National Living Wage: potential consequences

The employment experiment

7 October 2016

Tarrant Parsons looks at the potential economic consequences of the National Living Wage

After being unveiled in the July 2015 Budget, the National Living Wage (NLW) came into effect on 1 April 2016. Its introduction provided the largest annual increase in the UK's minimum wage for over a decade as the hourly rate rose 50p (7.5%) from £6.70 to £7.20, at least for those over the age of 25.

This makes the UK's legal wage floor the 9th highest in the world. Even so, this year's increase was only the first step towards the government's aim of lifting the NLW to 60% of median earnings by 2020. Reaching this target will require a mandatory minimum wage of more than £9 by the end of the decade.

Since the legal wage floor was first introduced in 1999, the Low Pay Commission (LPC) has been responsible for determining an appropriate rate at which it should be set without damaging employment levels. Overruling the LPC and introducing the NLW is a radical change in approach and will see the value of the minimum wage, in relation to median pay, rise by as much over the next 5 years as it did in the previous 16.

Possible impact

The Office for Budget Responsibility (OBR) estimates that a full-time worker previously on the national minimum wage will earn £4,800 more between now and 2020 thanks to the policy. By the end of the decade, nearly 3 million employees will be receiving the NLW.

Moreover, this will likely have knock-on effects for those higher up the wage spectrum, as appropriate pay differentials will need to be maintained to compensate roles with greater responsibility. When such effects are considered, OBR calculations suggest as many as 6 million employees' pay will be affected.

Overruling the LPC and introducing the NLW is a radical change in approach and will see the value of the minimum wage, in relation to median pay, rise by as much over the next 5 years as it did in the previous 16

Given the sheer volumes involved, it is little wonder that firms in labour-intensive sectors paying a high share of their workers the minimum wage have warned that jobs could be lost as a consequence. The OBR's central projection points to 60,000 resultant job cuts by 2020. Nevertheless, this translates into a rate of unemployment just 0.2%higher than would otherwise have been the case. However, certain professions or trades are certain to be more severely affected.

Reducing headcounts is just one way firms may attempt to offset higher wages; the government is hoping, perhaps optimistically, that businesses will make more effort to boost productivity. In principle, having to pay staff higher wages creates an incentive to invest in training and other methods to make labour more productive.

But enhancing efficiency could prove harder in practice than anticipated and the scope for improving productivity in parts of the services sector is extremely limited, particularly in the short term. Alternatively, firms may opt to reduce working hours – the OBR expects almost 4 million will be lost – employ a greater share of under-25s, or see a squeeze in profits. Some businesses could attempt to pass extra costs on to consumers by raising prices, although competitive pressures may deter this in many sectors.

Feeling the squeeze

In sectors such as facilities management, as well as hospitality, retail and restaurants – where a large share of workers are at the lower end of the pay scale, profit margins are thin and fierce competition impairs firms' capacity to raise prices – the NLW will be quite a burden. Interserve, a FTSE 250 support service and construction company, warned investors that profits may be hit by up to £15m in 2016 because of the policy. Smaller businesses, without a wide base across which to spread costs and with less room to secure efficiencies, will be affected further still.

Sharp increases in the minimum wage could potentially freeze some people out of the labour market completely. When higher costs begin to outweigh the benefits to a firm of creating or retaining a job, they simply will not do so. This problem will be further exacerbated if the economic backdrop worsens.

Of course, it may be entirely possible for this year's rise to £7.20 to be absorbed by businesses. But with each future increase, a greater number of firms will start to feel the bite. A cynic might suggest that the policy was devised more with a view to lowering the level of in-work benefits as part of the Chancellor's strategy to close the deficit. To that extent, it is likely to be judged a success. How it plays out in terms of employment, however, remains to be seen.

Tarrant Parsons is an economist at RICS

Further information

  • Related competencies include: Business planning
  • This feature as taken from the RICS Property journal (July/August 2016)