A higher National Minimum Wage: is this a bit of a stretch?

Today’s speech by the Labour Party Leader marks the latest in the long-running ‘cost of living’ debate. Whilst often the talk has been of the squeezed middle (which, as the SMF shows, may not be as squeezed as some may think), the focus now is squarely on the smacked bottom (which certainly is).

There is growing evidence that the scale of ‘in-work poverty’ is growing and that many living under the poverty line are in working households. With parties of all persuasions talking about further budget cuts post-2015, low wages are also a fiscal problem, with the state spending some £21 billion per year on tax credits for those in work.

In addressing these problems, Ed Miliband announces today “a new five-year ambition to restore the link between doing a hard day’s work and building a decent life for your family”. He goes on to suggest that “a Labour government will establish a clear link between the level of the minimum wage and the scale of wages paid to other workers in our economy.” This suggests that a statutory minimum wage target would be linked to average earnings. It is likely that it would be pegged to a percentage of median earnings (quite possibly 60% of median earnings because this is the low-pay threshold used internationally).

The shift to a specific target would be a radical departure from existing policy. Currently the NMW is set each year by the Low Pay Commission which aims to increase the NMW but to a degree that doesn’t significantly risk additional unemployment.

So, is the idea of a stretch target that aims for a link to average earnings a good thing?

Targeting higher wages for the low paid unequivocally is a positive move. The UK is second only to the USA internationally when it comes to the proportion of workers paid below the low pay threshold, and there is significant bunching of workers paid at or just above the NMW. Seeking to raise wages over a reasonable time period (five years) is also a sensible goal. And, in addition, the timing could be good. Launching such a policy now when inflationary pressures appear low is preferable to initiating such a policy when the risks of higher inflation look less sanguine.

However, three things must be borne in mind:

First, such a link is great (for the low wage worker) if average real wages are going up. Of course, they were going down for much of the last five years. In 2010, the NMW was £5.93. It reached £6.31 in 2013. This equated to an increase of 2% in nominal terms per year. This increase was slower than inflation (nearer 3% per year). However, it was a lot quicker than the increase in median wages from £499 (2010) to £518 (2013) (taken as median gross weekly earnings for full-time employees). The growth in average real earnings equated to a percentage increase of 1.4% per year. So, had the NMW already been linked to average wages, it would have been lower than it is now. Or, put another way, someone on the NMW would have had about £250 less in their pocket (per year) had we had this policy since 2010. The policy looks good when real wages are on the up but disappointing when real wages fall. To counteract this, policymakers may look to link the NMW to average earnings or inflation whichever is the highest (a bit like the Triple Lock for state pensions). But, this ties the hands of policymakers further and aggravates the second problem below.

Second, the whole purpose of the current methodology is to balance the risk of additional unemployment against the desirability of a higher NMW. Either a Labour government would continue to balance off these two (competing) priorities or it wouldn’t. If it continues to do so, then it is hard to see how a stretch target really affects anything because either an increase will or will not mean a significant risk of higher unemployment. The Chancellor could be criticised for the same thing when he spoke of pushing the NMW to £7 but didn’t wish for this to trump the focus on unemployment.

Third, low wages and the UK’s low wage economy are symptoms of the industrial structure and productivity of the UK economy. As the SMF set out in our report Making Progress, there are 2.9 million workers who remain stuck on low pay for a year or more. Many of those on low pay have poor skills and qualifications. When this is set next to the UK’s languishing productivity measures (about a quarter behind Germany and France in terms of output per hour workers), this suggests that we need to tackle the fundamental causes of low pay rather than the symptoms.

None of this is to imply that we shouldn’t seek to boost the wages of the low paid significantly. However, there might be better ways to do it: by focusing more on those who get stuck in low pay rather than those who have an easy and quick rite of passage; by strengthening the skills base of the UK ensuring workers are more productive as well simply as better skilled; by seeking to influence employer demand for skills and for adopting higher value-added business processes – which must come with greater investment in R&D and capital assets alongside better management, leadership and HR practices.

If the Labour Party’s new ‘ambition’ can hit these targets as well, then it will be on to something.


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