Living wage? Careful what you wish for

7 Nov 13

The law of unintended consequences could undermine efforts to improve incomes via a living wage, or by capping energy prices. Policy makers should take note

The announcement this week by Ed Miliband of a tax relief for firms that start paying the living wage, should Labour win the next general election, is the latest in the party political battle over living standards.

This wage policy, proposed for 2016, is very much the twin of the Labour Party’s proposal to freeze energy prices from 2015. One intends to keep down household expenditure on bills; the other to increase the amount coming in from work for those on the lowest wages. But, designed to boost living standards after 2015-16, they may both do exactly the opposite in the interim. And, alongside measures put forward by the Coalition, they illustrate the interplay between politics and the market when policymakers seek to intervene.

Since Labour revealed its proposal to cap energy prices in September, four of the ‘big six’ have announced major increases in tariffs. These may be just the latest in a recent litany of price rises, but the motivation certainly exists for firms to raise prices ahead of any prospective cap so as to give themselves as much headroom as possible, and the highest figure from which to negotiate any fixed price. In the short-term therefore, the prospect of a Labour victory in 2015 may actually lead to higher energy bills.

For its part, the living wage policy could have a similarly counter-intuitive effect over the next 18 months. It appears (quite sensibly, for many reasons) that eligibility for the tax relief will be limited to those firms that raise the wages of their employees from below £7.45 to the living wage threshold £7.45 or above. But, firms therefore have a strong incentive to hold back any increases in wages until the policy comes into force. It is far from impossible that the policy idea will serve to constrain wages in the short-term.

Ironically it appears that policy prescriptions for 2015, directed at alleviating the squeeze that households are now facing, may have exactly the opposite effect in the short-term because of how the market responds.

Such policy cliff-edges create opportunities for gaming but are not particular to the Opposition. For instance, the government has asked the Bank of England’s Financial Policy Committee to review its ‘Help to Buy’ scheme next September so that it can judge on whether the policy to boost mortgage lending and affordability is overheating the housing market.

Ironically, this policy uncertainty may have exactly the opposite outcome to the stated desire, with the market bringing forward as many schemes and transactions as possible ahead of the review. Therefore the threat to pour cold water on the market in 12 months’ time may serve simply to pour petrol on it now. (The government could, of course, have given the Bank a freer hand and encouraged it to intervene at any moment it sees fit – but this might have injected more immediate uncertainty and dampened enthusiasm from the start.)

All these cases raise interesting questions about how markets respond to future policy uncertainty. The potential for ‘gaming’ may well undermine the outcomes of the intended policy.

None of this is to say that politicians should leave the market to its own devices when problems are apparent. And, they are in part an outcrop of politics ahead of an election and of the tension that comes from government tending to work by fixed schedules for public decision-making, whereas companies can be flexible and adapt their strategies accordingly.

But, they show that policy intervention and uncertainty may provoke short-termism in the market. At a time when the government is accepting a set of recommendations to promote long-termism amongst investors, politicians and policymakers it might do well to reflect on how far they themselves are helping.

This post first appeared on the Social Market Foundation’s Market Square blog

  • Nigel Keohane

    Nigel Keohane is the director of research at the Social Market Foundation

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