and Dube’s research has shown, once again, that the impacts have largely been benign.
We don’t know what he will recommend for the UK. But while the scope for further large increases in the NMW itself is limited, there’s plenty more to look at. The UK is not one labour market, and it’s far from obvious that the same NMW is appropriate in London and Llandudno. It’s quite easy to imagine that an NMW at a level that would cost jobs elsewhere in the country might not do so in London (and if it led so some displacement of low-paid employment out of London, that might not necessarily be a bad thing). Sectoral minimum wages—which used to exist, in the form of Wage Councils, until abolished by the Major government in 1993—might also be on the agenda.
So, 20 years on, the NMW is a good news story. Economics—not ideology or theory-based, but careful evidence-based research—helped politicians to formulate policy. Politically canny institutional design has ensured that it has informed implementation ever since. And rather than reversing the innovation of a Labour government, Conservative chancellors have built on it—and appear to want to go further. Alan Krueger died, tragically, last week, but British workers have a lot to thank him for.