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This is not 1997

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Although introduced to the UK by a Labour government, the National Minimum Wage is closer to the Tory approach to economic policy.  This is because it passes the costs onto someone other than the state immediately.  In this case, Britain’s employers.  Labour governments, in contrast, have generally sought the politically easier approach of passing costs onto future generations via public borrowing… which was often the better policy if a combination of inflation and growth served to lower the real cost of the debt even as the state’s ability to repay it became easier.

Not that minimum wages are anything new.  The USA introduced its Federal Minimum Wage as far back as 1938; although today each state sets its own rate.  And the general consensus is that minimum wages help raise wages in general with little or no impact on employment as a whole.  The broad theory being that by increasing wages at the bottom – where people’s propensity to spend is higher – we increase demand across the economy.  As the economy grows, demand for labour increases and forces wages up still further.  And so, demand rises and promotes further growth.

This was no doubt the outcome desired by Tony Blair and Gordon Brown when they were elected in 1997.  After two decades of suppressed wages – first under James Callaghan, and then under Thatcher – and despite the deregulation of the City of London and the increasing revenues from North Sea oil and gas, it was hoped that a legal minimum wage would generate the growth needed to lift people out of poverty.  In neoliberal terms, it would “make work pay.”

There was though, a countervailing theory which served to inject a degree of caution into the policy.  To avoid generating redundancies and dampening new starts, the minimum wage had to be set at a level which still allowed employers to profit from employing workers.  That is, if the minimum wage was set at £7.50 but the hourly return from a low-paid worker was just £6.50, then sooner or later the employer would have to let the worker go.  And more immediately, employers would be unlikely to employ workers on this basis.  And so, the British minimum wage was overseen by a Low Pay Commission which set the minimum wage at a rate which employers could generally afford.

According to the conventional means of analysing the effect of the minimum wage – so-called “difference-in-difference” – the UK minimum wage has not had a negative impact on employment.  Moreover, this result has been replicated around the world; giving rise to the lazy media claims that there is no evidence that the minimum wage harms employment.  Far less often reported is the fact that difference-in-difference models are highly contested.  As the International Labour Organisation explains:

“Debates on employment effects are also frequently controversial, with different economic theories leading to different predictions. According to one view, minimum wages increase the cost of labour above the marginal productivity of low-paid workers and thus prices them out of the market. Other theories consider that up to a certain level, the cost of minimum wages can be absorbed through a combination of lower wage increases for more highly paid workers, lower profit margins, higher productivity, and/or lower employee turnover…”

There is a problem here though.  For all the claims made in favour of the minimum wage, the fact remains that people earning below the median wage have seen their real wages fall since 2008, despite the annual increase in the minimum wage.  According to a recent paper from the Institute for Fiscal Studies:

“The two key characteristics of the labour market over the period bookended by the Great Recession and the onset of the COVID-19 crisis were the strong employment growth and the weak pay growth. The former was widely shared, and was strongest for those demographic groups that started out with low employment rates – including immigrants, lone parents and older workers. The weak pay growth probably stands out as the worst attribute of the labour market over the period: at the median, hourly pay actually fell slightly, and though wages grew faster at the bottom of the distribution, the pace was fairly meagre by historical standards…”

This suggests that the minimum wage has failed in its secondary aim of raising wages generally.  That is, that the increase in wages for those at the very bottom has been bought with real wage cuts to those earning above the minimum but still below the median.  This, in turn, raises questions about models which find no effect on employment.  As another IFS paper explains:

“Our concern is that too much weight has been placed on a body of research that has mostly failed to reject the null hypothesis that ‘the NMW has no effect on employment’: we fear that policy-makers have wrongly interpreted p-values as telling us how likely it is that the NMW has an adverse effect on employment, and have not paid attention to the range of impacts on employment that also cannot be rejected by the data. This concern is compounded by the fact that much of the UK literature has employed difference-in-difference (DiD) designs, even though there are significant challenges in conducting inference appropriately in such designs, meaning that the existing research has likely under-stated the statistical imprecision of its key parameter estimates…

“For example, in our preferred specification, one would need that the job retention rate in reality falls by 16% in response to a 10% NMW rise to be able to detect it with 80% probability using the data and research design typically used in the UK work…”

Put simply, the consensus model is too insensitive to notice even relatively large negative impacts on employment, and so are not fit for the purpose they have been put to.  As David Neumark from University of California—Irvine, USA, and IZA, Germany concludes:

“Although a minimum wage policy is intended to ensure a minimal standard of living, unintended consequences undermine its effectiveness. A good deal of evidence indicates that the wage gains from minimum wage increases are offset, for some workers, by fewer jobs. Furthermore, the evidence on distributional effects, though limited, does not point to favorable outcomes from minimum wage hikes, although some groups may benefit.”

