A higher minimum wage is an easy answer that won't work

It was Robert Heinlein, the science fiction writer, who put it best.

Writing in his 1966 classic The Moon is a Harsh Mistress , a novel which makes more sense than many an economics textbook, he pointed out that there is no such thing as a free lunch. We live in a world of trade-offs where one desirable thing must always be given up to obtain another.

This is certainly true of policies that seek to reduce poverty. It is cause for celebration that our political classes have belatedly caught up with the plight of the working poor, who often toil for extremely long hours for heart-breakingly low pay. Much more needs to be done to help them but that doesn’t mean that every idea to tackle this living standards crisis is a good one.

So far, the idea of a voluntary “living wage” paying substantially more than the minimum wage and, in theory, freeing taxpayers from the need to provide them with a top-up in the form of benefits has worked well. Thousands have benefited from better conditions, with several large firms deciding that there is a business case for paying staff more.

But the idea now risks being pushed too far and becoming dangerously counter-productive. The Coalition needs to resist a compulsory or near-compulsory living wage, which is where over-enthusiastic campaigners are taking the debate, egged on by Ed Miliband . For all the good intentions of its proponents, such a move would condemn a further swathe of the population to permanent unemployment.

It is absurd to think that a massive hike to the minimum wage for that is what it would be, de facto if not de jure would be a free lunch, a mechanism by which the poor could be helped without costing jobs. The living wage has been put at £7.45 per hour and £8.55 per hour in London. If drastically increasing the minimum wage from its present £6.19 were possible without any adverse consequences on the demand for labour or the health of the economy, it would already have happened by now. And if such hikes are costless, then why not £10 an hour or even £50? Why not decree that nobody can earn less than £25,000 a year, £50,000 a year or any other arbitrary number?

There is a good reason why the minimum wage has barely been hiked recently: the authorities are aware that excessive increases, especially in the current climate of falling productivity, would price out vast numbers from the labour force and have exercised restraint, despite the vote-buying opportunities such increases entail. Jobs only exist as long as the cost of employing somebody is lower than the benefits in terms of the extra output they produce; there is a strict limit to how far the market can be bucked. At some point, increasing prices reduces demand, including for workers.

We cannot simply legislate to eliminate poverty and create a nation of middle class earners. Bullying companies into paying above-market rates, Labour’s technique, would be almost as destructive as actual compulsion. If the social pressure became sufficiently intense, with naming and shaming, demos and public enquiries, firms would end up with little choice. Some would go bust. Others would slash labour costs in other ways, such as by reducing training. Many would replace staff by machines retailers would use more unmanned checkouts, pushing up unemployment and the benefit bill. Other industries would react by raising prices, which would hit all poor folk, including pensioners who wouldn’t be gaining from a living wage.

Public sector bodies can simply pass on higher wage costs to taxpayers. Many big companies that are offshoring to India or Poland might agree to a “voluntary” living wage, safe in the knowledge that paying cleaners and security guards in the UK (and gleaning the positive PR) would be easily compensated for by cheaper staff abroad.

But huge pay increases would amount to a death knell for many small firms, such as retailers, service sector industries or factories, for whom unskilled labour is a core part of their business and a large chunk of costs. In fact, some big companies undoubtedly back a living wage to inflict disproportionate pain on their smaller rivals, as an anti-competitive device.

Boris Johnson says that paying the living wage will be a badge of honour but what about those that cannot afford to? Must it now be seen to be dishonourable to be creating “mere” minimum wage jobs, extending vital opportunities to unemployed people at a time of renewed economic stagnation? Since when is struggling financially and an inability to increase one’s costs something that one must be ashamed of?

Politicians need to do much more to help the working poor but rather than trying to will away market forces, they need to focus on how their policies are crippling strivers. It is indefensible that people on desperately low incomes are still paying vast amounts of income tax and National Insurance, despite the Coalition’s laudable increase in the personal allowance. Somebody on the living wage would earn a gross £15,496 a year but pay income tax of £1,478.20 and employee National Insurance of £948.48.

The Adam Smith Institute points out that the current minimum wage before tax (£12,875.20 a year, full-time) is actually similar to the living wage after tax (£13,069.32 a year). So there is a solution which helps the poor without killing jobs: make the minimum wage free of income tax and employees’ National Insurance. Going the whole way and increasing the personal allowance to £13,069 would reduce tax revenues by £15.35bn, in addition to what is implied by the existing commitment to raise the allowance to £10,000. It shouldn’t be impossible to find such savings.

Politicians also need to make sure that energy policy is geared towards delivering the lowest possible costs to consumers. Current “green” policies are rabidly anti-poor and push up the prices of water and energy. The fuel price escalator has been horrendously unfair.

The war on childminders under Labour, which saw them over-regulated, reducing the supply of affordable childcare, was another anti-working poor catastrophe.

Just 141,950 homes were built last year; we need at least 250,000 a year to ensure lower prices and rents. Planning rules push up the cost of everything in the UK, including goods in shops.

Tariffs still remain on many imports, thanks to the European customs union. Everywhere one looks, tax and regulation make the cost of essentials more expensive, hitting the poorest hardest. It is a national scandal.

The only way to increase wages sustainably is to boost the workforce’s productivity. The more employees produce, the more their services are worth and the more they are paid in a competitive market.

That means better education, improved training and an economy where productivity-enhancing capital expenditure is incentivised. Our society needs to do much more to help the working poor. But let’s not pretend there are any shortcuts or easy answers.

Allister Heath is editor of City A.M.