The bidding war over the minimum wage is a dangerous political game

The last Labour manifesto contained a promise to raise the minimum wage to £8 an hour. Mr Osborne announced months later, in the July 2015 Budget, that he wanted to bring in what he called a national living wage for the over 25s, of more than £9 an hour by 2020. We were treated to the remarkable sight of the then work and pensions secretary, Iain Duncan Smith, punching the air in jubilation. Last week John McDonnell delighted the Labour faithful by announcing that he would introduce a minimum wage of more than £10 an hour.

There is a reason for these calls. In part because of big successes in reducing unemployment and economic inactivity, poverty and economic disadvantage are now concentrated in working households. The most recent statistics suggest that two thirds of children in poverty live in a household in which at least one parent is working. Finding ways to increase the incomes of such households should be a priority.

We have had the minimum wage since 1999 and there seems little not to like. Hourly wage inequality fell in the decade after its introduction, with the lowest earners doing better than any other group. It has not had any measurable negative effect on levels of employment.

The fact that it has now become part of a political bidding war is worrying, however. You can quickly have too much of a good thing. There are three things in particular to worry about.

First, there is the boring issue of process. The minimum wage was introduced on the basis of carefully constructed evidence and research. It was then increased each year in line with recommendations from the independent Low Pay Commission. Those recommendations have been based on a careful assessment of the evidence about what increase in the minimum wage is consistent with a nil or minimal impact on employment and hours worked. Under this regime the minimum wage has become gradually more generous with no serious negative effects on the labour market. Those much derided experts have done rather a good job.

In other words it has been successful because decisions have been kept away from politicians plucking numbers from the air and hoping for the best. Getting the level wrong can have serious consequences for the people the policy is trying to help. Announcing big increases in budget speeches and conference speeches without consultation is an irresponsible way to make policy on such an important issue.

Second, far too many hopes are pinned on increasing the minimum wage. Last year Mr Osborne implied that his new higher minimum wage could wholly or largely offset the effects of cuts in tax credits. It cannot. Not even close. In part that was just a question of scale — the total benefit cuts were bigger than the total wage increases. More importantly, minimum wage increases are not particularly well targeted on poor households. Those not working many hours gain little, as do many of those receiving benefits and tax credits because the wage increase reduces their benefit entitlement. Many gainers are second earners living with relatively well-paid partners.

None of these facts are in themselves arguments against a higher minimum wage. But whether it is Mr Osborne pretending that he can cushion people from benefit cuts or Mr McDonnell pretending that as a result of his announcement “under the next Labour government, everyone will earn enough to live on” we should take the promises of what a minimum wage can achieve with a huge dollop of salt.

Third is the dangerous, facile and utterly misleading way in which all these announcements appear to imply that wages for a large swathe of private sector workers can simply be set from Whitehall with no negative consequences. Until this year about one in 20 workers was on the minimum wage. The Low Pay Commission estimates that current government policy will take this to one in seven by 2020, reaching more than one in six in the northeast, Wales and other lower-wage regions. This is a huge change in the writ of government. And it will likely come at a cost. The Office for Budget Responsibility suggests that up to 120,000 jobs might be lost as a result, with an additional substantial effect on number of hours worked.

Mr McDonnell’s plans would involve even more people’s pay being set from Whitehall. After all, £10 an hour translates into about £20,000 a year for a full-time job. That’s a pretty high minimum. To be fair to Mr McDonnell, he recognised the risks and promised to find ways to ensure that the policy does “not impact on hours or employment”. What does this mean? I hope it means that he would not actually raise it that high if negative impacts became too great but it rather sounds like it might mean setting both wages and hours and employment levels from Whitehall. That sort of thing has been tried elsewhere under other economic systems. It has never gone well.

There is a case for raising the minimum wage. There is a case for trying higher minimum wages in some industries and some regions. There is a case for taking a risk, for trying out some generous increases and seeing how it goes. The idea that we can just announce a £10-an-hour minimum wage and guarantee all jobs is pure snake oil.

This article was first published in The Times and is reproduced here in full with permission.

Paul Johnson is director of the Institute for Fiscal Studies. Follow him on Twitter @PJTheEconomist