The economic consequences of the National Living Wage in the UK are many and varied

Today sees a raft of changes for the UK economy and should there be any problems the originators will have plenty of cause to wonder if it was none to bright to have introduced them on April Fools Day! A bit like Japan a couple of years ago with its Consumption Tax rise. The major change is the introduction of the National Living Wage as shown below.

From 1 April 2016 workers in the UK aged over 25 earning the minimum rate of £6.70 per hour will see a 50p increase……Many will see their pay packets rise by up to £900 a year. This will be the largest annual increase in a minimum wage rate across any G7 country since 2009 in cash and real terms.

The Resolution Foundation suggests that it will affect a large number of people directly as shown below and then even more indirectly.

Almost two million workers are expected to have their pay topped up to the National Living Wage this year……And the gains don’t end there, because minimum wage rises also create ripple effects further up the pay ladder as employers seek to keep gaps between their lowest-paid staff and those on the next rung up. We estimate that a further 2.6 million employees will benefit indirectly from the NLW, taking the total number of beneficiaries to 4.5 million in 2016.

So the hype of a pay rise for Britain does have some basis. Indeed as we move forwards into future years there will be an even larger impact from the future planned increases.

As a result by 2020 around six million workers will benefit from the NLW. It’s worth pausing here to note that by 2020 the government will be shaping the pay of almost a quarter of Britain’s workers.

There are always swings and roundabouts in such a move so let me discuss them and also explain why overall I am a fan of the changes.

UK Real Wages

These have had a very poor credit crunch. This mostly occurred when the Bank of England let inflation overshoot in 2010/11 in a disastrous effort to stimulate the economy from its models rather than looking at the real world. From the Office for National Statistics.

With Consumer Prices Index (CPI) inflation averaging 3.7% in the 12 months to April 2010, 2011 and 2012, there was a sharp fall in median earnings in real terms from their peak of £12.25 per hour (2012 prices) in 2009 to £11.21 per hour in 2012 – roughly the same as their real value in 2003.

According to the latest numbers real wages continued to fall in the UK until October 2014. In spite of the recent pick-up in real wages ( which is of course mostly due to lower inflation) we still have real wages which are just under 5% below the pre credit crunch peak. Also we know that under what the ONS calls “composition effects” not only has the credit crunch era been disproportionately bad for the low skilled and paid there are more of them.

Supported by evidence of a growing inflow into low-skilled positions,

A report by the Resolution Foundation put the wages issue thus.

This pattern was most discernible from the 75th percentile down among men and from the median down among women.

Analysis

As I pointed out above there are benefits in terms of real wages for those at the lower end of the pay spectrum. If we stick to the positive moves then this will also reduce the amount of tax credits and other benefits paid by the UK taxpayer. For much too long the taxpayer has effectively given a subsidy to employers who pay low wages. There will also be more income tax and national insurance paid on the higher earnings so there are gains here. Whilst the last two positive changes make not make us feel like it overall the move will also help with the issue of the low paid facing a “poverty-trap” of very high rates of effective taxation as the imposition of taxes combines with the withdrawal of benefits. I have written before about this being a national scandal where the poorest can end up paying what are much higher effective tax rates that even the richest.

It is a diktat

It would obviously have been better if employers had chosen to raise wages rather than being forced to do it. But the lesson of the current UK boom phase is that there was very little sign of this happening of its own accord. A rather contrasting pattern to chief executive pay and benefits.

The excluded

The downside of the plan is that it excludes two main groups and they are groups which have had a bad credit crunch on this front. The first is younger workers as those under 25 are excluded from the increase. Surveys into wage changes have shown that they have had a particularly bad credit crunch on the wages front.

The growing number of self-employed find themselves in something of a blackout zone. We know very little about their earnings as the official surveys and data sets ignore them leading us to fear the worst. Will there be growth in their lower paid numbers in response to this as they become the low wage sector? It is hard to say and it remains a national scandal that we know so little about pay in this sector.

