Will Osborne’s UK National Living Wage Really Cost 60,000 Jobs?

It’s pretty dismal if you’re left-leaning in the UK right now.  Not only did Labour lose the election catastrophically and – adding to the shock – much more badly than implied by the polls, they’ve now gone nuts and elected a leader who can’t win, and even if he did advocates policies that belong in the 1970s.  Meanwhile Osborne is implementing a policy Labour should have been pushing during the election campaign, namely what is in effect a higher minimum wage, his so-called National Living Wage (NLW) for over 25s.  Of course, Osborne’s overall package is disastrous for many of the poorest households who will be worse off even with the NLW because of simultaneous cuts to tax credits.

If you’re following the debate around the NLW – for example as expertly hosted by the Resolution Foundation – it’s clear that the Big Question is how much effect the NLW (and increased minimum wages in general) is likely to have on (un)employment.  Now, based on logical argument (that being my favoured modus operandi), and, of course, because my philosophy is to question everything, I am highly sceptical of the mainstream line of reasoning that labour behaves like paper-clips.  Put up the price of paper-clips and you’ll sell fewer; put up the price of labour and unemployment will rise is the gist of it.  But this ignores the fact that increasing wages itself creates demand.  More on this later.

Much as I believe in the power of reasoned argument, I nevertheless recognise that it’s a good idea to first look at the strengths and weaknesses of the opposing position.  In this post I therefore want to focus on the meme that Osborne’s NLW will cost 60,000 jobs.  How well-founded is this estimate?  You’ll see it quoted frequently, for example, by the Resolution Foundation and on the Institute for Fiscal Studies’ (IFS) website and no doubt in mainstream media reports.  The original source is the Office for Budget Responsibility.  As far as I can tell the 60,000 figure first appeared in a report, Summer budget 2015 policy measures (pdf) which was issued around the time of Osborne’s “emergency” budget in July (the “emergency” being that the Tories had won a majority), when he bombshelled the NLW announcement.

So, I asked myself, being keen to get right to the bottom of things, where did the OBR boffs get their 60,000 estimate from?  Well, what they did was make a couple of assumptions (Annex B, para 17 on p.204), the key one being:

“…an elasticity of demand for labour of -0.4… This means total hours worked fall by 0.4 per cent for every 1.0 per cent increase in wages;”

They stuck this into their computer, together with the assumption that “half the effect on total hours will come through employment and half through average hours” and out popped the 60,000 figure.

But where does this figure of -0.4 come from?  They explain in Annex B.20:

“The elasticity of demand we have assumed lies within a relatively wide spectrum of empirical estimates, including the low-to-high range of -0.15 to -0.75 in Hamermesh (1991). This is a key assumption, with the overall effects moving linearly with it.”

The Hamermesh reference is given in footnote 3 on p.205, together with another paper:

“Hamermesh (1991), “Labour demand: What do we know? What don’t we know?”. Loeffler, Peichl, Siegloch (2014), “The own-wage elasticity of labor demand: A meta-regression analysis””, present a median estimate of -0.39, within a range of -0.072 to -0.446.” (my emphasis)

Evidently Hamermesh is the go to guy for the elasticity of demand for “labor”.  So I thought I’d have a look at how Hamermesh’s figure was arrived at.

I hope you’ve read this far, because this is where matters start to become a little curious.

Both papers referred to in footnote 3 are available online.  Here’s what Hamermesh actually wrote (it’s a screen print since the document was evidently scanned in to produce the pdf Google found for me):

So what our guru is actually saying is that although the demand elasticity figure is between -0.15 and -0.75, as assumed by the OBR, his best guess – underlined, when that was not a trivial matter, necessitating sophisticated typewriter operation – was actually -0.3.

So why didn’t the OBR use the figure of -0.3?

Perhaps the answer is to do with the -0.39 they quote from the Loeffler, Peichl and Siegloch paper (pdf).  But this is what those guys actually wrote:

“Overall, our results suggest that there is not one unique value for the own-wage elasticity of labor demand; rather, heterogeneity matters with respect to several dimensions. Our preferred estimate in terms of specification – the long-run, constant-output elasticity obtained from a structural-form model using administrative panel data at the firm level for the latest mean year of observation, with mean characteristics on all other variables and corrected for publication selection bias – is -0.246, bracketed by the interval [-0.072;-0.446]. Compared to this interval, we note that (i) many estimates of the own-wage elasticity of labor demand given in the literature are upwardly inflated (with a mean value larger than -0.5 in absolute terms) and (ii) our preferred estimate is close to the best guess provided by Hamermesh (1993), albeit with our confidence interval for values of the elasticity being smaller.” (my emphasis)

Yep, the Germanically named guys from Germany came up with a figure of -0.246, not the -0.39 in the OBR’s footnote 3.  The OBR’s -0.39 is a rogue figure.  It must be some kind of typographical error, since they correctly quote the possible range ( -0.072 to -0.446) for the demand elasticity.  Bizarre, frankly.

