Academic Literature

From Low Pay to Higher Pay in UK – People who are on low pay more likely to be in employment in the future than the unemployed or not in the labour force

There is a sizable body of literature examining low paid employment with a focus on state- dependence of low pay – that is, whether and to what extent current low paid employment increases Pizathe probability of remaining in low pay in the future. The interest in state-dependence of low pay arises from a concern that with increasing earnings inequality, if there is state-dependence of low pay (i.e. low pay is persistent), life-time earnings inequality will increase as well. Indeed, state-dependence of low pay has been found in a number of studies even after individual heterogeneity is controlled for.

However, there is another form of state-dependence of low pay to which earlier studies have paid little attention – that is the effect of current low pay on influencing the probability of moving to higher pay in the future. We will refer to this form of state-dependence of low pay as a stepping stone effect of low pay. To be consistent with the earlier literature, we will continue to use the term state-dependence to refer to the first type of state-dependence of low pay (i.e. its persistence). Answers to the question whether and to what extent low paid employment has a stepping stone effect are particularly relevant to policy makers. From a welfare policy perspective, if low pay employment acts as a stepping stone to higher pay, welfare reforms that promote employment, even it is low paid, such as the work-first approach to welfare recipients, have a good chance of improving the financial well-being of welfare recipients over time and are therefore justified. This study extends the literature by estimating a dynamic multinomial logit model to examine both state-dependence and stepping stone effects of low pay.

Using the 18 wave BHPS survey, this study examined whether and to what extent low pay is genuinely persistent (i.e., state-dependence of low pay), and whether and to what extent low pay leads to higher pay (i.e., stepping stone effects of low pay). To this end, a dynamic random effects multinomial logit model was estimated separately for males and females in Britain to account for observed and unobserved individual heterogeneity, and state-dependence and stepping stone effects of low pay were then computed from the estimated models.

The results show that both state-dependence and stepping stone effects of low pay are present after observed and unobserved individual heterogeneity is accounted for. That is, other things being equal, those employees who are on low pay are more likely to be found on low pay in the future, compared with those who are not in the labour force, unemployed or on higher pay. On the other hand, other things being equal, those who are on low pay are more likely to move into higher pay in the future than those who are either not in the labour force or unemployed.

While there is evidence on state-dependence of low paid employment, people who are on low pay are found to be more likely to be in employment in the future than those who are either unemployed or not in the labour force. In addition, those who are on low pay do not appear to be more likely to move out of employment than those who are on higher pay. These results suggest that there is not a low pay – no pay cycle among British workers, once observed and unobserved individual heterogeneity is accounted for.

The findings that low pay acts as a stepping stone to higher pay and does not lead to non- employment provide supportive evidence for the work-first approach in welfare reforms and also suggest that minimum wages should be set at an appropriate level that promotes employment, even if the jobs created are low paid. This in turn suggests that the new Living Wage being introduced by the British Government at a level above the minimum wage may be unhelpful if it leads to a loss of employment for marginal groups of workers.

Consistent with many other studies that find the introduction the national minimum wage has little impact on employment, this study finds the introduction of the national minimum wage has little impact on state-dependence and stepping stone effects of low pay.

Chosen excerpts by Job Market Monitor. Read the whole story at Low paid employment in Britain: estimating state-dependence and stepping stone effects

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