UK: SMITH ON ECONOMICS - THE MINIMUM CHANCE OF SUCCESS.

UK: SMITH ON ECONOMICS - THE MINIMUM CHANCE OF SUCCESS. - New Labour's stance on the minimum wage has softened but, says David Smith, commitment to it could be misguided and lead to a rise in unemployment - as the American experience shows.

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Last Updated: 31 Aug 2010

New Labour's stance on the minimum wage has softened but, says David Smith, commitment to it could be misguided and lead to a rise in unemployment - as the American experience shows.

Ask people in business what their reservations are about the Labour party and quite a few things will crop up. Many of these reservations are encapsulated in a single policy - Labour's pledge to impose a minimum wage at a level yet to be determined. A minimum wage is plainly interventionist - direct government interference in the wage contract between employers and employed - and it reflects the influence of the unions, who have long campaigned for it.

True, under Tony Blair the commitment to the minimum wage has softened. New Labour, having learned a few lessons from the past, does not even pledge to introduce the minimum wage immediately. In practice, the battle will be between the unions, who would like it to be set at £4 an hour or more, and a Labour government, backed by employers, which would either want to drop the policy, or limit it to no more than £3.50 an hour.

More efficient use of workers

But would a minimum wage really be that bad? After all, many low-paid workers have had a raw deal in recent years. Most companies pay all their workers comfortably above the posited minimum wage, whether it be £3.50 or £4 an hour. It could even, say advocates of the policy, raise productivity by giving firms an incentive to use workers more efficiently. And isn't there some evidence from America which suggests that increasing the minimum wage had the effect, not of killing jobs, but of boosting employment?

Let us take these in turn. Would a minimum wage narrow inequalities in Britain, by giving the poorly-paid a government-inspired helping hand? Unfortunately not. For one thing, flexible labour market or not, differentials are differentials. The effect of pushing up wages at the lower end would ripple throughout the labour market, leaving the relative position of the worst-paid unchanged. More importantly, as the Institute for Fiscal Studies has shown, a minimum wage is a terrible way of helping those on the lowest incomes, because it is so poorly targeted. As we shall see, many of those whose pay would be boosted would be women working part-time and young people.

Second, while it is true that the majority of workers are paid well above the likely minimum, that still leaves four million whose hourly pay is £4 an hour or less. Half of these, to take up the point touched on above, are women working part-time. Overall, according to calculations by, the investment bank, Barclays de Zoete Wedd, a minimum wage of £4 an hour would add 1.5% to business's employment costs. But - and this is a key consideration - its effect would be highly uneven. In service industries such as retailing, hotels and catering, the impact on employment costs would be much greater, 4% to 5%. These, of course, are the very areas where employment growth has been strongest in recent years.

The argument that a minimum wage would boost productivity also fails even the barest plausibility test. Underlying it is the belief that companies are somehow careless in their use of labour, and need an official reminder that workers cost money in order to implement productivity improvements. Nothing could be further from the truth. Rationalisation and cost-cutting are a permanent feature of modern management. The only sense in which the productivity argument works is that if you push up the cost of labour sufficiently, the incentive for firms to invest in labour-saving machinery is enhanced. This, presumably, is not what the minimum wage lobby has in mind, particularly when most of the sectors which would be hit hardest by higher employment costs are naturally labour-intensive.

New Deal's raw deal

Finally, the lessons from America should be studied, not to demonstrate why minimum wage legislation is a good thing, but rather the exact opposite. The history of the minimum wage in the US goes back to the late 1930s and the New Deal, when it was introduced at 25 cents an hour, 40% of average wages at the time. The effect of even this low-level minimum wage, it was over-estimated, was the loss of up to 50,000 jobs.

Support for an increase in the minimum wage grew within the Clinton administration with the publication of research which showed divergent behaviour in two states, which are of course free to enforce a minimum wage higher than the federal figure.

When New Jersey raised its state minimum wage it appeared that the number of low-wage jobs in the fast-food industry increased, while in neighbouring Pennsylvania, where there had been no minimum wage hike, such jobs declined. Like all surprising results, this one deserved closer examination, and that revealed that, far from boosting employment among (predominantly) young people, the effect of increasing the minimum wage was to reduce it. After the minimum wage hike, teenage employment dropped by 28% in New Jersey, compared with a decline of 9% in Pennsylvania over the same period.

Let it wither on the vine

Indeed, the biggest problem with the minimum wage, and a strong reason why no government with designs on improving equality should think of introducing it, is that it hurts those on the margins of the workforce so much. As the graph shows, periods when the minimum wage has been allowed to 'wither on the vine' by not being uprated in line with inflation (and thus declining in real terms) have been good for the position of teenagers in the job market - unemployment among this group has fallen. But when the minimum wage is boosted, teenage unemployment rises.

There is every reason to believe that such results would be replicated in Britain. Minimum wage legislation costs jobs, particularly among the young, unskilled and minority groups. I have yet to see any convincing evidence that this is not the case. Business is absolutely right to be suspicious of it.

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