Tuesday, 22 September 2015


There’s no limit to the opportunism of politicians, and the extent to which George Osborne stole Labour’s clothes with the announcement of a new National Living Wage (NLW) is a case in point. To understand what is going on here we need to separate the economic arguments for government wage-fixing and tax credits for those in work, from the social justice arguments. In a free market economy the interplay between demand and supply should determine the price of all ‘factors of production’, including wages for labour. Government should only intervene to correct a ‘market failure’. The two most obvious forms of market failure arise from monopoly and monopsony power.

A ‘monopsony’ arises when employers dominate the labour market, sort of an employer equivalent of a monopoly. The economic argument is that a ‘monopsonist’ is able to hold wages below the market equilibrium, just like a monopolist would force prices above the market equilibrium.  Thus labour is being exploited by the market power of an employer, or small group of employers. This ‘market failure’ justifies government intervention that puts a floor under wages. 

But the idea that the UK’s national minimum wage (NMW) was introduced to combat employer buying power that was artificially holding down the level of wages for unskilled labour is ridiculous. The NMW was introduced in April 1999 and it raised the wages of workers who were largely unskilled or semi-skilled across a whole range of occupations, but it covered only 3% of the workforce. The justification for it was never an economic one, but a moral, social justice one. Put simply, the Labour Government believed it was just wrong for people to be paid below a given, hourly rate. So the NMW was introduced in the name of social justice, not to correct a market failure of the type defined above.
So, when in addition to the NMW Gordon Brown introduced Working Tax Credits in April 2003, he didn’t do so to subsidise ‘low-pay employers’ who otherwise would suffer a labour shortage, but to subsidise low-pay employees in order to correct a failure of government policy, namely, the way in which the benefits system was distorting the labour market and creating a ‘why work’ culture. If the gap between receiving benefits for doing nothing, and what a worker on minimum wage would receive net of tax was too small, then workers in this position realised they were really working for the difference and it wasn’t worth it to them. Working tax credits were introduced to widen that gap – solve a government policy failure, not a market failure.

So, now the newly elected Tory Chancellor comes along and says that he too wants to make work pay, and that a new, compulsory national living wage is the way forward. Again, there is no economic justification for this; it is a social policy/social justice objective. That’s fine, but it isn’t immediately apparent to me why the burden for realising that social policy objective should fall disproportionately on employers - who aren’t paying below the market equilibrium for labour and don’t operate as a monopsony. 

And it’s not just where these policies start that’s important, but where they end up. I support the general thrust of policy towards reducing dependence on benefits, reducing the cost of them and thereby enabling tax cuts that benefit workers on low pay, but when the NLW is fully implemented in 2020 at approximately £9.35 an hour, then 20% of all employees in the UK will have their wages determined by a government quango, the Low Pay Commission. So, a social policy that aimed to protect a small group of low paid workers, just 3% of the workforce will, just over two decades later, have morphed into a policy that fixes the wages of 20% of the workforce. This same mission creep can be seen in the rising cost of working tax allowances: a cost of £1.1 billion in 2003; rising to £30 billion by 2014 precisely because working tax credits were linked to the minimum wage which over its lifetime has exceeded both price and wage inflation. The consequence has been to create a ratchet-effect that has seen the cost of tax credits sky-rocket.

Currently the hospitality sector accounts for 26% of all minimum wage jobs, so the effect of creating a much higher rate of pay for those over 25 who will be subject to the new, compulsory living wage, is going to have a big impact on the sector, particularly on rented pubs where the net margins are small. 
Personally, I would have preferred deeper spending cuts to fund bigger reductions in taxes. And a more radical reform of the tax system to harmonise income tax and national insurance. Also, raising the level at which employees start to pay NI towards the level of the income tax personal allowance would do more to help those on low pay than a compulsory NLW that will throw between 60,000 and 120,000 people out of work. We should bear in mind that an increase from £6.50 per hour to £9.35 per hour is a 43.8% rise over four years at a time when retail price inflation is virtually non-existent. This is preposterous. Budgets are high political drama, but they also have a habit of unravelling. If this particular measure doesn’t unravel then our sector will pay a very high price for the Chancellor’s political cross-dressing moment.

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