Economics, politics and the reality of the 'squeezed middle'

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More than a minimum?

The minimum wage has fallen back to the level it was at in 2004 – what are the prospects for a futur

Minimum wage.

Once in a while a policy moves from being partisan and divisive to representing the mainstream consensus in a very short period of time. That is, or at least was, the case with the national minimum wage (NMW). It wasn’t so long ago it was denigrated by much of the business community and the then Conservative opposition - but only a few years later it acquired a very different status as a statement of the bleeding obvious. The result, according to a timely new report by Professor Alan Manning, is that it has ‘settled down into a premature staid middle age’ following a noisy infancy without ever having passed through a teenage rebellion.  

Yet for all its fast won respectability – it was recently voted most successful policy of the last 30 years by a group of experts convened by the Institute for Government – there has, over the last year or so, been growing chatter about the potential damage of the NMW culminating in the recent decision to freeze the youth rate. Hard evidence of it having a negative effect on employment is, however, hard to come by. Recently the IFS produced a major study of the impact of the NMW on youth employment and educational prospects, concluding that there is little evidence that it has hindered job prospects. Now Professor Manning provides something of a cold shower for those getting het up about the alleged burden of the NMW, showing that in real terms (adjusting for inflation) it’s now at lower level than it was in 2004.  

Looking closely across different regions in the UK he finds no evidence that the NMW has cost jobs, contrary to the dire predictions of the late 1990s. And this was achieved at the same time as there were – early on at least – major gains for low earners. Its history to date has been strong growth at the start of the millennium, followed by slower increases, then stagnation, and finally real terms falls over recent years.

The difference the policy has made in the distribution of rewards over the last decade or so can be seen in the significant shifts in the nature of wage inequality.  As the chart below shows, the gap between the very lowest paid (ie those on or around the NMW) and the middle fell considerably (in marked contrast to the gap between the top and the middle). In addition, the gap between those on low - but not the lowest - pay and the middle also fell, as increases in the wage floor trickled upwards in the workplace (as differentials were partially protected). And we can also trace its impact in the finding that since the late 1990s the steadily falling share of GDP going to the bottom half of wage earners has flattened out.

Changing shape of wage inequality in Britain
(Hourly wage ratios, 1975-2010)

The question, then, is what next for the minimum wage given the highly uncertain economic times?

At the moment the public debate on low pay is dominated by the credible caution of the statutory approach taken by the Low Pay Commission on the one hand, and the spirited insurgency of the grass roots (and voluntarist) living wage campaign on the other. Both have considerable merits. But the result is that there is relatively little fresh thinking about the wider policy framework on low pay, including the minimum wage, and whether the current one - conceived of in the late 1990s – is still fit for the very different challenges we now face.
   
Since the NMW’s inception in 1999 the ground has shifted in many ways – the rise and recent demise of tax credits being an obvious case in point. There has always been a crucial interaction between them: a NMW is supposed to provide a strong wage floor; tax credits top up household incomes to support those with children who will be unable to get by on a minimum wage which, on its own, will never be high enough to ensure a decent family life. Both need to be thought of in tandem.

Looking back it’s possible that the still chunky increases in tax credits in the mid 2000s outpaced the more incremental rises in the minimum wage. Today we face severe cuts to tax credits twinned with a falling minimum wage (in real terms). And looking forward prolonged fiscal austerity means that we may need the minimum wage to do some of the lifting that might have otherwise been undertaken via tax credits (a LPC study back in 2007 showed that a 10% increase in the minimum wage would generate gains to the exchequer of between £560 and £680 million per year via increased tax revenues and reduced spending on tax credits).

More generally, given the underlying weakness of the labour market, there is of course a risk that a significant hike in the NMW could cost jobs – though there is little solid evidence as to where exactly this pinch point lies (currently the minimum wage in the UK is around the international average when measured as a percentage of the median wage, and there is an absence of hard data confirming that those countries with a higher wage floor have paid a price in employment).

It’s against this backdrop that Professor Manning considers several ideas for how minimum wage policy could be developed over the medium term in order to secure rises where possible without running a high risk of increased unemployment. These include a ‘premium rate’ for specific groups or localities where the data suggests these could be sustained: for instance, the over 30s or those in London. Intriguingly he also considers whether the authority of the LPC could be used to influence pay bargaining more generally – producing evidence to demonstrate whether sectors could absorb wage rates above the NMW without there being a negative impact on jobs.  

It’s not hard to come up with practical objections, some of them potentially fatal, to at least some of these ideas. Given the strong track record of the LPC in governing the NMW it is, of course, wise to tread carefully. And yet.  In a world of scarce public money, plummeting tax credits, stagnating wages and relatively flush corporate balance sheets it must be right to ask challenging questions, informed by evidence, about how to lift low pay.

Given the fiscal outlook it’s even more likely that we will need the minimum wage to play a substantial role in lifting living standards over the medium to long term. And one way or another that is likely to mean unsettling some of the established wisdom about how it should work. Perhaps it’s time for a rebellious middle age.