October 12, 2015    7 minute read

Please Don’t Raise My Wages!

   October 12, 2015    7 minute read

Please Don’t Raise My Wages!

Two months have already passed since George Osborne announced in his July Budget the rebranding of the National Minimum Wage along with its increase. The debate and furore over the controversial topic has since slowed to a simmer but the rise of Jeremy Corbyn from the deep left seeks to enliven such issues as the Conservative government tries to neutralise the appeal of the more socialist left whilst maintaining its business-friendly persona.

Around 5% of the UK workforce is currently paid the minimum wage but this is by no means an even distribution; whilst 10% in Northern Ireland and 4% of jobs in Scotland are minimum wage, there is also considerable variation within the English regions; just 3% in London compared to 7% in the North East. This is clearly an important political topic then; not only does it represent the ethos of the parties to low-paid workers in the eyes of many, it also disproportionately affects particular voting regions, in turn influencing their outcome.

5% of the workforce is not an inconsiderable amount of spending power to be playing with, but let us remember, however, that it actually affects more of the population than this. Whilst it directly increases the wages of those being paid the minimum wage, those jobs where the pay is slightly above this rate must also maintain their incentive for workers to remain in these particular roles. As a result the rates for these jobs will also increase over time, either because employers wish for them to remain more desirable in terms of salary or because they eventually fall in line with the minimum wage and then must increase along with it.

In terms of businesses themselves the effect can vary widely, as the impact of any change is determined by what percentage of the workforce is actually employed on the NMW but also what percentage the business’ wage expenditure makes up of the overall cost base. The sectors most affected will tend to be the retail and hospitality sectors as these employ a large number of relatively low-paid workers and are labour intensive, hence the impact on the stock price of companies such as McDonalds and Starbucks after the July budget.

Starting with the disadvantages of such a policy, it is fairly evident that it will increase the costs to businesses to some extent unless they change their operating practices. They can attempt to mitigate this effect by laying off workers, reducing the number of hours employees work, raising the prices of their products or negating this, either reinvesting less or accepting a lower profit. If they do indeed raise prices the consequence is both inflation and a decrease in the international competitiveness of domestic business, whereas less investment leads to reduced profitability and growth.

Any resulting inflation is particularly counter-productive as this erodes the very outcome the government was trying to introduce. How this actually transpires depends on the way a change is introduced; should the government decide to consistently increase wages at an increased rate, say an average of 5% rather than 3% per year, then this changes inflation expectations and is likely to change the long-term inflation rate of the economy, neutralising the wage increase. Should they however make a one off change and then increase the NMW at a similar rate to before then the benefit may persist.

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(Source: Gov.scot)

As for the decrease in international competitiveness this must be somewhat qualified. Increasing unit costs will usually lead to an increase of the costs of goods however the market may react to this policy move and re-evaluate the growth prospects for the country and devalue the currency. This would counter-intuitively negate the increase in costs and maintain growth prospects. However there are far too many influences on the exchange rate for this to be a lasting or clear-cut effect and so it is likely to be detrimental to the economy. More important though is the UK’s focus on services, which make up a large portion of its exports. Employees providing international quality services are unlikely to be on minimum wage so the companies employing them, although they will be affected indirectly, will not be raising prices to the same degree This, of course, means that although the UK will become even less competitive in terms of low cost manufactured goods, its services sector and therefore overall exports should not be damaged too heavily.

As for the advantages increased consumer confidence and spending is an obvious one. Those in favour of this policy would also argue that this feeds through to increased growth that would then benefit businesses as well as individuals, obviously the trade-off with inflation is key here to whether this would indeed be the case.

Increased productivity however is a much more certain outcome. Increased wages should make employees more satisfied with their employment and this feeds through to being happier and so more productive. Individuals are also less likely to frequently change jobs and less employee turnover translates to a reduction in the cost of training new personnel. Further, employees who remain in a job for a longer period of time are likely to become more capable and efficient adding additional value to the business.

Looking at the problem from another direction, just as it is unthinkable to double the minimum wage within the next month, it is also untenable to consistently allow real wages to decrease. Not only is this a socially undesirable outcome as it increases the level of income inequality but it also leads to either reduced consumer spending or saving which impacts on growth prospects of the economy.

What becomes increasingly clear on researching this topic is that the background in which this discussion is held is one of, if not the most, important factors that influence the viability of a policy adjusting the NMW. For example, if inflation is rampant or wages have already been consistently increased above inflation then the argument to increase them further is much weaker than if consumer demand is weak or the economy is nearing deflation, rather than listing the infinite possibilities however we can analyse the situation in which we currently find ourselves.

The Conservative government has already massively reduced the welfare budget and promises to cut it further still in the next parliament. The hope then is that any further reduction in spending might be in part offset by increased spending on the part of individuals. The UK is also experiencing very low inflation as it stands, a rise in the minimum wage could be a welcome boost to aggregate demand especially in light of the further government belt-tightening we are likely to see. This could in turn be a factor in giving the Bank of England MPC the confidence to raise rates and signal the UK’s sustained recovery. Mr Osborne has also promised to cut corporation tax to 19% in 2017 and 18% in 2020, which should compensate companies for at least some of their increased wage bills.

real-wages-2

(Source: Left Foot Forward)

In my opinion the optimal policy is one of slow change and forward guidance, it is an unquestionable truth that markets hate uncertainty but that is also true in large part for change too. Slow change allows markets to function effectively whilst forward guidance ensures that companies can plan for the future and avoids sudden job losses. As for this particular change I believe it is justified, despite the weakness in China and the Eurozone, the UK is recovering strongly and inflation is lower than the target rate. Although the size of the change is larger than would be ideal the country has seen no growth in real wages since 2009 and could well do with the extra consumer stimulus to aggregate demand.

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