It’s even more mysterious when you consider that the OBR would surely have used the elasticity of demand for labour previously.

Based on the sources they refer to it seems the OBR should have plugged -0.3 at most into their model, not -0.4.  This would have given a significantly lower estimate of the increase in unemployment attributable to the introduction of the NLW, that is, roughly 45,000 rather than 60,000.

Why does this matter?  It matters because the idea that a higher minimum wage will increase unemployment is one of the main arguments against it, frequently cited by those opposed to fair wages and giving pause to those in favour.  Here, for example, is what Allister Heath wrote recently in a piece entitled How the new national living wage will kill jobs in the Telegraph:

“…it is clear that George Osborne’s massive hike in the minimum wage will exclude a significant number of people from the world of work. There is a view that this might be a worthwhile trade-off: if millions are paid more, does it really matter if a few can’t find gainful employment any longer? Again, I disagree: there is nothing more cruel than freezing out the young, the unskilled, the inexperienced or the aspiring migrant from the chance of employment.

Being permanently jobless is a terrible, heart-wrenching state; the Government should never do anything that encourages such a catastrophe.”

Clearly, Heath’s argument (which I don’t in any case agree with) carries more weight the greater the effect of a higher minimum wage on unemployment.  But getting the numbers wrong isn’t the only problem with the OBR’s use of the demand elasticity of labour, as I’ll try to explain in my next post.

Housing Horror

Over the last few decades, here in the UK, we’ve become very good at pointing to apparent failure.  Often despite considerable objective evidence to the contrary.  Apparently we’re no longer any good at making things (compared to Germany and China, maybe, but not to most other countries), our armed forces are puny (compared to the US, maybe…), our energy supply is insecure, our public services are falling apart, the English Premier League is in a mess…  Such angst is spreading elsewhere in the West, but somehow you rarely hear fundamental criticism of our political and economic system.  You’d think the political process was merely flawed, a little unfair in places, perhaps, a little too tolerant of peccadilloes by the powerful, but basically sound, and very difficult to improve.  Despite considerable objective evidence to the contrary.

We’re just now quite rightly much vexed over the issue of housing (warning, link is to page of all 865 comments, and counting).

The issue, in a nutshell, is the extent to which the state should pay to provide some people with a standard of housing higher than they can afford on the open market.  The 1997-2010 Labour government (supported by at least the non-Tory controlled local councils, who have executive powers in area of housing), was quite enthusiastic about doing so, though in the main merely continued existing policies.  As time has gone on, though, the provision of housing to some by the state has been a factor in driving those not eligible for, or simply not claiming, state support, into less desirable – smaller, and often, crucially, less conveniently located – accommodation.  It should be noted that Labour’s attempts to increase the supply of housing over recent years has been effectively stymied by nimby campaigns, if not supported, then at least not effectively challenged by foot-dragging Liberal and Conservative local councils.  Despite guilt all round, the new Coalition government has decided to address the problem, in part, I suggest, as part of their strategy of blaming everything on Labour.   And in that regard, housing is pretty much an open goal.

As the debate continues, we see not one but two failings of our political system in stark relief.

The first failing is a confusion: are we making policy on the basis of reason or emotion?  Let’s take people who aren’t working for whatever reason (unemployed, incapacitated or retired).  Now, I’m not even going to argue this on the basis of rights.  It simply makes no sense, as hundreds of bloggers have pointed out (to massive approval, judging by “Recommendation” statistics), for workers to commute in every day from the outskirts of conurbations such as London, whilst people who don’t actually need to live there are paid to do so by the state.  Why, oh, why does Labour defend the indefensible? (Link to where Polly Toynbee explains the Coalition’s inhuman proposals – remember we’re essentially taking about a zero-sum game, here: what we give to one household, we deny to another).

But – there’s always a “but” – there are “priority cases” as a Councillor Timothy Coleridge (Tory, Kensington and Chelsea) explained on Radio 4 this morning trying to “soften” the policy.  There’ll be a “transition fund”, we were told.  He seemed to be particularly sympathetic to the elderly.  So it seems we’re going to make value judgements.

