A minimum wage is poor economics

Minimum wage legislation has become the go-to policy in developed economies when trying to deal with years of sluggish wage growth and rising inequality.  Faced with increased global competition and slowing productivity growth, governments have turned to the easy solution of price fixing to force wages up. But while the winners from such a policy are easy to identify, as with all government policy, unintended consequences create a multitude of losers.

The UK The National Living Wage currently stands at £7.50/ hour. According to plan, it will reach £9 by 2020. This implies a rise in the minimum wage from the current figure of 55% of median earnings to 60%. Jeremy Corbyn’s Labour Party wants to go even further. Included in their manifesto is a pledge for a £10/ hour minimum wage, which will give ‘more than five and a half million people a pay rise’, according to Corbyn.

It is certainly true that those working for a higher minimum wage will be better off. But the figure of 5.6 million workers is simply the number of people currently earning less than £10/ hour. True to form, the Labour party completely ignores the effect of higher wages on the demand for labour. And while that effect is impossible to quantify, ignoring its existence is obviously naïve.  The Cameron government, when introducing the Living Wage in 2016, argued that it would force companies to invest in technology to bring productivity in line with the higher wages. But investment in technology will not just increases productivity but substitute capital for labour, amplifying the reduction in labour demand. The anecdotal evidence is already in: Britain’s big retail stores have made almost 4,000 low-paid workers redundant in the first few months of the year.

What the Labour Party and other proponents of minimum wage legislation also wilfully chose to ignore is who in the work force will be the losers. While touted as a progressive policy, minimum wage legislation in fact is regressive, forcing the weakest out of the labour market. The most vulnerable lose out to facilitate a pay rise for workers whose productivity can justify the higher wages. The most obvious, but controversial, example of this effect are the handicapped. While much political energy is spent on high profile, but low impact, measures to increase handicapped access to the work place, the fact that their labour may be worth less to an employer is wilfully ignored. Minimum wage legislation directly and adversely affects the labour market access of handicapped and others of low productivity.

Minimum wage is in fact not much help to the poorest in society, who often are not in work at all. The poorest households are largely unemployed and relying on benefits, and as such stand to gain nothing from higher wages. On the contrary, not only will they find themselves distanced even further from the labour market, the benefits system they rely on will face increased pressure as the workers priced out of the market by the hike in wages join the ranks of claimants. The grotesque fact is that these newly unemployed generally face a drop in living standards in their new lives as benefits claimants. The law has thus deprived them of the opportunity to provide for themselves, condemning them to a lower income on benefits. Henry Hazlitt, in Economics in One Lesson, gives the following example: ‘By a minimum wage of, say, 75 cents an hour, we have forbidden anyone to work forty hours in a week for less than $30. Suppose, now, we offer only $18 a week on relief. This means that we have forbidden a man to be usefully employed at, say $25 a week, in order that we may support him at $18 a week in idleness.’ And the loss of income may not even be the worst effect. The loss of a job impacts self worth, cuts off an important social network and idleness begins to deteriorate the value of a hard earned skill set.

The rise in unemployment of course hurts the economy as a whole, with a drop in overall production on top of the additional resources needed for income transfers. The goal for any economy should be for its citizens to be able to provide a decent life for themselves and their families. Minimum wages directly counteracts this goal.

Unfortunately, despite the economic illiteracy of minimum wage legislation, such measures are popular. Around 70% of Brits support Labour’s £10/ hour proposal. Low paid workers obviously like the idea of higher wages and fail to appreciate the downsides. And the unions have curiously also always been proponents, despite having few members actually affected by the minimum wage. The reason is subtle: by raising the wage of unskilled labour, skilled unionised workers, who command higher wages, eliminates cut-price competition. Union support for minimum wages is motivated by self interest, not concern for low-pay, non-unionised workers.

Instead of price fixing, the government should liberalize labour markets, reduce red tape, ease the tax burden on employers and remove barriers to entry such as mandatory licensing. The poorest are best served by the same as the rest of society: a dynamic, growing economy, where capital accumulation is encouraged. This is the only way to increase productivity and achieve sustainable wage growth. Such policies ought to be the focus of our next government. It is a great shame that no party offers such a platform.

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