Posted by

Nida Broughton, Chief Economist, Social Market Foundation

07 Apr 2016

The National Living Wage came into force in April 2016, giving the lowest paid employees aged 25 or over a pay rise. The current rate is £7.20 an hour, but it is due to rise over time, potentially reaching £9 an hour or more by 2020. The policy is part of the Government’s aim to move the UK to a high wage, high productivity economy.

The SMF, in partnership with Adecco, has been looking at how employers will be affected by the National Living Wage, and how they may respond. This is crucial, because the way in which employers adjust to higher wages will determine whether the policy is a success or not. The ideal outcome would be that firms find ways of increasing their productivity, allowing them to better afford higher wages.  If this does not happen, the risk of job loss as a result of the National Living Wage is likely to be greater.

Our research finds that the sectors that will be most severely affected are hotels and restaurants; arts, entertainment and recreation; and wholesale and retail. In these sectors, employers will have to raise the wages of a large proportion of their employees to comply with the National Living Wage. Severely affected firms tend to have high wage bills as a proportion of total costs. And they will also be facing a number of other regulatory and cost pressures at the same time as the introduction of the National Living Wage, for example, pensions auto-enrolment and the new Apprenticeships Levy.

This leaves employers with a big challenge on their hands. Short-term measures such as taking a hit to profits or squeezing pay for higher-salaried workers may be feasible in the first year of the policy. But they are unlikely to be a sustainable solution as the National Living Wage continues to rise over time. That means that firms will need to look to long-term productivity enhancements.

There are opportunities to drive such productivity improvements. The UK tends to have lower levels of investment in technology and machinery compared to other countries. Greater investment could allow firms to squeeze more productivity from every worker. Our research also finds that employers that are severely affected by the National Living Wage are less likely to provide training. There is substantial scope to upskill workers to help improve firm performance.

Measures to increase long-term performance will require upfront investment, which comes at a time when employers are facing higher bills because of the National Living Wage and other regulatory pressures. For this reason, we argue that Government should look at how employers can be supported through the transition to a higher wage. For example, the Government could look at the support programmes it provides to businesses, including through the Business Bank, and examine the case for temporarily expanding access to support and finance.

Further, providing additional certainty as to how the National Living Wage will rise to 2020 would help. The primary target is for the National Living Wage to reach 60% of median earnings by 2020. When the policy was announced, it was expected that this would equate to over £9 per hour, and indeed the Government set an objective for a £9 level to be reached. However, current uncertainty over earnings growth in the future means it is possible that 60% of median earnings will not equate to £9 in 2020. In July 2015, the OBR forecast that 60% of median earnings would equate to a cash target of £9.35, but subsequently this was downgraded to £9.00 (March 2016).  The uncertainty over earnings growth in the future means that it is quite likely that 60% of median earnings will not equate to £9 in 2020. The Government should confirm whether the £9 cash target for 2020 remains an objective so that employers can plan effectively.

The National Living Wage provides an opportunity to move towards a high productivity, high pay economy. But employers hold the key to achieving the Government’s laudable aim. The full report, “The New Going Rate: The impact of the National Living Wage on UK employers” is available here: http://www.smf.co.uk/publications/the-new-going-rate/