Incentives and the National Minimum Wage

April 15, 2011 12:00 PM

Dominic Browne has written a blog on the bold claim by the National Institute of Economic and Social Research (NIESR) that the National Minimum Wage (NMW) “need not harm youth employment” over at Left Foot Forward. Strong stuff. The paper finds that in the weeks preceding the 22nd birthday (when the higher adult NMW rate applied) employment rates in low skilled individuals fall and then rise in the few weeks afterward. The mealy-mouthed reticence is well advised. Unfortunately for the fanciful implicit theory that unemployment is caused by too low a minimum wage, the rate quickly falls away from that initial high and ends up even lower than people 18 months younger. You would expect the employment rate among those aged 22 and a half to be higher than those who are only just aged 21. Sadly, it’s not.



Browne doesn’t address this point in his blog but instead opts to use language almost calculated to misinterpret the data in the NIESR report, as indeed the authors seem to have done themselves. As can be seen from the chart above (taken from the NIESR report, p25), the data does show that the predicted employment rate falls steadily in the 52 weeks to the 22nd birthday of low skilled individuals. It also shows a significantly higher rate immediately after the 22nd birthday, the regression discontinuity, which then falls for approximately 30 weeks before slowly rising once again. The report concludes:
“on turning 22, young low skilled people find work more attractive compared to when they were 21 years old, because the wage on offer has increased. This may induce them to increase participation in the labour market, or to increase their job search intensity.”

It is significant that predicted employment rates deteriorate in the run up to the 22nd birthday. The NIESR says:
“Those just a few weeks short of 22 may turn down job offers that they would have taken in the absence of the NMW if they know they will receive a higher wage offer once they turn 22”

Such behaviour is irrational. Why would someone turn down a job because they would receive a higher rate after having qualified for the adult rate in the near future when, having accepted that job, their rate would increase to the higher adult one anyway? However, people do not always act rationally (especially in the short term) so it is nonetheless a conceivable explanation. Perhaps some might erroneously think that they would continue be paid at the youth rate even after they qualify for the adult rate. This is not a benefit of the scheme, though. It’s a cost. It means the minimum wage rate could be holding people back by dissuading them from applying for or accepting jobs before their 22nd birthday.

Sadly, Dominic Browne’s hesitance fades into foolhardy wishful-thinking toward the end of the blog when he criticizes the Adam Smith Institute’s Eamonn Butler for noting that young people often have little or no experience of employment and few marketable skills. Apparently such an observation is ‘insulting’ to those who ought to be paid a ‘fair wage’. However insulting he finds it, a ‘fair’ price must surely be one agreed by the buyer as well as the seller. When the seller is legally forbidden from selling below a minimum price and the buyer doesn’t think it’s worth that minimum price, we shouldn’t be surprised when there are fewer transactions. In other words, higher unemployment. Browne has some questions about what to do to help the young unemployed:
“Even if one were to accept there was any truth in this, one would still have the problem of how to incentivise young people into work so as to give the necessary experience, if a pay of £4.92 an hour has already priced them out of the market.”

[caption id="" align="alignright" width="224" caption="One for you, 19 for me"][/caption]

This isn’t difficult. A claimant who loses Housing Benefit, Council Tax Benefit and tax credits, at the same time as paying income tax and NICs, faces a marginal tax and benefit withdrawal rate of 95.5 per cent. See our paper on Welfare Reform in Tough Times and our video at the bottom of this blog for more about how taxes and welfare withdrawal rates stack up to make work very unattractive for those on low incomes.

First, you could stop banning them from selling their labour at a price employers are actually prepared to pay (rather than a price politicians and bureaucrats deem to be ‘fair’.) Second, you could reduce the attractiveness of the incentive package you offer in exchange for them not working, in the form of Job Seekers Allowance (JSA), Housing Benefits and other income and JSA-related material benefits that become less attractive with employment. Third, you could stop taxing already low wages so that they actually keep the money they earn rather than have it confiscated by the taxman. A good place to start would be raising the personal allowance to £10,000.

