Tag: median income

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Raising the minimum wage: its effects on poverty and employment

The first Budget of the new UK Labour government was announced on 30 October 2024. It contained a number of measures that will help to tackle inequality. These include extra spending on health and education. This will benefit households on lower incomes the most as a percentage of net income. Increases in tax, by contrast, will be paid predominantly by those on higher incomes. The Chart opposite (taken from the Budget Report) illustrates this. It shows that the poorest 10% will benefit from the largest percentage gain, while the richest 10% will be the only decile that loses.

But one of the major ways of tackling inequality and poverty was raising the minimum wage. The so-called ‘National Living Wage (NLW)’, paid to those aged 21 and over, will rise in April by 6.7% – from £11.44 to £12.41 per hour. The minimum wage paid to those aged 18 to 20 will rise 16.3% from £8.60 to £10.00 and for 16 and 17 year-olds and apprentices it will rise £18% from £6.40 to £7.55.

It has been an objective of governments for several years to relate the minimum wage to the median wage. In 2015, the Conservative Government set a target of raising the minimum wage rate to 60 per cent of median hourly earnings by 2020. When that target was hit a new one was set to reach two-thirds of median hourly earnings by 2024.

The Labour government has set a new remit for the minimum wage (NLW). There are two floors. The first is the previously agreed one, that the NLW should be at least two-thirds of median hourly earnings; the second is that it should fully compensate for cost of living rises and for expected inflation up to March 2026. The new rate of £12.41 will meet both criteria. According to the Low Pay Commission, ‘Wages have risen faster than inflation over the past 12 months, and are forecast to continue to do so up to March 2026’. This makes the first floor the dominant one: meeting the first floor automatically meets the second.

How effective is the minimum wage in reducing poverty and inequality?

Figure 1 shows the growth in minimum wage rates since their introduction in 1999. The figures are real figures (i.e. after taking into account CPI inflation) and are expressed as an index, with 1999 = 100. The chart also shows the growth in real median hourly pay. (Click here for a Powerpoint.)

As you can see, the growth in real minimum wage rates has considerably exceeded the growth in real median hourly pay. This has had a substantial effect on raising the incomes of the poorest workers and thereby has helped to reduce poverty and inequality.

The UK minimum wage compares relatively favourably with other high-income economies. Figure 2 shows minimum wage rates in 12 high-income countries in 2023 – the latest year for which data are available. (Click here for a PowerPoint.) The red bars (striped) show hourly minimum wage rates in US dollars at purchasing-power parity (PPP) rates. PPP rates correct current exchange rates to reflect the purchasing power of each country’s currency. The blue bars (plain) show minimum wage rates as a percentage of the median wage rate. In 2023 the UK had the fourth highest minimum wage of the 12 countries on this measure (59.6%). As we have seen above, the 2025 rate is expected to be 2/3 of the median rate.

Minimum wages are just one mechanism for reducing poverty and inequality. Others include the use of the tax and benefit system to redistribute incomes. The direct provision of services, such as health, education and housing at affordable rents can make a significant difference and, as we have seen, have been a major focus of the October 2024 Budget.

The government has been criticised, however, for not removing the two-child limit to extra benefits in Universal Credit (introduced in 2017). The cap clearly disadvantages poor families with more than two children. What is more, for workers on Universal Credit, more than half of the gains from the higher minimum wages will lost because they will result in lower benefit entitlement. Also the freeze in (nominal) personal income tax allowances will mean more poor people will pay tax even with no rise in real incomes.

Effects on employment: analysis

A worry about raising the minimum wage rate is that it could reduce employment in firms already paying the minimum wage and thus facing a wage rise.

In the case of a firm operating in competitive labour and goods markets, the demand for low-skilled workers is relatively wage sensitive. Any rise in wage rates, and hence prices, by this firm alone would lead to a large fall in sales and hence in employment.

This is illustrated in Figure 3 (click here for a PowerPoint). Assume that the minimum wage is initially the equilibrium wage rate We. Now assume that the minimum wage is raised to Wmin. This will cause a surplus of labour (i.e. unemployment) of Q3 – Q2. Labour supply rises from Q1 to Q3 and the demand for labour falls from Q1 to Q2.

But, given that all firms face the minimum wage, individual employers are more able to pass on higher wages in higher prices, knowing that their competitors are doing the same. The quantity of labour demanded in any given market will not fall so much – the demand is less wage elastic; and the quantity of labour supplied in any given market will rise less – the supply is less wage elastic. Any unemployment will be less than that illustrated in Figure 3. If, at the same time, the economy expands so that the demand-for-labour curve shifts to the right, there may be no unemployment at all.

When employers have a degree of monopsony power, it is not even certain that they would want to reduce employment. This is illustrated in Figure 4: click here for a PowerPoint (you can skip this section if you are not familiar with the analysis).

