Labour’s minimum wage reform is a gamble too far

Should businesses pay employees based on the work they do, or to cover their rising rent and energy bills? The government has changed the Low Pay Commission’s (LPC) remit, requiring it to factor in living costs and inflation when setting minimum wage rates for employers. In effect, Labour is asking the commission to make businesses pay enough to cover workers’ personal expenses — costs that companies have no control over.
This shift in the role of the minimum wage started in 2015. The LPC originally set the wage floor cautiously to avoid pushing up unemployment. After years of little apparent aggregate job impacts from a rising rate, politicians became more aggressive. George Osborne’s budget that year set a path for raising the minimum wage to a huge 60 per cent of median earnings, rebranding it the “national living wage” for over-25s. The Conservatives later commissioned a left-wing American academic who told them it could go up to 66 per cent without killing jobs.
Osborne’s rebranding, and the more relaxed attitude towards employment that it engendered, entrenched the idea that the minimum wage should be high enough to cover living costs, rather than setting a wage floor businesses could afford. After recent inflation hit low-paid workers hard, it was perhaps inevitable that Labour would task the LPC with ensuring businesses would bear the cost next time prices spiked.
In the short term, with inflation now below 2 per cent, it is unlikely this addition to the LPC’s remit will drastically alter its recommendations. Yet over time, economists worry that this additional requirement will keep pushing the minimum wage higher, especially during economic downturns, which could lead to more unemployment.
Take, for example, an oil or gas price shock. The former government economist Tim Leunig notes that under Labour’s new remit the LPC would recommend raising the minimum wage to protect low-paid workers from rising prices. Yet if businesses are already struggling with rising fuel costs, increasing wages at the same time could force them to cut jobs or reduce hours, leading to higher unemployment or underemployment.
One reason past minimum wage hikes haven’t cost many jobs has been the flexibility of the UK’s labour market. It allowed employers to adapt in other ways. London School of Economics researchers found that some firms leaned on zero-hours contracts to manage rising costs, while others cut perks or hired only experienced workers. Some even increased monitoring of staff to squeeze more out of them.
Now Labour’s Employment Rights Bill makes these adjustments harder. It introduces new workplace rights from day one and restricts the use of zero-hours contracts. It also limits businesses’ ability to reject flexible work requests. By reducing how businesses can respond to rising wage costs, Labour is thus increasing the chances that firms will lay off workers, freeze hiring, or turn to automation as the minimum wage rises further.
Adding to the pressure, Labour is considering raising employer national insurance contributions in the forthcoming budget. Businesses evaluate the total cost of employing someone against the value they create. If employer taxes rise, firms might squeeze wage growth to balance the books. Yet with a rising minimum wage, that option disappears for low-paid employees, meaning fewer job opportunities for young and unskilled workers. To make matters worse, Labour is phasing out youth minimum wage rates, further increasing the cost of hiring younger people, just as entry-level job vacancies are already plummeting.
None of this means the government should ignore high living costs. Yet rather than forcing employers of low-paid workers to provide relief for them, Labour should focus on policies that actually lower living expenses — such as planning reform to fix the housing crisis and making energy cheaper. While past wage hikes haven’t caused the job losses economists predicted, pushing wage rates higher without considering what businesses can afford, while limiting their freedom to adapt, will turn future increases into job killers.
Ryan Bourne is an economist at the Cato Institute and editor of the book The War On Prices