National Living Wage makes raising productivity even more important

by Mark Beatson, CIPD Chief Economist

On 1 October, the adult rate of the National Minimum Wage (NMW) increased from £6.50 per hour to £6.70 per hour, an increase of just over 3%, the largest increase in the main NMW rate since 2008.

This piece of good news for the low paid, however, has been eclipsed by the Chancellor's announcement in his summer Budget of a new National Living Wage (NLW). This is essentially a top-up to the NMW for all workers aged 25 and over. It is due to come into force in April 2016 at an initial rate of £7.20 per hour. The Chancellor has stated that he wants to see the new NLW reach at least £9.00 per hour by 2020 (the date of the next election).

The initial rate gives everyone aged 25 and over earning the NMW a 7.5% pay rise which is, in percentage terms, the single largest jump in the minimum rate of pay that we’ve seen since the 2004 increase in the adult rate of the NMW. According to an assessment made at the time of the Budget by the independent Office for Budget Responsibility (OBR), if the NLW reaches the government’s goal of 60% of median earnings by 2020, it will be about 13% higher than where the NMW will be if it rises in line with average earnings. About six million people will have higher pay as a result of the NLW. Half of these will be people paid at the (then) NLW. The other three million will be people earning a little bit more than the NLW whose pay has been pushed up by increases in the pay of those slightly further down the earnings distribution.

The expected impact
The OBR estimates that there will be a small positive effect on net labour costs, which in turn reduces slightly the overall level of employment and increases unemployment by 0.2 percentage points. In other words, some employers take on less people because of the extra cost. The effect is assumed to be small because the net effect on employment of the NMW has been minimal (either non-existent or too small to be detected). But, as the OBR acknowledges, this doesn't guarantee that history will repeat itself. Employers typically adapted to the introduction of the NMW through a combination of passing the cost on to consumers through higher prices (where market conditions allowed this), absorbing the cost through lower profits (where this was feasible) and passing the cost back on to workers by a variety of approaches: reducing hours worked (but not job demands), reducing non-wage benefits or recouping the cost by giving lower pay rises to workers paid above the NMW (squeezing the wage structure).

As we noted in our recent submission to the Low Pay Commission’s consultation on the NMW and NLW, there is another way of paying for a pay rise. If the productivity of the worker increases, so that he or she is generating more value from each hour worked, then there is no need to pass the costs on elsewhere. This might arise if greater investment is made in training and development, or if jobs and work processes are redesigned to use workforce skills in a more economically valuable way (for example, providing an enhanced or bespoke service that the customer is willing to pay more for). Productivity might also rise if higher wages mean less turnover, less absenteeism and greater employee commitment.

The experience of the NMW suggests these kinds of productivity-enhancing change are uncommon. Employers who have adopted the (voluntary) Living Wage often do say there are benefits in reduced employee turnover and absenteeism. However, these impacts could arise precisely because they are paying a higher wage than other employers. There is no guarantee there would be any such effects from a general uplift in wages.

Productivity gains mean moving out of survival mode
Employment legislation isn’t usually a direct force for productivity improvement. In small firms, legislation can have a more dynamic role, pushing firms towards higher value markets or new forms of work organisation. But even then its role is supporting or encouraging a change of direction rather than initiating it. New CIPD research shows that the mindset of a business can have a powerful effect on its investment, productivity and growth. A minority of firms still appear to be operating in ‘survival mode’ where a focus on the here and now leads to a failure to prepare for the future, which means they can fall further behind their competitors. Such firms are not going to see the NLW as a wake-up call. Nor are they likely to see any connection between the introduction of the NLW and other measures being introduced by the Government to help offset the cost, such as a reduction in Corporation Tax rates and the removal of employer National Insurance Contributions from apprentices aged under 25. Firms in survival mode may not be providing much training or making any profits to pay tax on. A more fine-grained approach to policy may be required, using business growth hubs and industrial or local-level networks to help businesses raise their sights by exposing them to what other businesses are doing and helping them to learn how to implement change.

Mark Beatson

Mark Beatson

Chief Economist

Mark leads the CIPD’s respected labour market analysis and commentary, while also strengthening the CIPD’s ability to lead thinking and influence policy making across the whole spectrum of people management and workplace issues. Prior to joining CIPD, Mark was an economic consultant and for over 20 years worked as an economist in the Civil Service, latterly at Chief Economist/Director level, in a range of Government departments. Mark is a Visiting Professor at London Metropolitan University.


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