Unemployment

Economic theory would predict that nominal and real wage rises will lead to more unemployment. Although of course conventional economic theory has been wrong so often in the credit crunch era. In a dynamic economic environment these things are very hard to measure but we do know that the introduction of the national minimum wage did not seem too.

The optimists say we will see an increase in productivity. This is a lovely idea but has two main problems. Firstly we have an increasingly patchy knowledge of what productivity is as the inexorable march of the services sector continues, and second we seem to be struggling to increase it.

Inflation

There is a clear danger of price rises in response to the new higher wage levels and these are likely to come in the sectors most affected. From the UK ONS.

The industries with the highest proportions of employees paid below the NLW before April 1, 2016 were: accommodation and food services (33.2%), administrative and support services (16.9%) and wholesale and retail trade (13.4%). Therefore, businesses in these industries are more likely to feel the impact of the NLW than businesses in other industries.

The media have mostly skipped by this because they have bought the line that we need more inflation. This leaves them in something of a mess regarding real wages as they cannot logically call for a rise. Poor old HAL 9000 from the film 2001 A Space Odyssey would be feeling it had been lied to again.

To the extent that other wages rise in response to this change then inflation will rise too. Back in the 1970s when we had more overt wages and incomes policies which this is something of a return too we saw rises caused by what were called “relativities” as other workers wanted to maintain what they called parity. It will be interesting to see how much this happens as it will tell us a fair bit of relative worker bargaining power in the credit crunch era.

Comment

As I wrote earlier it would have been much better if employers had chosen to raise wages but sadly these days they mostly seem to prefer to raise their own. So the government has stepped in and we can look at the same move in two ways. One way is to look at what 50 pence buys you and it is not much but over a week hopefully the hours worked will make a meaningful difference. The other is to anticipate all sorts of bad consequences as some have done. The truth is like many reforms we do not actually know for sure but the evidence from past moves and indeed from existing efforts – Lidl for example already pays it- is hopeful.

The main danger in my opinion is that it leads to inflation and this is on my mind today as the UK establishment tries to sneak through some institutionalised inflation. After all April Fools Day is a good day to bury bad news.

Council tax bills in England are going up by an average of 3.1%, or £46 a year, while residents of Wales will pay an extra £41……Air Passenger Duty: Up by almost 3% on long-haul flights. APD on economy flights up from £71 to £73…. NHS dental charges: Cost of a check-up goes up by 5% to £19.70. Cost of a filling up by 5% to £53.90……. Stamp Duty: Landlords and buyers of second homes will pay a 3% surcharge on Stamp Duty, or LBBT in Scotland.

You may note how many of them apply to the owner occupied housing cost sector that the official inflation numbers ignore. Time for the Fab Four.

Roll up, roll up for the mystery tour
Roll up, roll up for the mystery tour
Roll up (And that’s an invitation), roll up for the mystery tour
Roll up (To make a reservation), roll up for the mystery tour
The magical mystery tour is waiting to take you away
Waiting to take you away

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31 thoughts on “The economic consequences of the National Living Wage in the UK are many and varied

    • Hi Yoda

      There is evidence that rises in rents do tend to follow rises in income but the UK it seems to be lagged a bit. There is also the issue of some landlords claiming that they will raise rents in response to the new 3% Stamp Duty charge. Actually if we look back to March 18th when I looked at the profits made by the average buy to letter they have a bit of a cheek!

      There will be an inflationary effect as I discussed in the post and we will have to see exactly how it plays out.

  1. If there is such concern about the low-paid why not remove NIC which is a tax specifically for the low paid, though it is extending now. The middle-classes (me) can afford the needed tax increases, cetainly better than the low paid can. Save a lot in administration costs to help. None of that tosh about qualifying for pensions either. “No tax on the first £10,000 of earnings”. YES THERE IS! Why are they never held to account when they say that? Bah!