It might be worth digressing at this point to note that gerrymandering is a factor, because of first-past-the-post local elections.  Politicians want to keep their voters in their constituency and move the opposition’s out!  I suspect the Tories see the elderly vote as key to their next few terms in office, so I was immediately suspicious of Councillor Coleridge.  Any “prioritisation” must surely be done according to an objective, nationally applicable set of criteria.  Trouble is, value judgements are why we’re here in the first place.

If the policy is to minimise the fiscal cost of housing benefit, and optimise the use of housing, then that’s what we must do.

Here’s a case of the same sort of thinking, from a letter to the Guardian, by an Ann Tobin:

“The house was lovely, built to Labour’s postwar housing standards (later abandoned by the Tories). Us kids grew up and moved on and my parents stayed there until my mother died in 1998, 50 years after they had moved in. My father died three years before her. Yes, the house was too big for her, but she liked to invite her children, grandchildren and great-grandchildren to stay.” [my stress]

This partly explains how we’ve reached the present situation.  This identifiable individual (Ann Tobin’s mum) “liked” her big house, provided by the state.  Meanwhile, there is a waiting list of millions of families for such houses.  Maybe, because Ann Tobin’s mum was allowed to keep a house she liked, a family with a couple of school-age kids spent years moving about between emergency B&B accommodation to temporary lodgings.  Maybe that family would have “liked” a house of their own.  Because Ann Tobin’s mother has been allowed to stay in a family house, another family that can’t be precisely identified is living in poor or insecure accommodation.  This is crazy.  Housing supply is limited (though could be improved).  Why is it so difficult for people to understand that because of that limitation one decision impacts on others?  In areas with a limited supply of housing, its allocation is a zero-sum game.  You can’t give some people a place they’d “like” without denying others the same thing.

To my mind what we’re witnessing is the complete failure of post-war housing policy in the UK.  Council housing, for example, makes no sense.  It locks in housing allocation at one moment in time, making no allowance for the changing world we live in. Or the changing size of individual families for that matter.

This brings me on to the second failing of the political system.  Politicians see direct action by the state as the only way to achieve anything.  So we’re told we have to build more social housing.  Wrong.  We simply have to build more housing, period.  100,000 private homes will house 100,000 households just as well as 100,000 social homes will.  100,000 fewer households will be waiting for housing in either case.

And in actual fact, over the last decade or so, demands for social housing have actually reduced the total provision of housing.  Why?  Because the main way social housing has been provided has been through Section 106 agreements with housing developers.  In this daft system, housing developers have been given planning permission in return for including schools, hospitals or social housing in their schemes.  And you thought schools, hospitals and social housing all came out of the health, education and housing budgets?  This tax on developers, or first-time buyers, however you want to look at it, has the effect of reducing housing provision.  At a given house-price level, building houses is less profitable than otherwise would be the case, so fewer invest in that activity than in other opportunities.  Fewer houses get built, house prices rise, and more prospective purchasers find themselves on social-housing waiting lists.  Section 106 agreements to provide more social housing because it’ll be needed are, in aggregate, self-fulfilling!

I can’t even bring myself to discuss how shared equity schemes and other devices to subsidise house purchases simply push up the general price in the market.

The solution seems to me blindingly obvious, so I’m going to cut to the chase (a phrase, incidentally, that grated when used by Bob Hoskins in Made in Dagenham, since it wasn’t in general usage in 1968 when the film was set – I remember first hearing it in 1994).

We’ve simply got to manage the relationship between wages, at the low end, and house prices so that working people can afford to house themselves and their families.  The implication is that there needs to be a higher minimum wage in areas where housing is expensive.  It is simple exploitation to be paying the national minimum wage in central London, because there are only a limited number of possible outcomes.  Either workers commute in which case they spend more time and money than if they were working near their home; or living-standards drop and people end up sleeping in shifts; or benefits are necessary to top-up earnings, subsidising employers and consumers in expensive areas.  Ideally, employers would have to pay more in expensive areas, but the labour market is, has been for some time, and will be for some time, a buyers’ market.  Indeed it is government policy to force people to take any job they can get.

What a mess! State provision of housing has led to a situation where the minimum wage is nowhere near a “living” wage.  Perhaps that’s a bit strong: rather, state provision of housing and other benefits has provided a safety-valve so that pay has been allowed to become gradually lower and lower relative to socially accepted minimum living standards.

Maybe some blame should be apportioned, in order to unravel some of the mystery how we arrived in this absurd situation.

First, there are those, almost all in the Labour Party, but not all of the Labour Party, who believe it is right that the state provides housing and benefits on the basis of need.  “Capitalism” is so “unfair” that the state must step in.  As I’ve mentioned this policy has failed.