Dominic Browne has written a blog on the bold claim by the National Institute of Economic and Social Research (NIESR) that the National Minimum Wage (NMW) “need not harm youth employment” over at Left Foot Forward. Strong stuff. The paper finds that in the weeks preceding the 22nd birthday (when the higher adult NMW rate applied) employment rates in low skilled individuals fall and then rise in the few weeks afterward. The mealy-mouthed reticence is well advised. Unfortunately for the fanciful implicit theory that unemployment is caused by too low a minimum wage, the rate quickly falls away from that initial high and ends up even lower than people 18 months younger. You would expect the employment rate among those aged 22 and a half to be higher than those who are only just aged 21. Sadly, it’s not.



Browne doesn’t address this point in his blog but instead opts to use language almost calculated to misinterpret the data in the NIESR report, as indeed the authors seem to have done themselves. As can be seen from the chart above (taken from the NIESR report, p25), the data does show that the predicted employment rate falls steadily in the 52 weeks to the 22nd birthday of low skilled individuals. It also shows a significantly higher rate immediately after the 22nd birthday, the regression discontinuity, which then falls for approximately 30 weeks before slowly rising once again. The report concludes:
“on turning 22, young low skilled people find work more attractive compared to when they were 21 years old, because the wage on offer has increased. This may induce them to increase participation in the labour market, or to increase their job search intensity.”

It is significant that predicted employment rates deteriorate in the run up to the 22nd birthday. The NIESR says:
“Those just a few weeks short of 22 may turn down job offers that they would have taken in the absence of the NMW if they know they will receive a higher wage offer once they turn 22”

Such behaviour is irrational. Why would someone turn down a job because they would receive a higher rate after having qualified for the adult rate in the near future when, having accepted that job, their rate would increase to the higher adult one anyway? However, people do not always act rationally (especially in the short term) so it is nonetheless a conceivable explanation. Perhaps some might erroneously think that they would continue be paid at the youth rate even after they qualify for the adult rate. This is not a benefit of the scheme, though. It’s a cost. It means the minimum wage rate could be holding people back by dissuading them from applying for or accepting jobs before their 22nd birthday.

Sadly, Dominic Browne’s hesitance fades into foolhardy wishful-thinking toward the end of the blog when he criticizes the Adam Smith Institute’s Eamonn Butler for noting that young people often have little or no experience of employment and few marketable skills. Apparently such an observation is ‘insulting’ to those who ought to be paid a ‘fair wage’. However insulting he finds it, a ‘fair’ price must surely be one agreed by the buyer as well as the seller. When the seller is legally forbidden from selling below a minimum price and the buyer doesn’t think it’s worth that minimum price, we shouldn’t be surprised when there are fewer transactions. In other words, higher unemployment. Browne has some questions about what to do to help the young unemployed:
“Even if one were to accept there was any truth in this, one would still have the problem of how to incentivise young people into work so as to give the necessary experience, if a pay of £4.92 an hour has already priced them out of the market.”

[caption id="" align="alignright" width="224" caption="One for you, 19 for me"][/caption]

This isn’t difficult. A claimant who loses Housing Benefit, Council Tax Benefit and tax credits, at the same time as paying income tax and NICs, faces a marginal tax and benefit withdrawal rate of 95.5 per cent. See our paper on Welfare Reform in Tough Times and our video at the bottom of this blog for more about how taxes and welfare withdrawal rates stack up to make work very unattractive for those on low incomes.

First, you could stop banning them from selling their labour at a price employers are actually prepared to pay (rather than a price politicians and bureaucrats deem to be ‘fair’.) Second, you could reduce the attractiveness of the incentive package you offer in exchange for them not working, in the form of Job Seekers Allowance (JSA), Housing Benefits and other income and JSA-related material benefits that become less attractive with employment. Third, you could stop taxing already low wages so that they actually keep the money they earn rather than have it confiscated by the taxman. A good place to start would be raising the personal allowance to £10,000.

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