In the run-up to the Labour Party conference, Ed Miliband has announced that a Labour government will raise the national minimum wage to £8 per hour. It’s an important announcement, and one that builds on Labour’s commitment to ensure that people in work are able to earn a decent sufficiency.
It will be attacked by Tories as a measure that destroys jobs. But as it happens, increases in minimum wage are among the most studied economic phenomena – there is a huge body of evidence, especially from the US (where states tend to allow minimum wage rates to stagnate and then make significant increases). The evidence shows overwhelmingly that significant minimum wage increases do not increase unemployment. And although this may sound counter-intuitive for those with a superficial grasp of economics, the theoretical basis is actually quite simple: it’s because the labour market is nowhere near as straightforward as the market model, in which employers and employees are active in a situation of perfect competition. The real world just isn’t like that – people don’t simply move jobs to get higher pay, and employers can use their control of the labour market – to use the economic term, monopsony power – to pay workers less than their marginal product. It is the relation of actual pay levels to the marginal product of labour that determines whether a raise in wages will cause unemployment; within that model it is perfectly possible and indeed natural, theoretically, for wage rises to increase employment.
Add to that the fact that increasing wages of the lowest paid will mean a significant increase in consumption, and an increase in the minimum wage can produce a significant stimulus to demand – especially where the increase is met from profit and dividends that are saved rather than invested. The Tories will no doubt argue that small businesses will be hit, but many of the worst payers – retailing, catering, outsourced public sector functions – are dominated by huge and highly profitable businesses. To the extent that an increase in minimum wage shifts income from rent on assets to pay for work, it’s a powerful redistributive measure in the face of a rentier economy.
In other words: the Tory who claims that increases in minimum wage will destroy jobs is both ignoring the evidence and showing their inability to grasp an even moderately sophisticated piece of economic theory.
There is a fly in the ointment of Ed Miliband’s announcement: it may be less ambitious than it sounds. Assuming a 3% rate of inflation, a rate of £8 now will be the equivalent of nearly £9.40 at 2020 prices. We need more clarity on indexation. But increasing minimum wage is a powerful economic instrument that will stimulate the economy, potentially create jobs, promote equality and – insofar as it reduces dependency on in-work benefits – reduce public expenditure and help reduce the deficit. It’s evidenced and theoretically robust – and absolutely the right thing to do for anyone who believes in social justice.