The living wage

A few of the consequences of the ‘living wage’ that George Osborne announced yesterday:

1) Some people will be priced out of the workforce.

Why?

In order for an employer to be able to afford to employ a person, that person must be able to perform some activity which earns the employer enough to pay that person without the business losing money. E.g. making something, or performing a service, which can be sold to another company at a profit.

Some people with few skills cannot do a job that creates enough value for employers to justify employing them at the mandatory minimum rate. These people are trapped in poverty, and suffer the indignity of a life on benefits.

But why can’t the employer take the hit and employ these people anyway? Because if the business loses money for every hour it employs any person who isn’t worth the mandatory minimum wage, the business will be inefficient. It will lack the funds to invest in R&D of new products or services, and to employ more people who will add value and make the business grow. In extremis, if a critical mass of low-value employees are employed – think of a shop or a cleaning company for example – the business will be unsustainable and will eventually fold.

The over-valued employee, and every other employee, will lose their jobs.

 

2) Prices for consumers will rise.

Why?

An employer may decide to look at things a different way. If the can push up the prices of their goods or services to the point where they can afford to employ the low-value/low-skilled person at the minimum wage without making losses, the outcome is obvious.

Prices for everyone will rise. Every cup of coffee, pint of beer, item bought from a shop, will be more expensive. Including for the person who is paid the artificially high wage.

And that isn’t even a zero-sum game.. there’s the transfer cost of moving this money through the cycle of more expensive wages and more expensive goods – e.g. VAT is levied.

 

3) Taxes will rise or services will be cut.

Why?

It ought to be self-evident (though sometimes I don’t think it is to some people) that if a person is employed in the public sector, or works for a company whose services are bought by the public sector, that all of the cost of employing those people is paid for out of taxation. There is, after all, no other source of income for public sector organisations.

If wages are pushed up – by the living wage or otherwise – then the cost of those wages is ultimately born by the tax-payer in council taxes, income tax etc. Thus again, those costs are borne by the person on the inflated living wage, again with the associated inefficiency of transfer costs.

 

4) The black economy & benefit fraud will thrive as incentive to resort to these increase.

Why?

People who cannot gain legitimate employment at the minimum wage will be on benefits. Benefits are not enough money for any proper quality of life. Today, it’s pretty normal for people on benefits to supplement their income doing cash jobs of whatever sort, be it cleaning, child care, or something less savoury like dealing in illegal substances.

As more unskilled folk are pushed out of the job market as described above, and prices rise, as above, there will be more incentives to engage in the black economy which, for anyone on benefits, amounts to benefit fraud as well as tax avoidance.

And that’s just one side of the story. Let’s consider the effect on a business that runs on people paid minimum wage.

Lets say that Mary employs a child minder through an agency for £12 per hour. That £12 pays for the child-minder’s wage of, say, £8/hour, and the agency’s overheads, including wages of admin staff, premises, employers national insurance contributions etc.

The minimum wage is pushed up by £1 per hour to £9. The employer’s overhead goes up by at least £1.12 per hour with employer’s NICs, before we take into account that the admin person’s wage also goes up. The net result therefore is that the agency puts up their prices, and Mary has to now pay £14 per hour.

Mary now has an increased incentive to offer the child-minder the opportunity to work cash-in hand for £10 per hour. The net result is that the child minder is better off, and Mary is better off too. The losers are the agency and the tax man, since neither of them get a cut of this transaction. If enough of the agency’s staff and clients make this decision, the agency becomes unviable & folds, the admin person is laid off, the agency vacates its business premises, meaning the landlord is also out of pocket.

But Mary and her child-minder are both better off, and they have been incentivised to make this arrangement due to an increase in the minimum wage. The woman who runs the agency is out of pocket, as is her admin person, the office landlord and the tax man (no income tax, corporation tax, NICs or business rates).

If the child-minder were so inclined, now that her pay is undocumented, she could sign on for benefits etc.

So that’s a bit counterproductive to say the least.

“So what?”, you may say, “it’s not like they’ve even set this living wage at a level making for a reasonable life.”

Well, perhaps. But as I hope I’ve explained above, raising the minimum wage may well not give people a better quality of life, because they’ll pay more for things, so the pound in their pocket will be worth less.

The negative effects are minimised by such a small increase above the existing minimum wage. Only a few more people will be rendered unemployable, and the cost of goods and services will rise by a negligible amount. And this is true, but let’s think about what would happen if the more radical proposals for a living/minimum wage were to become a reality.

What if the living wage were set at £15/hour? What about £20/hour? £30/hour? Well, by now that ought to be obvious: With each increase relative to inflation, more people will be rendered unemployable and stuck in the poverty trap, more goods & services will be more expensive, more people will resort to a cash economy, and more tax rises & public sector cuts will be necessary,

Simple, innit?

So the next time someone on your Facebook wall is daft enough to demand a mandatory living wage of ££££, you’ll be able to explain to them in simple terms why their desire is at best counterproductive, and at worst disastrous for the economy on which they depend for their wage at any level at all.

Here are some external resources that explain these things. They probably explain better than I have, but I don’t think any of them contradict my basic indisputable points.

http://smallbusiness.chron.com/problems-minimum-wage-2692.html 

http://www.economicsonline.co.uk/Market_failures/Minimum_wage.html

http://www.cnbc.com/id/101834767

http://www.economicshelp.org/labour-markets/disadvantages-minimum-wages/

http://www.forbes.com/fdc/welcome_mjx.shtml

http://www.cato.org/publications/commentary/raising-minimum-wage-will-hurt-more-help

http://dailysignal.com/2012/04/25/raising-the-minimum-wage-hurts-low-income-workers/

AJ

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