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Policy sticking plasters won’t solve the low-pay, low-skills problem

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Last week saw the publication of the latest annual data on earnings. After a brief recovery starting in 2014, once again they are rising more slowly than prices. That’s not because the rate of increase in cash wages has slowed down; it simply hasn’t sped up enough to match the recent acceleration in prices inflation.

That’s relatively unusual. What is truly staggering, though, is that average real earnings remain lower than they were a decade ago. This is easily the worst decade for earnings growth since anything resembling comparable data has been available, and possibly the worst decade since the middle of the 18th century. Among advanced economies, only Greece has done worse since the financial crisis.

Yet other forces are altering the experience of working life. Most urgently, it has become clear that left to itself the labour market is not working for the low-paid and the low-skilled. The old, and important, mantra that the overwhelming priority should be to make sure that people have a job is no longer enough. There are more people in jobs than ever before, but for many their earnings are not enough to lift them out of poverty. Those with low skills not only experience low pay, they also tend to get stuck on low pay. They have little access to training and their wages don’t grow as they gain more experience. Those who enter work with poor qualifications and low levels of skill may have the most need for training once they are in work, but they are much the least likely to get any. The better educated you are to start with, the more training you’ll get.

For low-skilled men, another more recent phenomenon has been added to this toxic mixture: an extraordinary growth in part-time working. In the mid-1990s, among the fifth of men aged 25 to 55 with the lowest hourly wage, only one in twenty worked less than thirty hours a week. That’s one in five today. Obviously, fewer hours means less pay, but another reason this matters is that working part-time tends to have remarkably little value in leading to higher wages later on. For most people, especially those with higher levels of education, more experience begets more skills leading to higher wages over time. In the UK, that happy upwards trajectory simply does not exist for most part-timers.

Not all is gloom. Two policies have been remarkably successful at mitigating some of the effects of these trends. The first was the big expansion in tax credits during the 2000s. Over the past 20 years, low-income working households have experienced much lower increases in earnings than have high-income households. But, in large part because tax credits have filled the gap, their incomes have not fallen behind. The result is that, beyond what has been happening at the very top of the distribution, increased earnings inequality has not led to a rise in overall income inequality. Indeed, income inequality has declined somewhat in the most recent period.

The second is the minimum wage, now the national living wage, which has boosted the hourly earnings of the lowest-paid relative to the average. Not that one should think that a higher minimum wage can stand in place of in work benefits. Those with low hourly earnings (often, for example, second earners in a household) are not the same people as those with low household incomes. Minimum wages and in-work benefits are complements, not substitutes.

Yet even in combination, minimum wages and benefits are nowhere near a full solution to the wider problem of low skills, low wages, low incomes and growing insecurity. They create their own problems.

Benefits are withdrawn as earnings rise, limiting the value of taking on any additional work. The present system is structured to give many people a big incentive to work 16 or 24 hours a week, but not a minute more. Universal credit will get rid of the very weakest work incentives, but many recipients will still lose more than 70 pence for every pound of additional earnings.

There is obviously also a limit to how high minimum wages can be pushed. As the balance of power between firms and workers has shifted in favour of the former, there is an obvious temptation to legislate to increase pay, to enhance worker rights and to impose more responsibilities on employers. That has happened with some success not only in raising minimum wages but also in enforcing auto-enrolment into pensions.

But we are already seeing the limits to such an approach. Firms don’t have to enter into an employment contract to get the job done. The extraordinary explosion in the ranks of the self-employed in recent years is clear evidence of that. The more rights we assign to employees, the more companies will use other contractual arrangements, which will leave workers with fewer rights and less security. The growing divergence between the rights of employees and the self-employed, the growth in the gig economy and the persistence with which we continue to provide firms with enormous tax incentives to hire self-employed contractors rather than employees are all pushing in the same direction.

Tax credits and minimum wages have proved effective and important, but they are sticking plasters. Relying on a piecemeal approach to solving problems risks perverse outcomes, damaging precisely those we are trying to help. The deep problems in our labour market — low skills, a lack of training and of progression opportunities for part-time workers — require deeper and longer-term solutions.

This article was first published in The Times and is reproduced here in full with permission. Paul Johnson is director of the Institute for Fiscal Studies. Follow him on twitter @PJTheEconomist.