Low Pay and Economic Growth - Analysis and Evaluation Arguments

Here is a suggested answer to this question. "Evaluate the view that low pay in the UK labour market is a barrier to economic growth."

KAA Point 1:

Economic growth is defined as a sustained increase in a country’s productive potential. Low pay occurs when someone in a full-time job earns less than sixty per cent of median earnings. One likely impact of low paid work is that aggregate consumption will be lower even though households on low incomes have a higher average propensity to consume. Weaker demand for goods and services can lead to a fall in planned capital investment which in turn has consequences for both the size and productivity of the capital stock operated by firms. Flat consumer spending also leads to higher levels of spare capacity which is a further barrier to investment including FDI inflows. In the long run this holds back GDP growth.

Evaluation Point 1:

A counter argument is that there are many factors affecting aggregate demand and consumption in particular. For example, the welfare benefit system might offer top-up transfer payments to help to stop family incomes falling below a desired minimum level. And, in an increasingly flexible labour market, many people have more than one job – perhaps working extra hours part-time to supplement their income. If income tax allowances are increased, this takes the majority of the lowest-paid workers out of direct taxes altogether which provides extra support to their disposable income and spending.

KAA Point 2:

A second way in which persistent low pay can stifle economic growth is through damaging the incentives for people to actively search for work in the labour market. In many jobs such as cleaning, caring and security, the hourly rates of pay are only marginally above assistance available from the social safety net. When one adds in the costs of commuting to work and finding affordable child care, for many people there is an ongoing poverty and unemployment trap which can lead to higher levels of economic inactivity. This can cause a contraction in the aggregate labour supply and ultimately bring about an inward shift of long run aggregate supply. If LRAS declines, then the trend rate of economic growth might decline.

Evaluation Point 2:

However, there are several ways in which the growing problem of economic inactivity can be addressed. One is to encourage more businesses voluntarily to pay a living wage to their employees, especially those firms that are sufficiently profitable to do this over the long term. A living wage is higher than the statutory minimum wage and should help to create a “wedge” between earnings in and out of work. The government might also reform work-based training (e.g. via the apprenticeship levy) and increase means-tested funding for students from low-income families who wish to stay in further and higher education. In the long run this will increase take-up of degree level qualifications and increase productivity.