Second, there are those in all three parties who take a position I would characterise as “hand-wringing liberals” who make no attempt to analyse the problem and produce a complete policy.  They just want to address the problems of those with whom they empathise.  The trouble is, as I’ve also already said, with limited supply, allocating a house to Mr Jones simply moves Mr Smith onto the waiting list.  As a rationalist this is the position I detest most of all.  Government has a duty to find as solution for everyone, not self-righteously apply sticking-plaster where they most easily can.

Third, there are those in all three parties – since many of the individuals concerned have a vested interest in the form of their own properties – who explicitly or tacitly believe the natural order of things is for people like themselves to own their own homes, ever-rising in value, and that there must necessarily be “the poor” who don’t deserve or are incapable of having the same thing.  Explicitly in the case of some Conservatives… heeeere’s Boris!:

“Better a stagnant housing market, [those arguing for an end to housing speculation] will say, than another great boom and another great bust. Which is all very well, in theory.

In practice, it looks as if flattening off the housing market is both risky in the short term, and unachievable in the long term. The sad truth is that it is still psychologically essential to the British middle classes to have a sense that our principal asset is gently appreciating in value, or at least that it will over the long term.”

Stark-staring bonkers, of course.

Houses simply can’t appreciate in value indefinitely compared to other goods and services.  The world doesn’t work like that.  Eventually house price rises will become self-defeating: even if they don’t stimulate more new-build supply (because of self-interested nimbyism); or inflation, causing interest-rate and hence mortgage increases; they’ll eventually act as such a drag on the economy that activity moves elsewhere – abroad, most likely – and housing demand and prices fall.

Those who buy into the view that the increasing value of their home represents a permanent increase in wealth support the ongoing British class division implicitly.  What they refuse to countenance is entirely feasible: it is possible for everyone in work to own their own home, or rent at a market rate, if they prefer the flexibility they gain that way.

So the three stooges are “Old Labour” socialists, who don’t believe markets can ever be fair; bleeding heart, sawdust-headed “Liberals”; and divided nation, blue-blood-is-just-better “Conservatives”.

It doesn’t have to be this way.  Instead of accepting capitalism as it is (“Conservative”), or rejecting it (“Old Labour”), or ooh, poor little kitten! (“Liberal”), we can make capitalism fairer.  A much higher minimum wage, relative to local house prices, would solve many of the problems that are causing such angst.

 

Job Sums

I’ve been trying to avoid commenting on the General Election campaign, since it would be a huge distraction from far more important issues, but I can no longer ignore the absurd reasoning that’s making its way into the media.

Yesterday, the Guardian, bless their little cotton socks, tried, under the banner “Reality check”, to answer the question “Do national insurance rises cost jobs?” (if you follow the link, then don’t be puzzled – as usual, the online title is different to that in the print version of the paper). The Guardian’s answer is slightly to the “solid” side on a cute little dial that goes from “shaky” to “solid” – let’s call it “mushy”. They seem to think NI rises might cost jobs.

The article included some strange logic, most notably from Richard Dodd of the British Retail Consortium who apparently argued that “…in a competitive market, retailers will struggle to pass the tax on in the price of goods…”. The “competitive market” has nothing to do with it, since the tax will affect all employers. No-one has a new competitive advantage as a result of the tax.

The Guardian also failed to question why business leaders might be against an NI rise. The point is that increasing taxes (like other costs) reduce profitability (temporarily) because in general it takes time to raise prices and recover margins following an increase in costs. As clearly testified by Richard Dodd’s concerns about how “retailers will struggle to pass on the tax”.

But the Guardian’s piece made a bigger mistake – in fact they managed to completely miss the point. You can only answer a question like whether an NI increase will “cost jobs” by considering also what happens to the money raised by the tax. Taxes rob Peter to pay Paul, so if you can only evaluate the effect on any measure – in this case jobs – by looking at the issue in the round.

Since, as argued by the Guardian, the effect on (private sector) jobs of the NI increase is marginal and the money will be spent on retaining jobs in the public sector, then, if it’s the overall number of jobs in the economy you care about, you should be in favour of the NI proposal. The arguments put forward by the Tories and their business friends are misleading.

[I should say I don’t actually believe the prime goal of an economy should be to create jobs and I don’t believe the Tories or business leaders do either. The goal should be to produce as much as possible with as few resources – including people – as possible. Then we’ll all be rich and jobs will then take care of themselves. What I object to is all the dissembling. Having said that, unemployment is high and rising, so it’s not the best time to be bearing down on jobs. In other words, the trajectory Labour wants to put the economy on makes more sense to me than that which the Tories propose. We may as well, for instance, maintain staffing levels in the NHS – thereby saving and improving lives – and, in particular, continue to invest in the IT necessary for future efficiency savings, rather than have people sitting around on the dole].

