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March 31, 2016

Commentary on high minimum wage proposals

I am continually amazed at the absurdities of proposals that one sees made by politicians searching for votes. One of the most ridiculous labor-related proposals that I have seen in recent years was made this last week by Anthony Watson (whom a UK newspaper refers to as a business spokesman for the UK Labour Party) who recommended instituting a £35,000 per year minimum wage, roughly £17.50 per hour. This policy idea will no doubt warm the hearts of the party faithful, and probably attract votes from constituents who do not pay attention to evidence; but it is a dreadful idea.

The average hourly income for a British worker is currently well below £17.50. So if this proposal became law, it would appear to raise the earnings of the overwhelming majority of British workers. Who could argue against that? The answer is most labor economists. I should hope that even those who argue for increasing the current US minimum wage of $7.25 per hour—which is one-third of the US average wage—would see the intrinsic flaws in this proposal. A £17.50 per hour minimum in the UK would raise employers’ labor costs for most workers, and double them for the average worker affected by this policy. The evidence makes absolutely clear that this would result in a huge drop in the number of workers whom employers wish to employ, and in the number of hours each individual works; employment would significantly decrease, negatively affecting those whom minimum wage policies are designed to help.

The Labour spokesperson argued that a higher wage would motivate workers more, so that their productivity would rise enough to justify this massive increase in labor costs. There are two reasons why this point is specious: (1) Even with this possible motivation for greater effort, could the typical bank employee, retail salesperson, or factory worker really double her or his effort? I doubt it. (2) Logically, if employers believe that such an immense increase in pay would increase effort and perhaps raise their profits, have they started paying such higher wages already? No, they have not, which suggests employers know that this increase would not pay for itself.

Given those answers, would such a large escalation in labor costs actually generate a significant drop in employment? I would argue probably not, because no democratic government could survive in the face of the drastic number of redundancies that would result from it. Rather, policymakers would pump huge amounts of money into the economy, creating rapid inflation and thus reducing the real costs to employers imposed by the higher minimum (the wage compared to the now inflated price level). A proposal for a £35,000 minimum salary is really a proposal for price inflation—and in the UK, a return to the 1970s.

Read our articles on the minimum wage.

Read Daniel Hamermesh's article Do labor costs affect companies’ demand for labor?

Please note:
We recognize that IZA World of Labor articles may prompt discussion and possibly controversy. Opinion pieces, such as the one above, capture ideas and debates concisely, and anchor them with real-world examples. Opinions stated here do not necessarily reflect those of the IZA.

*This article has been updated*