REFUTATION : Minimum wage, maximum woe

Nirvana economics is back in fashion, warns Deepak Lal
Click to follow
The case for a minimum wage is, to many politicians and ordinary people alike, intuitively plausible. Low pay as determined by the market is seen to be a cause of poverty; so the "cure" is to raise pay to a "living wage".

But the consensus among economists - until recently - has been the opposite. Innumerable studies of the impact of minimum wages have shown that it is a poor anti-poverty device compared with subsidising incomes directly through social security or negative income tax regimes.

The most powerful argument against the minimum wage has always been that it can actually lead to a reduction in the employment of the very people it is trying to help. Studies of the impact of a minimum wage in the UK, US and Europe have found it leads to a slight decrease in youth employment in particular. More dramatic examples are found in developing countries.

One of the most telling is Singapore's raising of the minimum wage in 1979 by nearly 20 per cent a year for three years. The purpose was to persuade producers to move towards hi-tech industries by artificially raising their labour costs. The result was a severe recession and an accompanying decline in employment and manufactured exports until the policy was reversed.

Recent "revisionist" studies in the UK and US have challenged this finding, suggesting a rise in the minimum wage increases, rather than reduces, employment. It is claimed that wage rates in the market for hamburger flippers in New Jersey and for workers in residential homes on England's south coast are for some reason being artificially held down by employers. A minimum wage which raised pay levels would thus increase employment, as well as market efficiency. The economic analysis behind such a conclusion is an example of "nirvana economics" - the same kind of central planners' hubris that sank the Eastern bloc countries of "really existing socialism". More seriously, these revisionist economists have ignored other deleterious side-effects such as the disincentive to learn new skills. All the empirical studies show a minimum wage compresses the overall wage structure of an economy. This in turn weakens incentives, especially at the lowest wage levels, to acquire new skills, because the extra effort is not judged to be worth the additional financial reward.

This was borne out dramatically in a study Professor Paul Collier of Oxford and I conducted of the post-independence Kenyan labour market. Between 1954 and 1962, the minimum wage was doubled in real terms, largely on the humanitarian grounds of providing African urban workers with a "living wage".

Although the expected employment effects were swamped by a general boom in African employment following independence, Collier and I found "the minimum wage had a powerful effect upon the wage structure, reducing the pace of skill accumulation, especially among manual workers".

Support for the minimum wage in the US, UK and Europe is therefore at odds with another professed aim of its advocates - to promote skill accumulation by unskilled workers - particularly the young and women.

In short, the textbook conclusion still holds. The minimum wage is an inefficient, well-intentioned but inexpert interference in the solutions discovered by the market to the unavoidable "market failures" identified by "nirvana" economists.

The author is James Coleman Professor of International Development Studies at the University of California, and emeritus professor of political economy, University College London. His pamphlet `The Minimum Wage; No Way to Help the Poor', is published today by the Institute of Economic Affairs, 2 Lord North Street, SW1P 3LB.

D Lal