Assume initially that there is no minimum wage. The supply of labour to the monopsony employer is given by curve SL1, which is also the average cost of labour ACL1. A higher employment by the firm will drive up the wage; a lower employment will drive it down. This gives a marginal cost of labour curve of MCL1. Profit-maximising employment will be Q1, where the marginal cost of labour equals the marginal revenue product of labour (MRPL). The wage, given by the SL1 (=ACL1) line will be W1.

Now assume that there is a minimum wage. Assume also that the initial minimum wage is at or below W1. The profit-maximising employment is thus Q1 at a wage rate of W1.

The minimum wage can be be raised as high as W2 and the firm will still want to employ as many workers as at W1. The point is that the firm can no longer drive down the wage rate by employing fewer workers, and so the ACL1 curve becomes horizontal at the new minimum wage and hence will be the same as the MCL curve (MCL2 = ACL2). Profit-maximising employment will be where the MRPL curve equals this horizontal MCL curve. The incentive to cut its workforce, therefore, has been removed.

Again, if we extend the analysis to the whole economy, a rise in the minimum wage will be partly passed on in higher prices or stimulate employers to increase labour productivity. The effect will be to shift the (MRPL) curve upwards to the right, thereby allowing the firm to pass on higher wages and reducing any incentive to reduce employment.

Effects on employment: evidence

There is little evidence that raising the minimum wage in stages will create unemployment, although it may cause some redeployment. In the Low Pay Commission’s 2019 report, 20 years of the National Minimum Wage (see link below), it stated that since 2000 it had commissioned more than 30 research projects looking at the NMW’s effects on hours and employment and had found no strong evidence of negative effects. Employers had adjusted to minimum wages in various ways. These included reducing profits, increasing prices and restructuring their business and workforce.

Along with our commissioned work, other economists have examined the employment effects of the NMW in the UK and have for the most part found no impact. This is consistent with international evidence suggesting that carefully set minimum wages do not have noticeable employment effects. While some jobs may be lost following a minimum wage increase, increasing employment elsewhere offsets this. (p.20)

There is general agreement, however, that a very large increase in minimum wages will impact on employment. This, however, should not be relevant to the rise in the NLW from £11.44 to £12.41 per hour in April 2025, which represents a real rise of around 4.5%. This at worst should have only a modest effect on employment and could be offset by economic growth.

What, however, has concerned commentators more is the rise in employers’ National Insurance contributions (NICs) that were announced in the Budget. In April 2025, the rate will increase from 13.8% to 15%. Employers’ NICs are paid for each employee on all wages above a certain annual threshold. This threshold will fall in April from £9100 to £5000. So the cost to an employer of an employee earning £38 000 per annum in 2024/25 would be £38 000 + ((£38 000 – £9100) × 0.138) = £41 988.20. For the year 2025/26 it will rise to £38 000 + ((£38 000 – £5000) × 0.15) = £42 950. This is a rise of 2.29%. (Note that £38 000 will be approximately the median wage in 2025/26.)

However, for employees on the new minimum wage, the percentage rise in employer NICs will be somewhat higher. A person on the new NLW of £12.41, working 40 hours per week and 52 weeks per year (assuming paid holidays), will earn an annual wage of £25 812.80. Under the old employer NIC rates, the employer would have paid (£25 812.80 + (£25 812.80 – £9100) × 0.138) = £28 119.17. For the year 2025/26, it will rise to £25 812.80 + ((£25 812.80 – £5000) × 0.15) = £28 934.72. This is a rise of 2.90%.

This larger percentage rise in employers’ wage costs for people on minimum wages than those on median wages, when combined with the rise in the NLW, could have an impact on the employment of those on minimum wages. Whether it does or not will depend on how rapid growth is and how much employers can absorb the extra costs through greater productivity and/or passing on the costs to their customers.

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UK Government reports and information

Data

Questions

  1. How is the October 2024 Budget likely to affect the distribution of income?
  2. What are the benefits and limitations of statutory minimum wages in reducing (a) poverty and (b) inequality?
  3. Under what circumstances will a rise in the minimum wage lead or not lead to an increase in unemployment?
  4. Find out what is meant by the UK Real Living Wage (RLW) and distinguish it from the UK National Living Wage (NLW). Why is the RLW higher?
  5. Why is the median wage rather than the mean wage used in setting the NLW?
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Why do people in some countries work much longer hours than in others?

Workers in the UK and USA work much longer hours per year than those in France and Germany. This has partly to do with the number of days paid holiday per year, partly with the number of hours worked per day and partly with the number of days worked per week.

According to the latest OECD figures, in 2017 average hours worked per year ranged from 2257 in Mexico (the OECD’s highest) to 1780 in the USA, 1710 in Japan, 1681 in the UK, 1514 in France, 1408 in Denmark and 1356 in Germany (the OECD’s lowest). Annual working hours have been falling in most countries across the decades, as the chart shows. However, in most countries the process has slowed in recent years and in the UK, the USA and France working hours have begun to rise. (Click here for a PowerPoint of the chart.)

But why do working hours differ so much from country to country? How do they relate to productivity? How do they relate to human happiness and welfare more generally?

