The Living Wage is a false solution to our problems

I normally agree with the Centre for Policy Studies on economic issues, so I was surprised to see Adam Memon’s call for a mandatory ‘Living Wage’ last week. Philip Booth has already written a post criticising Memon’s original piece, but I’d like to add my perspective to Adam’s response to Philip, posted today.

To be clear, Adam prefers “tax cuts, deregulation and other supply-side measures to boost productivity”. He and the CPS have long argued for tax cuts for the poor. This is admirable, and as Adam says it deserves to be acknowledged.

My main contention is that Adam is comparing apples with oranges by using the impact of historical increases in the National Minimum Wage (NMW) to justify a future rise to the NMW to Living Wage levels. There is a lot of evidence against his position that he ignores.

Adam says that “an objective reading of the studies of the impact of the National Minimum Wage can only lead to the conclusion that it has boosted the incomes of the low paid without particularly damaging employment”. Correct. There does not seem to be much, if any, good evidence that the NMW has increased unemployment in the UK.

But this doesn’t tell us that employment would not be higher without rises to the minimum wage. Simply looking at times when we have raised the NMW, and looking at whether unemployment has risen or not, as Adam does once, is extremely crude – there are of course many other factors going on, and without an analysis that attempts to control for those factors we have no idea what the counterfactual would be. But, yes, there have been more sophisticated studies in the UK that do suggest that the NMW has not harmed employment compared to there being no NMW.

Adam says that “This is quite a big deal because it does rather make the traditional argument that the minimum wage would destroy jobs somewhat out-of-date”. But, unless we think there is something particularly unique about the UK’s labour market, the UK is not the only place we have to look at.

Internationally, most of the evidence is that increases in the minimum wage do increase unemployment at the margin. I looked at some of this last year:

Neumark and Wascher’s review of over one hundred studies found that two-thirds showed a relatively consistent indication that minimum wage increases cause increases in unemployment. Of the thirty-three strongest studies, 85 per cent showed unemployment effects. And “when researchers focus on the least-skilled groups most likely to be adversely affected by minimum wages, the evidence for disemployment effects seems especially strong”. There is evidence that suggests that minimum wages deter young workers from acquiring these skills that allow them to get better jobs in the long run.

Of course there are times when this does not happen, but most of the time it does. Most of this evidence is based on US data, and much of it compares employment rates in similar US states where one has had a minimum wage rise and the other has not.

Though UK evidence might be the most relevant evidence we have, we would need a very good reason to completely ignore the international evidence and suppose that the UK experience is all that we should look at.

I am certain that Adam agrees, because he has cited international evidence in discussions about the UK in the past. And rightly so.

Is the UK special? Maybe. But the Low Pay Commission seems to disagree, because its recommended increases have been very low compared to what Adam is proposing. Similarly, the Living Wage Foundation does not call for a mandatory Living Wage.

Distributionally, if some people are put out of work but others receive pay rises, this may well be a negative. Adam says that “There are of course some who lose out from the minimum wage but there are many more who benefit”, but concludes that “broadly speaking the minimum wage is a net positive.”

But taking all of one person’s earnings and distributing them among other people who are already in work is likely to be harmful overall, because of diminishing marginal utility. If there is an unemployment effect it may well be an upwards income redistribution from now-unemployed people to the people who hang on in their jobs.

I do think the Low Pay Commission has done a good job at keeping NMW increases quite restrained. That’s why I suspect they would balk at the idea of raising the NMW to the Living Wage level for the foreseeable future. It’s simply not convincing to compare previous rises that the Low Pay Commission has deemed safe with a future rise that it presumably deems unsafe.

Note that productivity has been very low recently, and the Low Pay Commission has barely raised the NMW as a result.

I find it extremely implausible when Adam defends his claim that the Living Wage might lead to extra productivity gains from workers. This concept is known as ‘efficiency wages’ – a well-paid worker is often a more profitable one.

But firms are profit-seeking, so wouldn’t they be doing this already? Adam addresses this by saying that “often some of these productivity gains through eg reduced absenteeism are unanticipated by firms because unsurprisingly, they don’t always have perfect information” – fine, but these firms will be the exception, not the rule. Yes, firms sometimes miss out on profit opportunities – this doesn’t mean that I or Adam or anybody else knows better.

I enjoyed Alex Tabarrok’s recent post on this, “The False Prophets of Efficiency Wages”. He points out that ‘efficiency wages’ were actually studied by economists as a way of explaining unemployment:

In the original efficiency wage literature there is no wishful thinking–no idea that we can have more of everything that we want without tradeoffs. Instead of being desirable, the efficiency wage is a problem because lower wages would reduce unemployment and be better for the economy as a whole.…

Firms routinely track turnover and productivity and they are well aware that higher wages are a possible means to reduce turnover and increase productivity although, as it turns out, not necessarily the most effective means. Indeed, the whole field of workforce science deals with retention, turnover and job satisfaction and the relationship of these to productivity and it does so with more nuance than do most economists. Thus, it’s simply not plausible that large numbers of firms on the existing margin can increase wages, profits and productivity.

