Minimum Wages

Why have statutory minimum wages become more prominent in recent decades? Why have they generally had little adverse effect on employment?

Prior to the introduction of the national minimum wage (NMW) in 1999 there had been no statutory wage floors since the abolishment of the Wages Councils in 1993 by the Conservative government. Growing wage inequality in both the D50:D10 and D90:D50 measure (which looks at the differing wage rates in the respective percentiles) was one of the leading reasons in the demand for some form of minimum wage to counter this growing inequality. Metcalf finds that the NMW reduced the D50:D10 ratio by 9 points if we include the effects of immigration. As a result of the NMW the D50:D10 ratio lost half the growth it made between 1978 and 1996 (Metcalf).

20% of the workforce was in a low paid job in 2001 which is classified as earning less than two thirds of the median pay of all workers (Mason et al 2008) which is an increase from the level of 12% in 1977 matching the decline of unions. This is despite the rise of new technologies (which should increase productivity and eliminate low skilled work) and the increased share of graduates in the workforce along with off-shoring of low wage jobs in manufacturing and service sectors. This high proportion of low paid workers can therefore be used as a reason for the necessity to introduce a minimum wage level, but whilst its introduction may lead to a fall in inequality in the D50:D10 ratio, assuming no spill-over’s, is unlikely to directly affect the D90:D10 ratio. Rubery and Grimshaw find that there “was little change in the incidence of low wage work”.

During the period when minimum wages were being discussed there was increasing immigration, partly as a result of the increasing integration with the European Union with the proportion of immigrant workers to native workers rising from 8.71% in 1999 to 11.5% in 2006. Dustman et al (2007) conclude that the NMW “performs an important role to secure wages of workers who otherwise would lose out from immigration”, showing the political desire for a minimum wage to permit the opening of borders and mitigate against the political and social effects of increased immigration.

A final point for why minimum wages have gained prominence is because of the rising cost to the government and taxpayers of tax credits and subsidies to the low paid. The government hoped that a minimum wage would solve this issue by passing costs on to employers and thus resulting in a redistribution of income from profits to wages and potentially absolving the government of the burden of low paid workers.

In 1997 the Low Pay Commission (LPC) was formed to propose to the government the level and inclusion of a national minimum wage. When created its purpose was given as to “mitigate a number of deepening problems developing from Britain’s increasing inequality of income” showing that this inequality was the major reason for the introduction of the NMW (Brown). In additional, Metcalf believes that the NMW made a significant contribution to the compression of the gender pay gap. It was composed of a mix of 3 representatives from unions, 3 from business organisations, 2 independents and a Chair. It is important to note that these representatives were not delegates – they were not negotiating on behalf of their organisations, but instead giving their input based on their respective backgrounds. This Commission used a mixture of consultation, evidence and the reviewing of international minimum wages and their cover and costs.

Conventional economic theory proposes that the higher the wage the less demand there is for labour. Therefore we might conclude that this would mean that a national minimum wage, set above the competitive equilibrium, will cause a reduction in demand for labour leading to excess supply, more commonly known as unemployment. Fortunately, this doesn’t seem to be the case despite Minford’s scary predictions in 1999 that the minimum wage would cause unemployment to rise by millions. Stewart looks at the effects on employment before and after the introduction of NMW and finds “no significant adverse employment effects in any of the four demographic groups (male, female, adult, youth) considered”. The only possible effect from the NMW is that the hours of low-paid workers may have fallen: 1/10 of those affected by the NMW had a small reduction in hours (Stewart and Swaffield 2002).

The composition of the committee and its distance from the government (the LPC is independent but in practice the government has so far accepted all the proposals from the LPC) may provide our first –weak- argument for why the minimum wage has had little adverse effect on employment. Because the LPC is formed of people from a background in unions and employers it is able to strike a balance for the minimum wage which is high enough to capture as many workers as possible without leading to an increase in unemployment – something the commission highlights as its target in its reports. This argument assumes that the members of the LPC have access to perfect information (something we have seen is not the case from the errors in the LFS) and can calculate the level of wage which will result in firms making redundancies – an unlikely prospect.

One of the most intuitive answers to why the national minimum wage has had little adverse effect would be if it wasn’t properly enforced and so there was low compliance. The ONS finds that 327,000 jobs were paid below the NMW in April 2005; 1.31% of all UK jobs. Some of this will be due to trainees, apprentices and employees receiving free accommodation; all of whom are legally permitted to be paid lower wages. Indeed, some of this will be due to non-compliance, a figure which should be higher given that statistically a typical employer can expect a visit from HRMC once every 320 years and found not complying once a millennium (Metcalf). Grimshaw and Rubery report that between November 2004 and December 2006 20% of employers were found by HRMC to be non-compliant: a high figure which may explain why the national minimum wage has had little effect on employment – because it isn’t being used and so firms are still paying workers below this wage thereby not causing higher unemployment. This may be particularly the case for ‘vulnerable’ firms – those who have a high number of low paid workers and so don’t comply in order to remain cost effective (or maintain profits).

We have been assuming that the wage market is in fact competitive, when in reality this might not be the case due to search frictions or mobility costs to changing jobs. If this is the case then the employer may have monopsony power which means it doesn’t need to charge the competitive rate, but can charge below it – “companies have significant power to set wages at an appropriate level” (Lam et al 2006). Hence firms were earning supernormal profits and the introduction of the NMW merely shifted profits away from the firm back towards employees.

It is possible that even within the constraints of the competitive framework a rise in the wage rate from the introduction of the NMW wouldn’t necessarily lead to higher unemployment (and could actually lead to higher employment). This could be seen because productivity may rise as employees have higher morale or motivation, there is a reduction in staff turnover rate and there is a higher cost of job loss to the employee (Marsden). Firms may be more induced to provide education and training to workers, to make them more productive, to account for them having to be paid higher wages. The probability of receiving training rose by 8-11% and the intensity (measured in days) of training rises by 10% as a result of the NMW (Arulampalan et all, 2004). Furthermore, if staff-turnover is reduced because of higher costs of job loss then the benefits of training staff will be more forthcoming to a firm. Forth and O’Mahoney do indeed find that there was growth in labour productivity in the textile, security and hairdressing industries around the time of the NMW introduction.

Alternatively, we could maintain the competitive framework if it is the case that in the short run it is too costly to make workers redundant and so it is only in the long run that we see the effects of unemployment. However “it is unlikely that the lack of significant employment effects is a consequence of the studies all focusing on the short run” (Metcalf). A more likely alternative explanation is that increased labour costs are passed on to consumers through higher prices thereby not affecting employment because costs don’t have to be cut.  According to Brown the industries have been affected by the NMW are largely in the domestic service sector – with 46% of minimum wage jobs confined to hospitality and retail – (most low paid manufacturing jobs have already been outsourced) which have low price elasticity of demand, making it easy for firms to pass on costs to customers. Even if some firms do go bust, the jobs they lose are likely to be picked up by competitors who expand to replace them in the market.

In conclusion we have seen that national minimum wages were introduced in order to reduce wage inequality which had arisen from the decline in trade union activity and to a lesser extent deal with the issues of gender disparities in pay and mitigate against the effects of immigration. Fortunately the introduction of the NMW and its upgrades since hasn’t been perceived to have adverse effects of employment, although there may be errors in statistics and it is impossible to know what employment would have been without the introduction of the NMW. Suggested reasons for why this wasn’t the case include; low compliance in sectors which are heavily affected by the NMW permitted by low enforcement or punishment; the comparison of effects in the long and short run; a resulting increase in productivity; and the possibility that a monopsony framework needs to be considered instead of a competitive one.

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