Squeezed households will need higher wages

While Libya takes the spotlight, the British economy wheezes in the dark. Monday’s survey from Markit showed household finances worsening at their fastest rate since early 2009. Yesterday, a new poll from the Resolution Foundation confirmed that picture. Half of all low-to-middle income households say they’re running out of cash each month; only one in four are making regular savings. Many households now face the unenviable choice between cutting their spending still further and increasing their borrowing. Needless to say, at the national level, neither option translates into a promising path to recovery.

In the coming months, then, we’re likely to hear more about what the coalition could do to relieve the squeeze on household incomes. As Gavin Kelly and I argued at the weekend, the chances are this debate will turn first to tax cuts, ever the first instinct of politicians. Longer term, though, we need a serious debate in Britain about actions the government and private sector can take to raise wages. From the role of legislation such as the minimum wage to other ways to encourage the voluntary adoption of better pay, wages rarely feature in debates about the present squeeze on disposable income. That’s entirely understandable in the context of an economic slump. But with government finances strained, and big real increases in tax credits unlikely, they’ll need to play a more important role in future.

The truth is, having a fair and informed national discussion in this area won’t be easy. Just as the left rarely does itself justice in debates about tax—often falling into tired positions, and overstating the role of tax in redistribution—the right doesn’t equip itself well in debates about raising wages. Too many trot out the standard line that any government action on pay increases unemployment; too few look at the evidence.

In doing so, this talk by Nobel Laureate Robert Solow, is not a bad place to start. It’s based on the findings from a major international research project on low wages in the wealthy world. The project found, first, that some economies have much higher rates of low-wage work than others; in the US, one in four workers is in a low paid job and in the UK one in five, compared to around one in ten in Denmark. But the project also found that the choices of government can have a big effect on the proportion of people in low wage work—without a significant effect on employment.

In fact, as Solow points out, the interesting question when it comes to government action to raise wages is why we don’t see a large effect on employment. His answer—and that of the broader project—is that when the government puts upward pressure on wages, companies have many more options open to them than simply firing their unskilled workers. In practice, many companies respond by taking the ‘high road’, adapting their business model in a variety of ways—increasing capital intensity, changing manufacturing processes, investing in training and even redesigning their products. Firms change rather than reduce the jobs they offer—and they change them in positive ways.

The real lesson for any British policy debate is not just that government can nudge companies towards such decisions, but that no government is neutral when it comes to guiding companies towards a low- or high-paying road. By supporting hard won employee rights, for example, from maternity leave to public holidays to training, the British government in effect already accepts that it should subsidise high road strategies, tilting the balance in their favour. The question isn’t whether we should remain neutral—we’re not—but whether we tilt the balance well and tilt it enough. The answer comes down to the social costs of low wages, including, for example, the destabilising effects of household borrowing, encouraged by poor wage performance in the run up to the crash.

Of course, none of this is to say that a real terms increase in the minimum wage would be sensible now—or indeed, that this is the only answer. No doubt the short-term route to recovery looks very different from the medium-term route to a more sustainable economic model. Clearly there remains strong appetite for public sector pay restraint. And there are other hard truths for the left in the evidence on wages too. Increased competition, as a result of globalisation, may be making some high road strategies more difficult to sustain, fencing off some options formerly open to government. As Solow puts it, “that thing at the end of the tunnel may not be a light.”

But as the debate over household incomes goes from hot to boiling point, we need to ensure that short-term talk of providing relief and securing recovery doesn’t displace longer-term thinking. For now, tax cuts may be politicians' instinctive response to squeezed living standards (not least because the Westminster village still grossly underestimates the extent of low pay in Britain). And, for now, that may be the right answer. But we also need a serious debate, informed by the evidence, on ways that government can tilt the balance in favour of higher pay.