To be fair, Adam suggests that his Living Wage rise would be offset by cuts in taxes for business. If these were specifically cuts to the cost of hiring workers this may actually work: cutting employer NICs for NMW workers workers might offset the extra cost of paying the worker the Living Wage. But this would just be a roundabout way of cutting the income taxes or employee NICs of those workers. The Living Wage would be doing none of the heavy lifting, and would still exclude some workers from jobs.

Adam claims that tax credits and other in-work benefits subsidise employers by letting them pay their workers less. I’ve always found this a strange claim. Why would workers’ wage demands fall just because they’re getting top-up money from elsewhere? Do lottery winners ask for lower wages? In any case, he does not provide evidence of this. The consensus from the literature I have seen is that both payroll tax cuts and wage subsidies go to the workers, without driving down wages. So there is no subsidy effect.

In light of all this, my basic view is that raising the minimum wage always risks creating unemployment, and raising it as high as Adam wants would run a very large risk of creating unemployment. I believe that low pay will be the economic problem facing my generation, as unemployment was for my parents’ and grandparents’ generations. To address it, I prefer cash transfers like the Basic Income and anything that boosts innovation, so we can improve people’s productivity and the total stock of wealth.

At best the Living Wage will act as a roundabout way of cutting taxes on workers. At worst it will put many people out of work. I admire Adam’s willingness to challenge the orthodoxy on our side, but in this case I believe that the bulk of the evidence in favour of the free market orthodoxy. The Living Wage is a false solution to our generation’s problems. We should reject it.

The case against caring about inequality at all

Readers of this blog will probably not need convincing that inequality is not something to worry about. We’re more interested in reducing absolute poverty. If you become £100 richer, and I become £50 richer, I say that’s a good thing. But because we’ve become less equal, someone who is concerned with inequality alone would not.

But even given this, inequality might matter. Whether we think they should care about it or not, people do, and it makes no more sense to think of that as a ‘bad’ or unimportant desire than thinking a passion for expensive or high-tech watches is bad.

And because people care about it, they might act on it. If inequality makes a revolution or populist, anti-market governments more likely, as Noah Smith suggests it does, then it might reduce investment and growth as well.

Crucially, these harms from inequality come from people’s perceptions of inequality, not necessarily actual inequality. Which makes a new NBER working paper, “Misperceiving Inequality”, rather interesting (hat tip to Bryan Caplan, who quotes some of the key parts directly).

The paper shows that most people know very little about the extent and direction of income inequality in their societies, or where they fit in to the income distribution. This holds for wealth as well as income.

Screen Shot 2015-05-28 at 14.32.55

This isn’t a pedantic complaint about imprecision. One question asked people to choose which of five diagrams, above, best described where they live. Responses differed significantly between different countries (68% of Latvians chose Type A, 2% of Danes did), but in almost every country a majority got it wrong.

Globally, respondents were able to pick the “right” diagram only slightly better than randomly – 29% got it right, compared to a random baseline of 22.5%. Accuracy differed significantly between countries: 61% of Norwegians got it right, 40% of Britons did, 5% of Ukrainians did. In only five countries out of forty did more than half of respondents guess correctly. (All this uses post-tax-and-transfer data; people’s accuracy is much worse if you use pre-tax-and-transfer data.)

And respondents weren’t even close – looking at how many people were only one diagram off the right one, respondents only did one percentage point better than random (69% versus 68%). As the authors note, “with only five options to choose between, getting within one place of the correct option is not a very difficult task”.

The paper also shows that people are terrible at judging where they fall in the income distribution – 40% of British second-home owners said they were in the bottom half. 3% said they were in the top 10%.

Crucially, given worries about investment and political instability, “In countries where inequality was generally thought to be high, more people supported government redistribution. But demand for redistribution bore no relation to the actual level of inequality.”

There’s too much in the paper to cover in one blogpost, but the results are extremely clear: people’s perceptions of inequality are really, really inaccurate – that holds globally and in all but a handful of Scandinavian countries.

There are some good arguments in favour of reducing inequality based on how people perceive it – that it makes people unhappy, more left-wing, more prone to revolution, more hateful to the people around them.

But this paper shows that those perceptions are related to the realities of inequality only very slightly, if at all. Redistributive policies that reduce actual inequality are costly, and because actual inequality is barely related to perceptions of inequality they may do little to make the country more stable or market-friendly. If these are important problems, we can only solve them by making people feel less unequal – not by making them less unequal in fact. In short: even if people’s perceptions of inequality matter, the reality does not.

