George Osborne's Magic Has Us Fooled, For Now
The chancellor can alter the law but cannot make costly workers worth hiring, says Tim Harford
He has mastered the art of misdirection as well as any stage magician. Everyone knew George Osborne was going to butcher the tax credit system on Wednesday, more or less halving the income at which they begin to fall away. But few expected him to announce a much higher minimum wage, and he did it with such an extravagant flourish that no one clearly remembers seeing him wield the cleaver.
For most of the poorer working households who qualify for tax credits, the combined effect of Mr Osborne's Budget will be to make them worse off financially, and to push them away from the labour force by raising the effective rate of tax they pay.
Monique Ebell of the National Institute of Economic and Social Research reckons that a single mother working 30 hours a week at the minimum wage will be more than a £1,000 a year worse off in two years' time than she is today, despite the increase in the wage she must legally be paid.
That assumes, of course, that she keeps her job at all. This is the big question about the minimum wage: will it increase the earnings of low-paid workers, or price them out of the job market entirely? Should we expect to see these workers laid off and replaced with one-touch espresso machines, automatic checkouts and call-centre workers from India? The minimum wage is a delicate balance, and Mr Osborne has put his thumb on the scale.
The chancellor's aim is to raise the minimum wage for those over 25 beyond £9 by 2020, from £6.50 today. That is dramatic, although not quite as dramatic as it first seems. Mr Osborne is setting the minimum wage where it might be if the economic crisis of 2008, and the long stagnation that followed, had never happened. He is hoping that employment will not suffer. He has a few other countries to look to as a precedent. France is one example, and it is not encouraging. Australia is a more hopeful case.
Mr Osborne's move would once have been unthinkable from a Conservative chancellor. A quarter of a century ago, the conventional wisdom was that the idea of a minimum wage was absurd at any level. The logic of that position was simple enough. If the minimum wage was below the market-clearing wage — at which employees want to work the same number of hours that businesses want to hire them for — it would be irrelevant; if it was above, it would be worse than useless. Productive workers do not need a minimum wage because they will anyway be well paid. Less productive workers will be harmed by a minimum wage because employers would rather sack them than pay more than they are worth. One does not simply repeal the laws of supply and demand.
The world has moved on since then, and we know that while supply and demand matter, there is more to the labour market than the simple story above.
Some employers have market power and could pay higher wages if they were forced to; the higher minimum wage may simply redistribute from employers to low-paid employees. Another possibility is that if forced to pay higher wages, employers will invest in training and equipment to justify the labour expense. On this view, wages do not need to follow productivity; productivity can be led by wages.
A third explanation is that since many low wage jobs are in non-traded sectors such as retail, employers will simply put up prices, spreading the burden of the higher minimum wage across all consumers, and possibly reducing inequality.
There is also the argument that higher wages can encourage workers to show up more often and smile at the customers. This is true, but in most cases managers will have reached that conclusion by themselves without the need for a legal minimum.
A large body of empirical evidence suggests either that reasonable minimum wages do not destroy jobs at all, or that they do not destroy very many. The evidence is, of course, mixed and contested.
Much of it comes from the US and concerns the experience of teenagers, who — in the words of Alan Manning of the London School of Economics, "represent about 2 per cent of hours worked and 98 per cent of the studies of the minimum wage". But it is clear enough that if modest increases in the minimum wage were disastrous for jobs, we would know that by now.
Whether the chancellor's wage rise counts as "modest" is far more questionable. Professor Manning is guardedly optimistic: he thinks that the bold increase in the minimum wage is worth a try. But he is nervous, and so am I. We are at the edge of what the data can tell us. Mr Osborne is about to provide a fascinating new case study.
The best scenario is that the minimum wage helps to drive up British productivity, which has long languished. Employers invest in training, and rather than replacing workers with machines they give them the latest tools to do their jobs.
To the extent that productivity does not rise, employers absorb the costs or pass them on to consumers, equitably bearing the burden of giving hard-working people a decent wage.
A gloomier scenario seems more probable for some sectors, especially social care. The law of supply and demand turns out to matter after all. Faced with a sharp increase in the minimum wage that runs well ahead of what the Low Pay Commission has felt able to endorse, employers lay off many workers and reduce the hours of others. The welfare bill rises and — as so often in the past — it proves much harder to create jobs than to destroy them.
My own bet is somewhere in the middle. We will discover that Mr Osborne has pushed too hard, and that the minimum wage must be allowed to slip back again relative to median earnings. Some jobs will be lost, a lesson will be learned, and Mr Osborne's political purposes will have been served. He will be hoping to have upgraded his own job to that of prime minister by then, which may be appropriate: he is a masterful politician but has never shown much grasp of economics.
Written for and first published at FT.com
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