Where next for the minimum wage?

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Today marks the first real terms rise in the minimum wage in six years. It speaks volumes about the convulsions in our labour market that something that was once taken completely for granted is now viewed as a significant and welcome departure. And the rise occurs at a time when there is something of a competitive bidding match between the political parties about possible increases in the next parliament.  How should we interpret today’s rise and what should we make of some of the recent pronouncements about the scale of future increases?

Welcome as it is, it’s important to keep the rise from £6.31 to £6.50 in perspective. The increase means that Britain’s lowest paid workers will see their wages restored to the level they were at in 2005. We’re still almost a decade adrift. Indeed, to put this wage-loss in proper context, consider that if a prolonged recession hadn’t occurred, and the NMW had continued to rise in line with the pre-crisis trend, we’d expect it to be roughly £8.50 today: that’s far above the national living wage (and not too far short of the London equivalent).

Another notable feature of tomorrow’s rise is that significantly more people are likely to benefit from it than was the case when the NMW was first introduced. The number of minimum wage workers (and those within touching distance of it) has risen very significantly since 1999. A record 1.2 million will benefit from today’s rise – compared to just over 600,000 when it was introduced. Around one in ten employees (2.5 million) now earn within 50p of the minimum wage and are likely to be significantly affected by its level. It says something about our topsy-turvy economic times that at the very same time as the wage floor has sunk in value ever more people are relying on it. That’s because even though it’s fallen, the median wage has fallen by more, dragging more workers downwards towards it.

A related but different point is that worryingly high proportions of minimum wage workers are now stuck on (or very near) the minimum wage for extended periods. Those people advocating a high and rising wage floor need to spend just as much time worrying about how to encourage wage progression over and above any minimum. Simply scooping up ever more workers on a rising wage floor, without creating more opportunities and pressures for advancement beyond this, does not add up to anything like a coherent low pay strategy.

It’s also the case that today’s rise is of note because it may have potentially wider significance. Currently our labour market is stuck in a rut of zero, or very low, pay-rises. In the medium to long-term increases in productivity are the only sustainable solution. But in the short term an external spark might help shift expectations about the going rate of pay increases. In previous eras a particularly newsworthy union pay settlement might have shifted the mood. But in our current times of public sector pay caps and very low levels of collective bargaining in the private sector, there are far fewer such potential reference points. Visible and widely reported increases in the minimum wage may be the nearest thing we have left that can set something of a pay precedent.

The real question about today’s rise is whether it marks a new era of more significant real-terms rises to come – might we be on the cusp of returning to business as usual? That is the expectation of some seasoned economists working in this area, and it is a mood that has been picked up on by political leaders over recent months. To recap: Ed Miliband announced last week that he is committed to £8 by the 2020 election (which actually means the October 2019 increase). George Osborne has previously said he would like to see real terms increases in the years ahead that would imply a minimum wage of £7 by 2015/16.  Similarly, Vince Cable has said he’d like to see all the lost value of the NMW fully restored over the next two to four years.

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The chart above sets out various benchmark scenarios for the future of the NMW to help us interpret these different aspirations.

Let’s assume that a worst case scenario is that the NMW simply tracks CPI inflation in the years ahead (and that would be a very bad outcome); and a relatively good – but by no means implausible – scenario is that it rises in line with its pre-crisis trend. This would mean a likely range for 2020 somewhere between £7.18 and £8.31 – both of which, we should note, are miles away from the figure of close to £11 that the minimum wage might have got to by 2020 without the downturn.

But all these figures come with major caveats: we should be very leary about any scenario for the cash value of the NMW (or any other wage) some years in the future. In part this is due to the fact they often rely on necessarily flaky earnings assumptions (as what happens to the NMW typically depends on wage trends more generally). And, if the last few years have taught us anything it is that economists have a dire record in predicting what is going to be happening to wages in five months, never mind in five years. Every scenario for the cash level of the NMW in 2020 is based on assumptions about which we can say one thing with confidence: they will be wrong.

Another reason for scepticism is that using a future cash figure for the minimum wage reflects another example of politicians’ fondness for ‘money illusion’ in order to make their commitments sound better than they really are. A minimum wage of £8 in 2020 sounds rather more impressive than pointing out that this equates to a real terms increase of 82 pence over and above what inflation achieve. (There is, of course, an all-party consensus in favour of money illusion. Take the Liberal Democrat commitment to a Personal Tax Allowance of £12,500. It really means a real terms increase from £11,600 – which occurs due to inflation – to £12,500. Indeed, if we were to use the RPI measure then all of the increase is eaten up by inflation).

The minimum wage is playing a more vital role as a floor for more people than in the past. It’s also become far more of a going rate – with ever larger numbers stuck on, or near, it with fewer means of escape. The cost of this is very high and the implications are far-reaching for the current political debate. Whether it is the scourge of working-poverty, the stubbornness of tax-revenues or concerns about high levels of spending on ‘welfare’ – our low pay problem is a major part of the explanation. A steadily rising wage floor is, of course, an important part of the solution – even if we need to interpret some of the political aspirations for the wage floor carefully. Today’s rise certainly marks a new mood of hope after a very long fall. But on their own, minimum wages can only ever achieve so much. Dealing with low pay and inadequate living standards and securing a higher wage floor are not the same thing.