Causes of the differences

There are various reasons for the differences in hours worked between countries.

In a situation where individual workers can choose how many hours to work, they have to decide the best trade off for them between income and leisure. As wages rise over time, there will be substitution and income effects of these extra hourly wages. Higher wages make work more valuable in terms of what people can buy from an extra hour’s work. There is thus an incentive to substitute work for leisure and hence work longer. This is the substitution effect. On the other hand, higher wages allow people to work fewer hours for a given income. This is the income effect.

As incomes rise, generally the substitution effect will tend to decline relative to the income effect. This is because of the diminishing marginal utility of income. Richer people will tend to value a given rise in income less than poorer people and therefore will value the income from extra work less than poorer people. Richer people will prefer to work fewer hours than poorer people. Generally workers in richer OECD countries work fewer hours than those in poorer OECD countries.

But this does not explain why people in the USA, Canada, Japan and the UK work longer hours than people in Germany, Denmark, Norway, The Netherlands and France.

One possible explanation for these differences is the role of trade unions. These tend to be stronger in countries with lower working hours. Reducing the working week or obtaining longer holidays is one of the key objectives of unions.

Another is income distribution. The USA, despite its high average (mean) income, has a relatively unequal distribution of income compared with Germany or France. The post-tax-and-benefits Gini coefficient in the USA is around 0.39, whereas in Germany it is 0.29, meaning that Germany has a more equal distribution of disposable income than the USA. In fact, rises in real incomes in the USA over the past 10 years have gone almost exclusively to the top 10 per cent of earners, leaving the median income little changed. In fact median household income only rose above its 2007 (pre-recession) level in 2016.

Social and cultural explanations may also be important. People in countries with higher working hours relative to hourly wages may put a greater store on consumption relative to leisure. The desire to shop may be very strong. The ‘Anglo-Saxon’ economic model pursued by right-of-centre governments in English-speaking countries, such as the USA, Canada, Australia and the UK puts emphasis on low taxes, low regulation, low public expenditure and self-advancement. Such a model encourages a more individualistic approach to work, with more emphasis on earning money.

Then there is the attitude to hours worked generally. There is a saying that in the UK the last one to leave the office is seen as the hardest working, whereas in Germany the last one to leave is seen as the least efficient. Social pressures, from colleagues, family, friends and society more generally can have a major effect on people’s choices between work and leisure.

Productivity

Productivity, in terms of output per hour worked, tends to decline as workers work longer hours. People get tired and possibly bored and demotivated towards the end of a long day or week. If workers are paid by the output they produce and if productivity declines towards the end of the day, then the hourly wage would fall as the day progresses. This would act as a disincentive to work long hours. In practice, most workers are normally paid a constant rate per hour for normal-time working. For overtime, they may even be paid a higher rate, despite their likely lower productivity. This encourages them to work longer hours than if they were paid according to their marginal productivity.

Linking pay more closely to productivity could encourage people to opt for fewer hours (if they had the choice). Indeed some companies are now encouraging workers to choose their hours – which may mean fewer hours as people seek a better work–life balance. (See the BBC article below about PwC’s employment strategy.) Alternatively, some other employers adopt the system of giving workers a set amount of work to do and then they can leave work when it is finished. This acts as an incentive to work more efficiently.

It is interesting that countries where workers work more hours per year tend to have a lower output per hour worked relative to output per worker than countries where workers work fewer hours. This is illustrated in the chart opposite. The USA, with its longer working hours, has higher output per person employed than France and Germany but very similar output per hour worked.

Hours and happiness

So are people who choose to work longer hours and take home more money likely to be happier than those who choose to work fewer hours and take home less money? If people were rational and had perfect knowledge, then they would choose the balance between work and leisure that best suited them.

In practice, labour markets are highly imperfect. People often do not have choices about the amount they work; they work the hours they are told. Even if they do have a choice, they are unlikely to have perfect knowledge about the impact of long hours on their health and happiness over their lifetime. They may not even be good judges of the shorter-term effects of more work and more pay. They may believe that more money will buy them more happiness only to find soon afterwards that they are wrong.

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Questions

  1. What factors are likely to encourage workers to work longer hours?
  2. Give some examples of jobs where workers have flexibility in the amount of hours they work per week and jobs where the working week is of a fixed length.
  3. For what reasons are annual working hours longer in the USA than in Germany?
  4. Would it be in employers’ interests if the government legislated so as to reduce the maximum permitted working week? Explain.
  5. What is meant by ‘efficiency wages’? How relevant is the concept to the issue of the average number of hours worked per year from country to country?
  6. Explain why people in poorer countries tend to work more hours per year than people in richer countries.
  7. If workers’ wages equalled their marginal revenue product, why might some workers choose to work more and others choose to work less (assuming they had a choice)?
  8. Are jobs in the gig economy and zero-hour contract jobs in the interests of workers?
  9. Is South Korea wise to cut its work limit from 68 hours a week to 52?