Rejoining the north European mainstream

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by Professor Simon Deakin, Assistant Director of the Centre for Business Research

The campaign to increase the £6.19 an hour national minimum wage to a living wage of £8.55 in London and £7.45 in the UK should be supported on the grounds of both equity and efficiency. The living wage is good for families and workers, but also for firms and for the UK economy.

Joint research by the Resolution Foundation and the Institute for Public Policy Research has found that gross earnings would rise by £6.5bn if employees were paid a living wage. It also showed that paying UK workers a living wage would save the Treasury more than £2bn a year by boosting income tax receipts and reducing welfare spending.

This comes as no surprise to those who conduct research on public policy. If employers do not pay a living wage the state has to make up the difference through tax credits. These arrangements benefit no one except, possibly, firms which use tax credits as a pretext for paying low wages. These firms are more profitable as a result and their shareholders may also be better off. But their gains are being made at the direct expense of low-paid workers and the taxpayer.

The Council of Europe sets a decency threshold which implies that the minimum wage should be around two-thirds of the median wage (that is, the wage paid at the midpoint in the earnings distribution). The UK’s national minimum wage has generally been around 45 per cent of the median wage since the late 1990s. The gap between the legal minimum and the decency threshold set by the Council of Europe has been met, in practice, by tax credits. This system has been allowed to develop because of fears that a high minimum wage would cause unemployment.

When the minimum wage was introduced in 1998, the Low Pay Commission was set up to advise ministers on its level. The commission was given the remit of determining what the likely economic effects of the minimum wage would be. Its membership consisted of a number of academic economists, in addition to representatives of management and labour. The outcome was a statutory minimum wage set at a level which did not meet families’ living costs. To meet the gap, the then Labour government, which was committed to reducing household poverty, expanded the system of tax credits which it had inherited from the preceding Conservative administrations. This worked for a while. The rise in child poverty levels was reversed, but only up to the mid-2000s. The burden on public expenditure of increasing tax credits to make up for persistently low wages was becoming excessive.

The living wage campaign began as a response to adverse effects of low pay on many working households. These included very long working hours which were often spread over two or three separate jobs as earners attempted to meet living costs. Supporters of the living wage do not argue that it should become legally binding in the same way as the national minimum wage. Rather, they call on employers to recognise the principle of the living wage on a voluntary basis, and to make their position known to their contractors and suppliers, and to the public at large. The campaign is based on persuasion and an appeal to employers’ enlightened self-interest.

Why would employers want to sign up to the living wage? The direct benefits include a more loyal and highly motivated workforce. Indirectly, employers with a stake in their local community may view the living wage as contributing to social cohesion. This is undoubtedly a factor in the support given to the living wage by many local authorities, hospitals and universities. But private sector employers in the retail and service sectors are also interested. There is a growing realisation that employers cannot insulate themselves from the social consequences of the decisions they make on wages and terms of employment.

What would be the effect of employers more generally accepting the principle of the living wage? Would it increase unemployment? This seems unlikely. One of the arguments for taking a cautious view on the level of the minimum wage in 1998 was that firms had come to rely on low pay as a means of cutting costs. The introduction of a high minimum wage would have been a shock to the economy, leading to increased unemployment. This argument has less resonance today. Employers have had over 15 years to get used to the minimum wage. As a result, the idea that wages should more reflect real living costs is becoming more generally accepted. Because the living wage is not mandatory, progress towards achieving it can be tailored to the circumstances of particular firms.

From the point of view of government expenditure, the living wage would be largely self-financing, thanks to the offsetting effects on tax credits. It would also bring wider benefits to the economy. The most productive economies in the world, those of the Nordic countries and the northern European systems influenced by the German model, either have high legal minimum wages or multi-employer collective agreements which set basic minimum rates of pay which are high by UK standards. These pay norms provide an incentive structure for investment by workers and employers in firm-specific skills. High minimum wages do not work on their own; they must be combined with other policies. These include active labour market policy to support the welfare-to-work transition such as in the Nordic countries, or the national vocational training system in Germany. Such measures might seem expensive, particularly during an economic recession. In fact, they largely pay for themselves once their impact on productivity is taken into account.

The living wage can be the basis for Britain to become a high-wage, high-productivity economy. We should aim to rejoin the north European mainstream on this issue. Looking further overseas, the very last thing we should be doing, if we wish to compete with the BRIC countries, is further deregulating our labour market. Brazil is addressing the issue of informal employment by putting a floor under household incomes through a basic income guarantee, while China has adopted a labour code which acknowledges the need for protection of individual and collective labour rights. These developing economies are gradually building systems of collective wage determination and social insurance of the kind we used to have. They understand that a competitive economy requires labour laws and a welfare state to provide insurance against labour market risks. We have not completely abandoned the same idea, which served us well for most of the 20th century. It is not too late to reconstruct our labour market institutions around the twin themes of equity and efficiency, as exemplified by the idea of the living wage.

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This blog post also appeared on the Progress Online website >

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