The lunacy of cutting or abolishing the minimum wage

A quick economic sketch:

Dr Eamonn Butler, Director of the right-wing think tank The Adam Smith Institute, makes the argument that we should scrap the minimum wage in order to reduce unemployment. Similar calls have come from right-wing Tory MPs. The IEA also unsurprisingly chimes in. With unemployment up again today, it’s likely we’ll hear more of the same from the usual suspects.

The argument behind this is simple enough. Assuming firms have a fixed amount of money to spend on wages, and they could pay some of their workers a lower equilibrium wage (because the current one is held artificially high by the minimum wage floor) they could then hire more workers – thus reducing unemployment.

But Iain Duncan Smith, the Secretary of State for Work and Pensions helpfully points out that the current benefit system leaves you better off out of work that in work. Presumably if people were able to work for below the minimum wage this would be even more true.

So what would the result of scrapping the minimum wage be? Firstly, if Butler is right, those who were currently working at the minimum wage would have lower wages. Secondly, if Duncan-Smith is also right, those who were previously unemployed and were now in work would have less money to spend than they did when they were unemployed – maybe even more-so than if they got a job today, because the minimum wage would have been scrapped.

What is a fall in wages and disposable incomes going to do? Almost certainly cause a fall in effective demand. Which as Duncan Weldon points out, is exactly the problem with the economy at the moment. And of course, unless demand were to pick up, firms are unlikely to start investing that cash they’re sitting on either.

Let’s hope that Butler and Duncan-Smith aren’t both right! As it happens I think Dr Eamonn Butler is probably the most wrong here. Firms aren’t likely to hire more people simply because labour costs have reduced. Firms are already in surplus and are net savers at the moment – they could hire more people if they wanted to. The reason they’re not doing it is because there is no effective demand for their services. And one of the reasons why there is no demand is because real wages are falling

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