Assess the view that wide wage differentials are good for the economy and that governments
should therefore play no part in deciding wage rates [25 marks]
Wage differentials, defined as the variance of wages between different occupations in the UK labour
market, have always existed in the economy. However, the outrageous salaries enjoyed by CEO’s of
FTSE-100 companies have attracted particularly attention in recent years, leading many to call for
government intervention. In fact in 1999, CEO’s of FTSE-100 companies were paid on average 69
times the average salary. By 2010 the multiple was 145 and on current trends it will be 214 by 2020,
or around £8m a year. While it is generally accepted that governments should attempt to reduce
inequalities and alleviate absolute poverty to some extent, market economists argue that wage
differentials are essential to achieving efficient resource allocation in the market. Thus, according to
this view, any government intervention will cause an inefficient allocation of resources, and thus
intervention should be kept to a bare minimum. While there are clear moral arguments to counter
this view, there are also strong economic arguments.
The most popular argument against government intervention in deciding wage rates is that the
market mechanism works successfully. Free market economists argue that the UK is a meritocracy,
and thus for it to work correctly, those who work harder and are more innovative should receive
higher wages. The prospect of gaining a higher wage incentivises workers to work harder, and also
encourages innovation and enterprise. This is because those who are more productive or
entrepreneurial will have a higher marginal revenue product (MRP), will be in higher demand, and
thus will enjoy a higher wage. Thus, government intervention to reduce wage differentials will
discourage workers to raise their MRP levels and lead to a fall in worker productivity. Moreover,
inequality is necessary to encourage entrepreneurs to take risks and set up new business. Without
the prospect of substantial rewards, there would be little incentive to take risks and invest in new
business opportunities. This will have a negative impact on the UK economy, slowing economic
growth through the decrease in the potential productive efficiency of the economy. Free market
economists thus argue that government intervention will have the opposite of the desired effect; a
slower underlying rate of economic growth in the economy will act to increase absolute poverty (or
at least slow down the rate at which absolute poverty is reduced.)
The most common counter to this argument is simple – the market mechanism does not work
correctly when it comes to wages, it is a market failure. As Wilkinson & Pickett argue in Spirit Level,
many wage differentials come not from pure market forces, but through rent seeking or market
manipulation. There is certainly much truth to this argument. Rent seeking, defined as obtaining
money by manipulating the social or political environment in which economic activity takes place, is
certainly the cause for many wage differentials. Indeed, the motive of trade unions is not to achieve
overall economic efficiency, but to champion the interests of their members. As a result, trade
unions and big business have the ability to manipulate wage rates, causing wage differentials which
do not necessarily represent the most efficient allocation of resources. Thus government
intervention in deciding wage rates may not necessarily be detrimental to economic efficiency.
Likewise, interventionists argue that despite recent equal pay legislation (particularly the 2010
Equality Act), inequality in income still results from discrimination on the grounds of gender, race or
sexual orientation etc. Although it is difficult to empirically measure the wage gap resulting from
discrimination, ONS data from 2014 shows that the hourly wage of females is at 79% of male earning
