Thursday, 18 February 2010

Were we wrong about the minimum wage?

Stephanie Flanders points out some huge discrepancies in the labour market between older and younger workers, and between the current recession and that of the early 90s.
But of the 16-17-year-olds not in full-time education, nearly 41% were economically inactive during the last quarter of 2009. Back in 1992, the figure was less than 15%.
...consider the following astonishing fact.
In the second quarter of 1992, two-thirds - 65% - of 16-17-year-olds who were not in full-time education were reported to have a job. Now the figure is 35%.
These figures are startling and, especially having got used to economic statistics measured in increments (unemployment 2% higher, inflation 1% lower), really worrying.

What's more - though Stephanie surprisingly does not point this out - there is a very clear suspect here: the minimum wage.

Like all card-carrying bleeding-hearted liberals, I was in favour of the UK's minimum wage when it was introduced in 1997.

I did have some minor reservations, as the standard economic argument against minimum wages is clear and well-known. However, I took heart from a body of research indicating that minimum wages do not clearly cause a rise in unemployment; and from the social justice benefits of the minimum wage - having had friends who felt obliged to work for £1.30 an hour in the early 1990s, I wasn't very sympathetic to the positive effects of deregulation on employers' welfare. Under strong economic conditions, a minimum wage is a transfer program from shareholders to low-skilled workers; it helps to stop workers being played off against one another to reach a market-clearing wage. There are respectable arguments for why we should support this, based on bounded rationality and hyperbolic discounting.

And for the first twelve years of the minimum wage policy it, indeed, didn't seem so bad. Younger people, though still suffering higher unemployment than older, had plenty of opportunities and if there was a challenge, it was how to persuade 17-year-olds to stay in education rather than how to get them a job.

Now it appears that is no longer the case. The higher education system is oversubscribed (nothing wrong with that intrinsically, but it's a sign), and according to the figures above, young people can't - or don't want to - get jobs.

If the cause is that they don't want to work, that's a different thing. There could be cultural shifts which reduce the willingness of young people to work - maybe their parents are better-off on average, or maybe they have watched too much BBC Three [if this were a Chris Dillow post, the point would be illustrated with a picture of one of the girls from Coming of Age]. If that's the case, the minimum wage would help to increase employment among young people, because it would force employers to offer higher wages.

But if employers are not hiring - as, crudely speaking, they currently aren't - then the minimum wage forces them to hire more skilled people than they might otherwise do. Someone who might have employed three people at £3 an hour may instead choose to hire one or two more experienced people at £6 an hour. And young, low-skilled workers are the most likely to lose out from this. Long-run, this provides an extra incentive for people to stay in education and gain more skills. But that's a tough sell in this economy.

This point was no mystery when the legislation was written, which is why the minimum is lower for 16-17 year olds and 18-21 year olds than for older workers. But it inevitably has some effect - the size of which we cannot be sure about.

I'm not ready to write off the minimum wage yet, but we need to acknowledge that it has costs as well as benefits. Let's hope there are enough automatic stabilisers in the benefits system to avoid the worst hardship.

Talking of Chris Dillow, he has some slightly different thoughts on the same subject.

Update: Chris responds with two good points - first noting that the rate of employment among young people was already declining before 1997, and second that there is probably a strong selection effect affecting the characteristics of 16-17 year olds not in full-time education.

3 comments:

Min said...

Leigh, what is your take on a jobs guarantee program (mostly at minimum wage, and including training)?

Thanks. :)

PunditusMaximus said...

I'm not sure how many conclusions we should draw from economies so far out of equilibrium as the US's and the UK's.

Niklas Blanchard said...

The upcoming implementation of minimum wage legislation in Hong Kong may be the purest test of the the effects of such legislation. Hong Kong has a fairly normal demographic distribution.