      • I think Chrisrick 13 is saying the aggregate NIC’s will remain the same as the reduction of revenue from low paid workers is replaced by increased tax revenue from middle and higher earners.

        The idea has a lot to commend it and yes, I would be one of those who “suffered” (i.e. had less spending money as opposed to less money to live on) if his idea were implemented.

  2. Shows what mess the economy is in, if THE ONLY WAY TO GET INFLATION GOING, is for a Toerag Govt. to raise the pay of the poor.

  3. Shaun,

    Quite how the Resolution Foundation come up with the idea that employers will raise salaries of workers not on the minimum wage, I don’t know! I can possibly imagine local authorities doing so because they have different wage “levels”, but when I asked my employer if he will be putting up my salary just because someone on the minimum wage has their pay increased, he just laughed! As I would if I were an employer and I’m sure the vast number of employers will! Cloud cuckoo land, or perhaps an April Fools joke.

    • Hi Robert S

      Perhaps the collective memories of the Resolution Foundation stretch back to the incomes policies which began in the 1970s. They suffered a lot from unintended consequences which were called relativities as different pay gaps were re-established and the whole policy fell apart.

      Of course as you point out the world is very different and in many ways the position of workers and labour is weaker than back then. Those from then would be surprised to say the least. We wait to see how it will play out and how much weaker such forces will turn out to be.

  4. Hi Shaun

    I’ve always seen the move re a living wage as being not only popular but a stealth way of reducing the benefits bill; as you mention moving the costs of employment more onto the employer rather than the taxpayer.

    What is somewhat depressing is that the “poverty trap” you mention is still with us despite the fact that it has been known about for many years and yet we seem no nearer to resolving this.

    What I find equally interesting is that there is an assumption of inflation built into this; it assumes the continuance of inflation and the need for nominal wages to respond in order to support real wages. I wonder what the policy would be if we had to assume mild deflation (as has been the case in Japan)? In the US in the latter part of the 19 century incomes were going down but prices were going down faster; people didn’t like it but in fact their standard of living was rising quite sharply. Of course under the “deflation scenario” if nominal income goes down so does the tax take and this causes problems for the government finances which is a reason (perhaps the major reason) to avoid deflation.

    • “I’ve always seen the move re a living wage as being not only popular but a stealth way of reducing the benefits bill; as you mention moving the costs of employment more onto the employer rather than the taxpayer. ”

      Which is precisely where they should be.
      No benefits for full-time workers!!!

      • They should try to make affordable housing too – full time workers shouldn’t need housing benefit to put a roof over their heads.

        • “They should try to make affordable housing too”

          They used to have that years ago, it was called council housing ……..

        • Noo – agreed, and it was better value for money than the current BTL fiasco. But Tony B was busy building his £27M housing empire. Self interest ahead of his voters interests.

          Going forward I’d suggest co-operative housing schemes helped by public finance/funding. This gives residents a path to ownership, greater interests and say in a desirable community. I’d also suggest that the covenants include resident obligations not to behave in an anti-social manner. If a residents association had the means to evict obnoxious thugs – the quality of life for the many would be vastly improved.

          I’d hope that cooperative owner/resident associations could overcome many of the problems that bedevilled council housing.

    • ‘it assumes the continuance of inflation and the need for nominal wages to respond in order to support real wages. I wonder what the policy would be if we had to assume mild deflation (as has been the case in Japan)? ‘

      Absolutely Bob,that’s the wrong sort of inflation.

  5. Shaun,
    As you highlight the self employed are the missing in action – expect unscrupulous employers to encourage zero hour contractors to become self employed so min wage levels, pensions etc avoided.

  6. I have two objections.

    The most important one is the coercion involved in (ultimately) using the threat of government coercion and violence against individuals who wish to make a voluntary contract.