Today’s FT gives us some clues on how many jobs would be lost by reducing public expenditure by an amount equivalent to that which would be raised by the NI increase. The FT appears to consider a slightly different question, i.e. the effect on jobs of additional public spending cuts in 2010-11 (i.e. this financial year), as proposed by the Tories. The point, which several BBC news bulletins have missed this morning, is that the NI rise only comes in in 2011-12. With the usual disclaimer that unless I’ve completely misunderstood something, in which case perhaps someone will be good enough to put me right…

And it’s surprisingly in the FT, where a “Cameron adviser discloses cuts detail” that the serious dissembling starts.

First, there’s an enormous howler. The article describes a proposal for £1-2bn in job savings by natural wastage this financial year, 2010-11. That is, during the year that’s already started. But the article appears to reckon on a saving of the full annual cost of the jobs – estimated to be £50,000 each – this financial year. Wrong. You can only reckon on that saving if the jobs disappear at the start of the financial year. On average they will disappear halfway through the year (actually later than that, because the Tories wouldn’t even be able to start until May 7th). So on average only £25,000 will be saved this financial year per job shed. Therefore, to save £1-2bn this financial year would require the wastage of £1-2bn/£25,000 = 40,000 – 80,000 jobs, not the 20,000 to 40,000 stated.

Note that if the jobs are lost other than by natural wastage there will be redundancy costs and less, or more likely negative, cashflow savings this financial year. Basically the Tories need to find 40-80,000 retirees or leavers this year who have not yet been accounted for. And whose jobs are so inessential that they don’t need to be replaced. Tough call, I’d have thought, when there aren’t so many other jobs out there to move to.

Furthermore, some of the cost savings are in things like office space, not salary. There’s always going to be a delay in realising such savings, because you can’t move to a smaller office every time someone retires and is not replaced.

Even furthermore, the cost in benefits of 40-80,000 people who would otherwise have had a public sector job to go to needs to be subtracted from the fiscal saving. Let’s be generous and assume that this has been taken account of in the £50,000pa annual cost of a public sector job quoted in the article. You can do your own sums if you want to assume the actual saving is less than £50,000pa (or less than £25,000 saving on average in the current FY, 2010-11).

Second, we’re discussing jobs in the overall economy. The FT article considers how the Tories propose to save an extra £12bn this financial year:

“Other cuts set out by Sir Peter include reductions in IT spending, yielding ‘potentially at least’ £2bn to £4bn. Renegotiation of contracts with suppliers of goods and services – which Sir Peter described as ‘not rocket science … it’s not about beating them up on price’ – would save about £3bn.

Cuts to ‘discretionary’ spending, such as consultants and staff expenses, should yield a further £2.5bn for 2010-11, he said. He declined to be drawn on a figure for property costs.”

Let’s see. Reductions in IT spending will cost jobs at IT suppliers, not all of them overseas. “Consultants” last time I looked were living, breathing working people as well. Reducing staff expenses would cost jobs indirectly as would renegotiation of contracts. The trouble is the lead time on renegotiation of contracts as well as “property costs” – realised presumably by selling offices – is months to years, so achieving the promised cashflow savings this financial year is implausible, to say the least.

I simply don’t find the Tory plans credible. They’d have more chance of getting my vote if they were actually honest about what they believed in. I remember Labour came to power in 1997 with a promise to stick to the Tory spending plans for the next two years. Cameron thinks he knows better. His position is contradictory – he said on the radio this morning that it was difficult for an Opposition to make spending plans, yet he’s confident he can make huge additional cuts this year. Cameron was once thought of as the new Blair. He now seems to have morphed into the new Thatcher. It seems to me that he’d give the economy the sort of shock treatment it received in the early 1980s. Steeply rising unemployment, an assault on the public sector and so on. Maybe it needed it then. I don’t know. But if it needs it now, perhaps Cameron should be making that case, not promising to save jobs when, at least in the short term, his policies are more likely to produce higher unemployment than would otherwise be the case.

Cameron is giving the impression that he can reduce public sector borrowing and unemployment this year and next compared to Labour’s plans. If he really believes this then he’s seriously wrong and not ready for the job of PM. If he doesn’t believe he can square the circle, then perhaps he should clear up the misunderstanding (or is he already planning to make his old chum George Osborne the fall guy when the Government can’t deliver?). The only other possibility is that he’s deliberately misleading the electorate.