While employment at the minimum wage tends not to be affected – at least in the short-term – the same is not true for the creation of new jobs.  This is because while employers may be motivated to maintain their existing workforce, they may be far more mercenary when it comes to weighing the pros and cons of creating a new position or filling a vacant one.

It is also worth noting that while analyses of the impact of the minimum wage prior to the 2008 crash were favourable, analyses since have been more mixed:

“The key empirical takeaway is that the exceptions in recent work that find no evidence of employment effects generally come from one specific way of estimating the employment effects of minimum wages—focusing on geographically-proximate controls.  Meanwhile, several other methods in the most recent research, which also confront the same potential limitation of prior research, find disemployment effects.  At a minimum, even if one has somewhat different views about these alternative studies, blanket statements claiming that there is no evidence that raising the minimum wage costs jobs are simply untrue.”

Missing from all of these models, of course, is the role of surplus energy.  That is, one reason for the apparent success of the UK minimum wage – at least prior to 2008 – is that it arrived at a time when the UK was producing more oil than Kuwait (having recovered from the Piper Alpha disaster); oil which was used to underwrite the massive debt-based boom that was just beginning to take off as Blair became Prime Minister.  Similarly, the bursting of the debt bubble in 2008, and the ensuing rise in oil prices to a UK which had become a net importer in 2004, ushered in a period in which real wages fell even as the minimum wage increased.

Compared to today, the economy of 2008-2020 looks more like a golden age, despite its low pay and absent productivity.  With global fossil fuel extraction decreasing following the peak of oil production in 2019, and exacerbated by the response to the pandemic, energy prices are spiking dramatically.  This, in turn, is raising the price of everything which depends upon energy in its manufacture, transportation and retail.  The result is that already depressed demand for discretionary items is being squeezed even further.

It is into this weakened economic state that the UK government has introduced tax increases, benefit cuts and, in an attempt to boost wages and generate growth, a 6.6 percent increase in the minimum wage – from £8.91 ($12.26) to £9.50 ($13.08) per hour.  This at a time when the central bank is threatening an early hike in interest rates, and local councils are seeking higher local taxes to repay some of the costs of the pandemic.

The rise in the minimum wage may well result in the Tories’ stated aim of creating a high-skilled, high-paid economy… just not in the way they desire.  Because with running costs already pushing highly indebted businesses toward insolvency, the rising cost of labour may well prove to be the straw which breaks the camel’s back.  The high-skilled jobs are likely to be the only one’s left standing!

Precisely because the UK economy is rapidly running out of the surplus energy it requires, 2022 is going to be very different to 1997.  There is no possibility of becoming a net exporter of fossil fuels again.  Nor can the UK government borrow much more currency without undermining the value of the pound and thereby driving interest rates to untenable heights.  At the same time, the broad switch in consumer and business demand away from discretionary purchases as the cost of essentials like fuel and electricity eat into savings and profits, more or less rules out any private bank-generated financial bubble of a kind that created the illusion of growth after 1997.

The most likely outcome is a severe stagflation.  Stagnation, because the discretionary sectors of the UK economy are being decimated by shortages and rising costs.  Stagnation also, because to avoid the coming run on the pound, the UK government is going to have to make swingeing cuts to public sector spending (since further tax increases will not be possible).  Inflation though, because the UK is increasingly having to compete on world markets to secure the imports that it depends on.  Even if, for example, UK demand for oil falls to the floor because its consumers can no longer afford to drive, demand in developing states – where marginal utility is greater – will continue to hold prices up; even if not high enough for most producing countries and companies.

Things can only get worse from here on…

As you made it to the end…

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