#55. Where pragmatism meets vision

WHY THE RIGHT ARE WRONG ABOUT GEORGE OSBORNE’S LIVING WAGE

In an era when so much of each budget is “briefed” in advance, it can be difficult for a Chancellor to pull a really unexpected rabbit out of the hat. However, George Osborne certainly accomplished this when he introduced the “national living wage” in the first Conservative budget for almost two decades.

Though this initiative will raise the incomes of millions of working people, and will enable big reductions in benefits spending, its greatest significance lies elsewhere. At a stroke, Mr Osborne has ditched the low-wage, low-quality model, determining instead that Britain must compete primarily on quality, not price. As such, he has created a wholly new agenda for business and government. He is profoundly right to do so, but follow-up will be vital.

Mr Osborne would have expected, of course, that the official opposition would be rendered almost speechless by such a bold move. He will have anticipated, too, that employers in some low-wage industries would be furious. What might have taken him more by surprise is the vitriolic response of some supporters of free market economics. These opponents argue that wages must be allowed to find their own level, and that it is folly for the state to interfere in the market place.

Those of us who applaud the logic of the Chancellor’s bold move must question the consistency of these ideologues. Does their opposition to interference mean that they would repeal, too, the laws which interfere with the activities of trades unions? If so, then collective bargaining would bring in higher wages, though in a much messier way than Mr Osborne has done. If, on the other hand, these opponents wish to extend freedoms to employers whilst denying them to workers, their inconsistency surely strips them of credibility.

Aside from the need for consistency, there are three things that these opponents of the living wage seem not to understand. The first of these is the real nature of market capitalism. The second is the fundamentally correct economic calculation that inspires Mr Osborne’s thinking. The third is the scope of the further reforms that will need to follow if the Chancellor’s bold strategy is to succeed.

The intellectual problem that confounds and confuses the extreme advocates of laissez-faire is that a functioning capitalist economy is not a free-for-all, and nor is it the economic equivalent of the law of the jungle. Rather, capitalism works best when it promotes free competition in a context of transparency and probity. If the state simply withdrew, capitalism would soon destroy itself, first because large firms would gobble up or destroy their smaller competitors, thus putting an end to competition. Under a “law of the jungle” version of liberalism, transparency and probity, too, would quickly go by the board. Anyone doubting this need look no further than a banking sector that has been as short of probity as it has been of competition.

In short, the true capitalist economy requires a vigilant state, ready to defend a market-place in which competition is free, fair, honest and transparent, and is not undermined by concentration.

In addition to this reasoned understanding of capitalism, Mr Osborne’s wage policy is informed by an appreciation of where the British economy has, for many years, been going wrong.

A current account deficit of close to 6% of GDP, and a consequent need to borrow £100bn annually (and rising) from abroad, is one indicator that the model is not working. Another is the sheer quantum of debt that Britain’s government and households have taken on since the turn of the century. Public debt keeps rising – albeit at a gradually decelerating rate – whilst OBR statistics indicate that household debt is on a strong upwards trajectory.

These are not signs of success.

An economy that relies on capital infusions from abroad, and that keeps going ever further into debt, is an economy in need of a re-think. This is what George Osborne has done.

What he also needs to do is to explain why.

There is a central inconsistency at the heart of what can be called “the corporatist recipe” for the economy. Ideally, many corporates would like to see a combination of low wages and high consumption. Unfortunately, and as Henry Ford famously understood, a low-earning worker cannot be a big-spending consumer as well, unless, of course, he borrows the difference.

This glaring inconsistency has driven households deeply into debt. It has contributed mightily to the public debt, too, because it obliges government to pay ever-escalating amounts of “in-work” benefits (such as tax credits) to bring household incomes up to acceptable levels.

In other words, many employers are in the business of unloading part of their labour cost on to the taxpayer. It would be interesting to know how the laissez-faire fundamentalists square this subsidy with their philosophy of a small state.

Moreover, the case against the living wage defies not just logic but experience as well. The idea that countries become prosperous by winning a “race to the bottom” in labour rates would imply that low-wage countries like Ghana and Somalia would be more successful than Germany or Switzerland, something which we know to be nonsense. Britain can never make itself a cheaper labour market than countries like Ghana and, even if it could, it would drastically undermine demand by doing so.

Assuming that we are competing with Germany rather than with Ghana, the key to success is the quality of our goods and services, not their price. Many emerging economies produce cars that are cheaper than a Mercedes Benz, but this has not robbed the Stuttgart giant of its market. Indian-owned Jaguar Land Rover has succeeded on the basis of quality, not price. The relationship between wages, skills and productivity hinges very much on the competitive edge conferred by perceived quality. A sweatshop economy is not a productive one.

What this means is that George Osborne is surely right to drive Britain in the direction of high wages, robust demand based on income rather than debt, enhanced skills and productivity, and a competitive edge founded on quality, not cheapness.

To succeed in this, he will need to change mind-sets, so that companies grasp the need to produce the best service that they can, rather than (as is so often the case) the poorest service that their “terms and conditions” let them get away with.

So the next requirement is to raise ethical standards of customer service at the same time as increasing the real wages of people who are, by definition, not just workers but consumers as well. This means enhancing consumer protection, and rebuilding the premium provided by reputation.

But perhaps laissez faire purists will be against that, too?

Explanatory note:

Since George Osborne presented his ground-breaking budget, its key innovation – the introduction of the national living wage – has received much media coverage.

Unfortunately, most of this coverage has focussed on fiscal effects and political implications.

In fact, the greatest significance of this policy lies in starting a fundamental change in the British economic model. In order to emphasise this highly important point, this article has appeared today on CapX.