How much labour market flexibility for pounds 65 a week?

Last November a greengrocer advertised in his local JobCentre for an assistant, offering pounds 65 for a 37-hour week. Two months earlier it would have been illegal for the greengrocer to pay less than pounds 119 a week for the same job. This is what the Government is pleased to call 'labour market flexibility'.

In September the Government abolished the 26 remaining Wages Councils, which for more than 80 years had set minimum rates of pay for many of Britain's lowest-earning workers. Some 2.4 million people working in hairdressing, shops, hotels, catering and clothing manufacture were thrown to the mercy of the marketplace.

Only one relic of the minimum wage apparatus remains, the Agricultural Wages Boards, which set minimum rates for farm workers. The Ministry of Agriculture is reviewing their future and hopes to announce its verdict before Easter.

Free-marketeers have long claimed that minimum wages destroy jobs. Their logic seems impeccable. If you force a greengrocer to raise the price at which he sells apples, people will buy fewer of them. So surely if you force up the prices at which people are able to sell their labour, companies will employ fewer.

But the Government has been surprisingly reluctant to rehearse this logic in public. Ministers might be expected to welcome a fall in pay rates after the abolition of the Wages Councils as a sign that people were pricing themselves into jobs. But instead they claim that pay rates will change very little.

It is a mystery how the Government can make this claim while still insisting that the Wages Councils were a pernicious source of labour market rigidity and had to be removed for the health of the economy.

Whatever the Government really believes, the early evidence suggests that wage rates for low earners have indeed fallen since the Wages Councils were dismantled. A survey published last week by the Low Pay Network found that within nine weeks of abolition around a fifth of vacancies in the sectors formerly covered by the Wages Councils were offering pay below the old minimum rates.

The Low Pay Network looked at nearly 2,000 job advertisements in more than 45 JobCentres. It found, for example, that just over 20 per cent of the jobs advertised in hairdressing were paying less than the pounds 2.88 an hour minimum previously specified by the Wages Council. The underpaying vacancies averaged a little over pounds 2.20 an hour, around 23 per cent below the old minimum rate.

Not even good qualifications guarantee the old minimum rate: one hairdresser whose vacancy was surveyed offered stylists pounds 2.56 an hour for a 45 hour week, but only if they had either a National Vocational Qualification or a City & Guilds certificate, not to mention at least three years' experience.

These falls in pay levels have probably been reflected to a lesser but significant degree among higher earners in the same industries. Employers often complained that the Wages Councils established a 'going rate', which forced them to raise the wages of more highly paid workers to maintain cherished differentials.

Because this effect is bound to be weaker the more a worker is paid in excess of the minimum level, it seems likely that the Wages Councils reduced inequality between the low-paid and the well-paid by compressing the distribution of wage rates.

The toughness of the Wages Council rules - measured by the size of the minimum wages imposed relative to the average for all workers - was progressively reduced during the 1980s as the graphic shows.

The resulting relaxation of their compressing effect on differentials may help to explain why the gap between the pre-tax incomes of rich and poor is now wider than at any time since the 1800s. Abolition will simply accelerate the process.

Falls in the lowest pay rates clearly increase the number of people in poverty and as a result the amount of our taxes that has to be spent on social security benefits. The Government has tried to forestall this objection by asserting that 80 per cent of workers covered by Wages Councils were members of multi-earner households.

The insinuation is that the Wages Councils did little to alleviate poverty because most of the beneficiaries were women with working husbands who were simply making 'pin money'.

But this argument has little support from the facts. People covered by Wages Councils were only slightly more likely to be in two- earner households than the rest of the population. Indeed single parents were 50 per cent more likely to be covered by Wages Councils than the population as a whole. As single parents in work often have to pay for childcare, small cuts in their pay could well be enough to force them out of work and back on to benefits.

The cuts of 30p or more in hourly wage rates typically seen since the abolition of the Wages Councils may seem trivial. But economists at Cambridge University's Microsimulation Unit estimate that this is enough on average to cut the incomes after taxes and benefits of the poorest tenth of the population by nearly 7 per cent. For many people this would be enough to make a life solely dependent on benefits more attractive.

But what of the effects on employment? It is too early to tell directly whether the abolition of the councils has raised the number of jobs in the industries covered, especially as it has coincided with a cyclical upturn in low-paid, service sector employment.

However, a study of the impact of the loosening of Wages Council toughness during the 1980s found no evidence that this had boosted employment, and even very tentative signs that it had reduced it. This in turn suggests that the abolition of the councils will have little positive effect on employment now, and perhaps even be detrimental.

But how could minimum wages boost employment? Why does the consumption of workers not fall, like apples, when their price rises?

Traditional economic theory argues that companies maximise their profits by paying a wage that attracts enough workers so that the cost of the last one taken on is just equal to the extra revenue that he or she generates for their employer.

In theory if a company tried to pay below this level all its workers would defect to other employers. So if a minimum wage were applied, jobs would be lost throughout the industry or the economy.

But Richard Dickens, Alan Manning and their colleagues at the London School of Economics argue that this explanation is at odds with reality, (Wages Councils: Was there a case for abolition?, Dickens et al, British Journal of Industrial Relations, December 1993). They contend that companies are able to cut wages a little below this level without all their workers defecting.

This is because it is time-consuming, disruptive and costly for workers to quit and find another job. They might be unable to relocate, for example, because they cannot sell their house or do not wish to uproot their children from school.

A company exploiting this friction in the labour market may therefore be paying its workers slightly less than they are worth to it. In this case if the company is forced to pay a slightly higher wage by a Wages Council then more workers will apply for jobs at the company and it will still be profitable to take them on and keep all the existing employees, although profits will be lower than if the firm was free to set wages without restriction.

Too high a minimum wage would, of course, swamp the room for manoeuvre provided by labour market friction and mean that employment would have to fall for companies to maximise their profits. This does not seem to have happened with the Wages Councils, but should give the Labour Party pause for thought in proposing more general minimum wage legislation.

So the real impact of the Wages Councils appears not to have been to damage employment, but to cut profits and to redistribute income from low-paying employers to low- paid employees. The Government may well think that this is reason enough to be rid of them, but it should at least be honest about its rationale.

(Graph omitted)