Minimum wage increases can hurt exactly the people they are designed to help

Given all the disagreement between political parties on taxes, spending, benefits and pensions, the minimum wage is one of the unlikely places in which there is some agreement between the Conservatives and Labour. For the first time, both parties’ manifestos are promising increases in the minimum wage that exceed growth in average earnings.

The Conservative plan is the implementation of George Osborne’s “National Living Wage" policy (just a rebranded name for a higher minimum wage), which would see the minimum wage for those aged 25 and over rise from £7.50 now to 60 per cent of median earnings in 2020, forecast to be to £8.75. The Labour plan is more radical. It would implement a minimum wage of £10 per hour in 2020, not only for those aged 25+, but also those aged 18 to 24.

These increases may not sound all that substantial—but they are. Under Conservative plans, the fraction of employees aged 25+ on the minimum wage, which has already risen from 4 per cent in 2015 to 8 per cent now, would reach 12 per cent in 2020. Under Labour it would jump to 22 per cent, more than five times higher than the number of people in 2015. The Labour plans would also mean 60 per cent of 18-24 year olds were paid the minimum wage in 2020.

What effects would a higher minimum wage have? We do not know exactly; the proposed increases are very large compared to rises we have had in the UK over the last 20 years. Furthermore, the minimum wage would be increased to a high level compared to other developed countries. Under Labour’s plans, only France would have a higher minimum wage, but unfortunately there is not robust evidence of the impact of the minimum wage there.

However, we do know that minimum wage increases do not come for free. There really is no such thing as a free lunch. If employers simply pay the higher wages to all their affected employees, this money has to come from somewhere. It can come from lower profits for shareholders (including large numbers of people with pensions invested in listed companies), or higher prices faced by consumers, or pay cuts for other workers. There is a possibility that a higher minimum wage might boost productivity, but this is unlikely to be enough to offset negative effects. Large rises in the minimum wage are expected to reduce, rather than increase, national income.

Raising the minimum wage could also make it unprofitable for firms to employ low skilled workers. The Conservative policy would directly increase the cost of employing low paid workers by £1bn per year, and the Labour plan by £14bn per year. The higher cost of employing people could lead to people losing their jobs, having their hours cut, and unemployed people finding it harder to find work. At some point, increases in the minimum wage will start to have harmful consequences in this respect. It is just not clear at what point substantial job losses occur.

Therefore the irony of the minimum wage is that if it reduces employment, it can hurt exactly the people that it is designed to help. While some incomes will be a little higher following a wage boost, others might be considerably lower if they do not have paid employment. This is particularly the case for younger people—who would see a minimum wage rise under Labour, but not the Conservatives. Not only are the youngest workers the most affected (80 per cent of 18-20 year old workers would be paid the minimum wage), but there is strong evidence that unemployment at younger ages can have long-term negative impacts on future employment prospects and pay.

The other irony is that even if a higher minimum wage is successful in boosting the pay of low paid workers, this does not necessarily boost the living standards of those who are poorest in society. Many of the poorest households have no one in work. A significant proportion of low paid workers have a higher paid working partner. And those low income working people who do benefit will lose some of their means-tested benefits as a result.

Ultimately, the proposals from both parties are a gamble, particularly so on the Labour side. The potential negative effects of a high minimum wage could be severe: politicians should be careful when setting its level. The Conservatives, who in 2015 introduced the National Living Wage and pledged to increase it faster than earnings until 2020, have not allowed any time to see whether the current wage rates are having negative effects. The Labour Party, by committing to a £10 minimum wage in 2020, irrespective of the state of the labour market is taking an even greater risk. If further increases in the minimum wage do not result in higher unemployment, it will be more by luck than judgement.

Jonathan Cribb is senior research economist at the Institute for Fiscal Studies. he authored the Institute's recent report “Minimum wages in the next parliament”