Minimum Wage | Options for a radical reform

Professor Alan Manning, Head of the Economics Department at the London School of Economics where he has taught since 1989, takes steps back from the current annual debate about the appropriate but small rise in the value of the minimum wage to ask a bolder question: are there more radical reforms of the minimum wage that could raise living standards in the years ahead? in Minimum Wage: Maximum Impact (Adapted exceprts by Job Market Monitor following).

In part, we are interested in learning what happens in labour markets where the minimum wage is much higher than it is in Britain today. But we are also interested in targeting – could a smarter design do more to benefit the groups that are most in need of higher wages? And are there ways we could ‘project’ the effects of the minimum wage, so that it doesn’t just raise wages at the very bottom, but also of those higher up the distribution?

Thus far the NMW has been increased in cash terms every year, although increases have slowed recently. In real terms, adjusting for RPI inflation, growth in the minimum wage was greatest in the early 2000s, particularly around 2001. Last year’s revision in the cash value of the minimum wage, from £5.93 to £6.08, represented the largest ever real terms fall in the value of the minimum wage.

A more useful way to think about the relative generosity of the minimum wage is to consider its value relative to median wages. As Figure 2 shows, the initial level of the adult minimum wage was very modest at about 46 percent of median adult hourly earnings. In the following years, after the Low Pay Commission decided that the early NMW had had little impact on employment, this rate was pushed up rather faster than median earnings between 2001 and 2007 reaching 52 percent in 2010. In recent years, as with the real value of the minimum wage, this growth has slowed, with the minimum wage roughly keeping track with the value of median earnings.

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Although the proportion of workers who are paid below, at, and within 10p of the legal minimum has increased over time, the figures remain very small. Today around 2 percent of adult workers are actually paid the minimum wage, under 1 percent are paid below it (a combination of errors in reported wages, legitimate exceptions and non-compliance) and no more than 1 percent earn within 10p. All in all, even if one thinks this data contains inaccuracies, a generous estimate for the proportion of adults being paid the minimum wage is around 5 percent.

Standing back, then, what does the first thirteen years of the minimum wage tell us about how the minimum wage might be used in the coming years to ease the squeeze on living standards? With no adverse effect on employment detected, one might be tempted to conclude that we should continue to push the NMW up at a faster rate than average earnings. Unfortunately, though, we need to be more circumspect. The evidence tells us little about what would happen were we to go significantly further in raising the minimum wage faster than average wages. Any significant increase in the standard national rate would be something of a leap into the unknown.

What if we were radical? Evidence on the impact of much higher minimum wages

The UK is mid-table when it comes to the level of the minimum wage relative to median earnings. The UK level is in fact very similar to that in a large number of other advanced economies, sitting within three percentage points of 12 out of the 23 countries covered in the above chart.

France and New Zealand stand out as being particularly worth further consideration, having particularly high levels of the minimum wage, at about 60% of median earnings, while both also being broadly comparable to the UK in terms of their level of economic development.

Certainly the evidence does not give credence to exaggerated fears of a catastrophic effect of raising the UK minimum wage, even quite substantially. But nor does it give us the kind of confidence we might seek in order to justify a departure from the LPC’s gradualist approach. If the UK minimum wage were to be raised in line with the level seen in New Zealand, this would mean an increase in its value of 30 percent. On the basis of the existing evidence, such substantial increases, even if pursued over a few years, would need to be made incrementally and with a great deal of caution.

Options for more radical reform

If we are thinking about a world in which the minimum wage does far more work in raising the earnings of a far greater number of people, the blunt nature of these effects may well inhibit how far we could go. This puts the onus on thinking about more sophisticated tools than a simple national minimum. Put another way, the reasons for considering more variation in the minimum wage are not all about being cautious—there is also an argument for opening up more opportunities to be mbitious with wage policy over the longer term in a way that continues to limit the risk of surprising negative effects.

The author examines three  options for reform of the UK minimum wage:

1. A premium minimum wage for adults above a certain age
2. Regional variation in the value of the minimum wage
3. The use of the minimum wage infrastructure to put broader upward pressure on pay norms.

The idea of introducing a premium NMW for older workers, for example those over 30, has merit. This would have the added benefit of making the minimum wage somewhat better targeted on low-income households. The downside is that older workers do not earn so much more (at the lower percentiles of the distribution) than younger workers, meaning that any adult premium minimum would be not be much higher than the current adult NMW.

The second possibility we have considered is a higher minimum wage for London. Earnings in London are much higher than in the rest of the UK so the current NMW has less impact in London than it might. A higher rate in this region could lift the wages of large numbers of workers. Although there would be practical difficulties there is little reason to think they would be insurmountable.

Finally, we have considered what could be learned from the approach of the living wage. The method of computing the living wage delivers a number that is far too high to be considered as a national, mandatory minimum wage. A narrative that views a living wage as an alternative to existing support through the welfare system, in particular tax credits, overlooks the fact that an hourly wage for individual workers can never guarantee a minimum standard of living at the household level, where living standards depend on the hours of work and the number of children. That said, these limitations take nothing away from the fact that higher hourly wages would help to raise household income. The living wage campaign has demonstrated the virtues of a voluntarist approach. There may be a case for doing more to leverage the authority of the LPC to change pay norms. Asking the LPC to take a judgment on non-mandatory ‘affordable’ minimum wages in different sectors might be one way of raising the pressure on employers who pay unnecessarily low wages, as well as shining a light on sectors of our economy that are dependent on unsustainably low levels of pay.

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