Minimum wage debate is phoney

ECONOMIC VIEW

One of the few remaining expanses of clear pink water between the two parties is New Labour's old commitment to introduce a minimum wage. A dress rehearsal of a debate likely to be a key sparring point in the next election has been staged in the past week. The Trades Union Congress has put the case for a national minimum wage, the Confederation of British Industry the case against.

Yet the debate over the minimum wage is a phoney one. Labour and the TUC present the idea as a sure-fire way of tackling low pay and poverty. The Conservatives and the CBI present it as a sure-fire way of destroying jobs.

Both sides are wrong. Start with the potential effect on jobs. If you believe in free markets, any fixing of prices is wrong as a matter of axiom. If you raise wages above their market clearing rate, more people want to work, but employers want to employ fewer.

Yet if the economy conformed to the comforting simplicities of textbook free market economics, the sudden enrichment of the bosses of utilities would be a matter of supply and demand rather than the scam even the Greenbury Committee went half way to acknowledging. The setting of pay at the bottom end of the spectrum is arguably just as far removed from the conclusions of the standard economic model.

The case for the minimum wage is that the labour market for the low paid is not a fully competitive one but rather one where employers hold the whiphand. In these circumstances, employers will find it more profitable to hire fewer people at a lower wage than the market clearing one: if they took on more, they would have to bid up wages which they would have to pay to all their employees. Under this scenario, the effect of introducing a minimum wage is benign: it will actually increase employment. The only loser is the employer who has been exploiting labour to gain excess profits.

This challenge to conventional theory has been buttressed by hard empirical evidence from the US and the UK. Shock revelation though it may be to the ideologically pure in heart, the US, land of the free market, has had a minimum wage since 1938. In the 1980s, this was left to atrophy, but in 1990 and 1991, it was increased. At the same time, states like New Jersey exercised their discretion to raise the minimum wage by more than the federal level.

US academics exploited these changes to assess the actual impact of the minimum wage. They found no evidence that it destroyed jobs. States like Mississippi, with relatively more low-paid workers, fared no worse in terms of employment growth than states with relatively fewer. In a now-famous piece of research, evidence from New Jersey suggested that jobs increased in fast-food restaurants while they fell in neighbouring Pennsylvania, which stuck to the federal minimum.

In the UK, researchers have investigated the effect of abolishing the wages councils, which operated a minimum wage system for 2.5 million of the country's most poorly paid workers. Far from increasing jobs,the effect was to reduce them.

None of this means you can introduce a national minimum wage at any level. Beyond a certain point, nobody denies it can and will destroy jobs. And that level may vary depending upon the type of work and the age of employees. The figure of pounds 4.15 Labour became impaled upon at the last election would almost certainly have reduced jobs, although Michael Howard's claim of two million was wildly exaggerated.

In this light, Tony Blair's determination not to set a rate in Opposition seems only sensible. It has to be said, though, that a commission drawn from the unions and industry looks perilously like the reintroduction of national collective bargaining by the back door, particularly since any floor to wages will inevitable bring about pressure from those above it to restore differentials. This, no doubt, is the unions' real agenda in pushing for a minimum wage.

Half median male full-time earnings remains the goal of many in the trade union movement. This translates to about pounds 3.50 if the New Earnings Survey is used and overtime earnings are excluded. It's a lot less than pounds 4.15, maybe, but according to economists at Kleinwort Benson, "a minimum wage set at pounds 3.50 an hour would not be low by international standards".

All of this reinforces a crucial conclusion: the rate at which the minimum wage is introduced is vital. Just as important are the exemptions. In France, youth unemployment at double the national average is widely blamed on a minimum wage that is too high for young people and therefore prices them out of work. But even if Labour is able to crack that particular nut, that doesn't necessarily mean it will be a panacea for poverty.

A national minimum wage will do nothing to allay the principal problem of poverty today: its concentration in no-earner households. At best, it might reduce disincentives to move from benefit to work by improving the rates of pay on offer.

The debate over the national minimum wage is full of sound and fury, but it is a sideshow to the real questions of how we can upgrade skills at the bottom of the ladder and tackle the poverty trap that besets single- parent families and the like. It deserves to be an electoral sideshow, too.