Why William Nordhaus was right and Nick Stern wrong

Given that coal fired power stations seem to be closing down left right and centre we might think this is a victory in the fight against climate change. Sadly though what we’re actually seeing is the result of people following the advice of thwe wrong economist. It was William Nordhaus who was correct, Nick Stern who was wrong.

Ambrose:

The British electricity group SSE (ex Scottish and Southern Energy) is already adapting to the new mood. It will close its Ferrybridge coal-powered plant next year, citing the emerging political consensus that coal “has a limited role in the future”.

The IMF bases its analysis on the work Arthur Pigou, the early 20th Century economist who advocated taxes to stop investors keeping all the profit while dumping the costs on the rest of society.

Tony Lodge:

So why has the power station closed early, citing soaring running costs, when coal prices are at an eight-year low and when it was modernised to stay open until 2023?

The Carbon Price Floor is arguably one of the most hidden and unknown but ultimately damaging pieces of modern industrial taxation. To use a shorter and more descriptive title, this carbon tax is slowly forcing the premature closure of the backbone of our electricity generating base.

As we regularly say around here, if there is an externality, one which cannot be dealt with by market or private means, then yes Pigou and his tax can be the right solution.

However, there’s a difference possible in the way that it’s applied. Roughly speaking the UK government has followed Stern’s advice: here’s the amount the tax should be, impose it now. Which is why these plants are closing at such great expense in stranded assets.

What should have been done is the Nordhaus approach. Sure, we need the tax but it would be better to work with the capital and technological cycle than against it. Thus, have a low tax now rising into the future. In this manner we’ll still get the use of those capital assets that we’ve already built while also making sure that the next generation, to replace the current as they fall to bits, are non-emitting.

Don’t forget, we’re not imposing this tax to raise revenue: we’re imposing the tax to reduce future emissions. And we obviously want to do this in the cheapest manner possible. Which is, as above, to use the current installed base until it falls apart and then rebuild it differently. Not, as the Stern prescription makes us do, close down perfectly good plant right now.

We should, obviously, be at least somewhat grateful that the government did listen to economists on this. It’s just rather sad that they listened to the wrong one.

A blanket ban on psychoactive substances makes UK drugs policy even worse

It is a truth under-acknowledged that a drug user denied possession of their poison is in want of an alternative. The current ‘explosion‘ in varied and easily-accessible ‘legal highs’ (also know as ‘new psychoactive substances’) are a clear example of this.

In June 2008 33 tonnes of sassafras oil - a key ingredient in the production of MDMA – were seized in Cambodia; enough to produce an estimated 245 million ecstasy tablets. The following year real ecstasy pills ‘almost vanished‘ from Britain’s clubs. At the same time the purity of street cocaine had also been steadily falling, from over 60% in 2002 to 22% in 2009.

Enter mephedrone: a legal high with similar effects to MDMA but readily available and for less than a quarter of the price. As the quality of ecstasy plummeted (as shown by the blue line on this graph) and substituted with things like piperazines, (the orange line) mephedrone usage soared (purple line). The 2010 (self-selecting, online) Global Drug Survey found that 51% of regular clubbers had used mephedrone that year, and official figures from the 2010/11 British Crime Survey estimate that around 4.4% 16 to 24 year olds had tried it in the past year.

Similarly, law changes and clampdowns in India resulted in a UK ketamine drought, leading to dabblers (both knowingly and unknowingly) taking things like (the once legal, now Class B) methoxetamine. And indeed, the majority of legal highs on offer are ‘synthetic cannabinoids’ which claim to mimic the effect of cannabis. In all, it’s fairly safe to claim that were recreational drugs like ecstasy, cannabis and cocaine not so stringently prohibited, these ‘legal highs’ (about which we know very little) probably wouldn’t be knocking about.

Still, governments tend to be of the view that any use of drugs is simply objectively bad, so the above is rather a moot point. But what anxious states can do, of course, is ban new legal highs as they crop up. However, even this apparently obvious solution has a few problems— the first being that there seems to be a near-limitless supply of cheap, experimental compounds to bring to market. When mephedrone was made a Class B controlled substance in 2010, alternative legal highs such NRG-1 and ‘Benzo Fury’ started to appear. In fact, over 550 NPS have been controlled since 2009. Generally less is known about each concoction than the last, presenting potentially far greater health risks to users.

At the same time, restricting a drug under the Misuse of Drugs Act 1971 requires evidence of the harm they cause (not that harm levels always bear much relation to a drug’s legality), demanding actual research as opposed to sensationalist headlines. Even though temporary class drug orders were introduced in 2011 to speed up the process, a full-out ban still requires study, time and resources. Many have claimed the battle with the chemists in China  is one lawmakers are unlikely to win.