    The second is the way that it harms the poor. For an excellent analysis of this – and indeed many other things – I recommend Thomas Sowell’s “Basic Economics”.

  7. ‘For much too long the taxpayer has effectively given a subsidy to employers who pay low wages.’

    ‘It would obviously have been better if employers had chosen to raise wages rather than being forced to do it. But the lesson of the current UK boom phase is that there was very little sign of this happening of its own accord. A rather contrasting pattern to chief executive pay and benefits.’

    ‘The downside of the plan is that it excludes two main groups and they are groups which have had a bad credit crunch on this front. The first is younger workers as those under 25 are excluded from the increase. Surveys into wage changes have shown that they have had a particularly bad credit crunch on the wages front.’

    Some wise words there Shaun and a good piece in general.

    The reality is that the links between govt/pension funds managers and corporation boards have strengthened over the last twenty years to the point that shareholders now are a pretty weak bunch when it comes to overpaying poor performers.
    Henry Ford said:
    ‘There is one rule for the industrialist and that is: Make the best quality of goods possible at the lowest cost possible, paying the highest wages possible.’ ie slitting the throats of your customers isn’t a great business plan.

    There are more people on minimum wage than fifteen years ago 1.2 million compared to 600,000 and it’s no coincidence that the real economy for most people hasn’t improved much.

    Which sort of explains why all the QE in the world hasn’t really helped.If you can’t have a wages led recovery,then you haven’t really got a recovery in my opinion.

    • Hi Dutch and thank you

      Wages are the dog that has not barked in the recovery. This extends beyond the UK as this afternoon an annual increase in hourly earnings in the US of 2.3% was seen as good news. The output gap theories continue to fail.

      • But annual US inflation was 1% y/e February 2016 or 1.4% in y/e December 2015 if you prefer the gloomier outlook. Whatever your preference, a 2.3% increase demonstrates small real wage growth, so it is good news and the diminishing output gap theory appears to be starting to apply. What’s bad about it for workers?

  8. Relative to the cost of housing in the South East, the minimum wage increase is just insignificant. A single earner cannot support a family of 3 with minimum wage. And the biggest problem is accomodation costs.

    Here is a poverty reduction scheme from the USA http://www.fastcoexist.com/3056129/this-house-costs-just-20000-but-its-nicer-than-yours

    But sadly neither political group shows any interest in popping the UK’s housing bubble, dealing with planning gridlock or crossing swords with the rent seeking aristocracy.

    • Hi ExpatInBG

      I agree that housing costs are the main issue in the UK. That of course is why many of them are excluded from the inflation numbers. They can then tell people they are better off when they are not.

      • In short, the official inflation numbers are falsified and worthless, the systems that generate them are failing.

        • Well, look at the unemployment numbers in the 1980s changed what 30 times? and in only a couple of cases did it result in the figures going up.

          Even so many went onto DB as another way of reducing the figures – with the tacit consent of the government – whatever they say.

  9. I believe psychological benefit will accrue from this in that the majority of individuals would rather receive remuneration for work than having to be propped up by the state through tax credits and various other social benefits. Thus if your feeling valued you might just the extra mile and companies benefit in different ways which may go some to neutralise the impact.

  10. Hello Shaun,
    as a former self employed person, one major reason for the scant figures on this sector’s wages is the fact that many of us have no acual idea of our real wages until the accountants have pored over the figures for tax filing purposes! We work, we incur expenses, we put some costs on a credit card, we borrow, we pay back, we invoice, we get paid late, we set some aside for tax, we take the necessary minimum wage to qualify for NI, we draw dividends – it all comes out in the wash, but that might be 18 months down the line!

    • Hi Russell and welcome to my corner of the web.

      I take your point but having also been self-employed and knowing quite a few people who are most have an idea often a good one of how things are going. Whereas the official figures just completely ignore them and as the numbers of self-employed in the UK reach over 4.4 million it becomes ever worse as an omission.

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