Evan Vitale Consulting: George Osborne's Message To UK Business: Pay People More!

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I’m uninspired by the pronouncements of UK politicians. Their grasp of elementary economics is generally woeful. But George Osborne, the Chancellor of the Exchequer, has just displayed a fine command of economic doublespeak. Even I was impressed. Though I’m not sure that he fully understood the implications of what he said…..

The UK’s Conservative Party, like its Labour Party and most of the media, is obsessed with deficit and – ultimately – public debt reduction. Never mind dreadful productivity, falling real incomes, high private sector debt burdens, under-employment and inadequate investment: public sector borrowing is THE economic problem of our time. The deficit is TOO HIGH. Public spending MUST BE CUT. And George is the man to do it.

Osborne informed the Conservative Party Conference that, if re-elected, he would freeze working-age benefits for two years. Assuming inflation remains positive, this means a real-terms cut in benefits not only for the unemployed, but also for those in work who are receiving a range of benefits including earned-income tax credits, housing benefit and child benefit. It’s a further squeeze on real incomes for low- to middle-income earners. This went down very well with his predominantly grey-haired, well-heeled audience, the vast majority of whom would not be affected. Austerity is always popular when it affects somebody else.

George Osborne. Photo credit: The Telegraph

Speaking to BBC reporters afterwards, John Cridland of the Confederation of British Industry (CBI) welcomed Osborne’s announcement:

What businesses want is higher consumer spending. And that shouldn’t come from benefits. It’s got to come from people getting into work and getting higher paid jobs so that they can spend money at the weekend.

Spot on, John. Businesses do indeed need higher consumption spending, and it would be FAR better if it didn’t come from the Government by way of benefits. If there were higher consumption spending (and if UK exports weren’t being clobbered by the Eurozone disaster), productivity could increase, people would earn more (since wages are usually linked to productivity), business profitability would improve and everyone would feel good.

But there’s a problem, isn’t there, John? Earned-income tax credits and the like are indirect wage subsidies, since they enable businesses to pay lower wages than people can live on. The effect of this is that work is spread out more: fewer people are unemployed, but individually they both earn and produce less. To my mind, the UK’s strong employment performance is directly linked to its poor productivity and low earnings growth, and that in turn is due to the failure of both public and private sector investment since the financial crisis. Put bluntly, when businesses are being subsidized to employ large numbers of low-paid workers, why would they invest in technology to enable them to employ a smaller number of highly-paid workers for whom there is no subsidy?

Working-age benefits don’t give anyone but fraudsters a comfortable life. For there to be higher consumption spending, we need more people to be earning too much to qualify for benefits – not because benefits have been cut, but because employers are paying them more. We need the MEDIAN wage, not the minimum wage, to rise.

Unfortunately no-one is talking about this. Both the Labour Party and the Conservative Party have committed to raising the minimum wage, though they differ over the amount: but neither so far has addressed the clustering of wages around the minimum wage and the erosion of wage differentials. This is terrible policy. When people are unable to refuse work because of benefit sanctions, the combination of minimum wages with in-work benefits depresses wages for everyone. This, coupled with the disappearance of skilled middle-income production jobs and their replacement with lower-skill, lower-wage service jobs, is the reason why rising employment in the UK has not resulted in rising wages as we would normally expect.

So Osborne has now committed to a real-terms cut in in-work benefits. By doing so he has passed some of the responsibility for maintaining consumer spending over to the businesses that depend on it. His real message is not to benefit recipients, but to businesses:

If you want more consumer spending, RAISE WAGES.

Of course no senior Conservative party politician could say this openly. It would be political suicide. The Conservative party is supposedly business-friendly, after all.

But it desperately needs to be said. It’s not just that it is morally wrong for businesses to pay wages that people cannot live on in the expectation that they will be topped up with benefits. It’s the long-term effect on the economy of subsidizing businesses to employ low-wage unskilled labor instead of investing in physical capital and skills development. A low-skill, low-wage economy is a poor one. If the UK is to remain a rich, prosperous country, it must invest in both physical capital and in the skills of its workforce. To the extent that in-work benefits discourage businesses from investing and workers from training, they are a bad idea.

And of course – returning for a moment to the current obsession – in-work benefits also prevent deficit reduction. The key to “driving down the deficit”, as Osborne put it, is progressively to replace public sector benefits with higher wages. Raising the median wage would both reduce the benefits bill and increase income tax and National Insurance revenues, while increasing consumer spending would raise VAT receipts.

John Cridland. Photo credit: CBI

Of course, Cridland didn’t mention the need for businesses to pay higher wages. How could he? He represents businesses. Maybe he didn’t realize that Osborne’s announcement amounts to derailing their gravy train. Or maybe he did, but he didn’t dare say so. After all, just as it would be political suicide for Osborne to say openly that businesses must pay higher wages, so it would be more than Cridland’s job is worth to admit that this is what Osborne meant.

Osborne’s working-age benefits freeze will hurt people. But it will also hurt businesses, unless they change their ways. And it is the effect on businesses that really matters. Indirect government subsidy of low-wage, low-investment businesses must end. The business community must accept its responsibility to invest in physical resources, develop the skills of its workforce, and pay wages high enough to sustain the consumer demand upon which business – and ultimately the whole economy – depends.

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