And so with all of this in mind, the Queen’s Speech on Wednesday confirmed that Conservatives will take the next rational step in drug enforcement, namely, to simply ban ALL OF THE THINGS.

In order to automatically outlaw anything which can make people’s heads go a bit funny, their proposed blanket ban (modelled on a similar Irish policy) will prohibit the trade of ‘any substance intended for human consumption that is capable of producing a psychoactive effect’, and will carry up to a 7-year prison sentence.

Somewhat ironically for a party so concerned with preserving the UK’s legal identity it wants to replace the Human Rights Act with a British Bill of Rights, this represents a break from centuries of British common law, under which we are free to do something unless the law expressly forbids it. This law enshrines the opposite. In fact, so heavy-handed and far-reaching is the definition of what it is prohibited to supply that special exemptions have to be granted for those everyday psychoactive drugs like caffeine, alcohol and tobacco. Whilst on first glance the ban might sound like sensible-enough tinkering at the edges of our already nonsensical drug policy, it really is rather sinister, setting a worrying precedent for the state to bestow upon citizens permission to behave in certain ways.

This law will probably (at least initially) wipe out the high street ‘head shops’ which the Daily Mail and Centre for Social Justice  are so concerned about. However, banning something has never yet simply made a drug disappear. An expert panel commissioned by the government to investigate legal highs acknowledged that a 50% increase in seizures of Class B drugs between 2011/12 and 2013/14 was driven by the continued sale of mephedrone and other once-legal highs like it. Usage has fallen from pre-ban levels, but so has its purity whilst the street price has doubled. Perhaps the most damning evidence, however, comes from the Home Office’s own report into different national drug control strategies, which failed to find “any obvious relationship between the toughness of a country’s enforcement against drug possession, and levels of drug use in that country”.

The best that can be hoped for with this ridiculous plan is that with the banning of absolutely everything, dealers stick to pushing the tried and tested (and what seems to be safer) stuff. Sadly, this doesn’t seem to be the case – mephedrone and and other legal and once-legal highs have been turning up in batches of drugs like MDMA and cocaine as adulterants, and even being passed off as the real things.  Funnily enough, the best chance of new psychoactive substances disappearing from use comes from a resurgence of super-strong ecstasy, thanks to the discovery of a way to make MDMA using less heavily-controlled ingredients.

The ASI has pointed out somanytimes. that the best way to reduce the harms associated with drug use is to decriminalise, license and tax recreational drugs. Sadly, it doesn’t look like the Conservatives will see sense in the course of this parliament.  However, at least the mischievous can entertain themselves with the prospect that home-grown opiates could soon be on the horizon thanks to genetically modified wheat. And what a moral panic-cum-legislative nightmare that will be…

Another sign of the looming apocalypse

That Guardian opinion columns will have only a marginal relationship to economics, maths or even reality is well known. But it is possible to find signs of the looming apocalypse even there, knowing that point.

Are you paid what you are worth? What is the relationship between the actual work you do and the remuneration you receive?

The revelation that London dog walkers are paid considerably higher (£32,356) than the national wage average (£22,044) tells us much about how employment functions today. Not only are dog walkers paid more, but they work only half the hours of the average employee.

It is clear that the relationship between jobs and pay is now governed by a new principle. The old days in which your pay was linked to the number of hours you clocked up, the skill required and the societal worth of the job are long over.

There’s never been a time when pay was determined by societal worth. Cleaning toilets is highly valuable societally: as the absence of piles of bodies killed off by effluent carried diseases shows. It’s also always been a badly paid job. Because wages are not and never have been determined by societal worth. Rather, by the number of people willing and able to do a job at what price versus the demand for people to do said job at that price. You know, this oddity we call a market.

That a Guardian opinion column might opine that jobs should pay their social worth is one thing, to claim that the world used to work that way is an error of a different and larger kind.

We are surrounded by examples of this increasing disparity between jobs and pay. For example, average wages in western countries have stagnated since the 1980s,

And there’s the maths error. For that’s not true either. Yes, as we know, wages have been falling in recent years but according to both Danny Blanchflower and the ONS real wages are still, after that fall, 30% or so higher than in the 80s (median wages). 30% over three decades isn’t great but it’s also not to be sniffed at: and it’s also not stagnation.

But we expect such errors from the innumerates who fight for social justice or whatever they’re calling it this week. At which point we come to the signs of the apocalypse:

Peter Fleming is Professor of Business and Society at City University, London.

Actually, he’s in the Business School:

Peter Fleming
Professor of Business and Society

That long march through the institutions has left us with professors at business schools believing, and presumably teaching, things that are simply manifestly untrue.

Woes, society to the dogs, apres moi la deluge etc.

It’s not a happy thought that this sort of stuff is being taught these days, rather than just scribbled in The Guardian, is it?