Raising productivity in low-paid industries will be crucial if the National Living Wage is to be a success

Last week, CIPD and the Resolution Foundation launched our new report on how employers expect to respond to the National Living Wage (NLW).

To recap, the NLW comes into force on 1 April.  It sets a new, higher minimum wage rate for workers aged 25 and over of £7.20 per hour, compared with the current National Minimum Wage (NMW) adult rate of £6.70 per hour.  That’s a 7.5% pay increase.  According to the Resolution Foundation, 1.9 million employees stand to gain directly from the higher minimum wage rate when it is introduced next month with a further 2.6 million benefiting indirectly if employers choose to maintain a pay difference by increasing the pay of those just above the NLW.  The government wants the NLW to reach a rate of at least £9 per hour by 2020, although this is conditional on future wage growth, the impact on business and the advice of the Low Pay Commission (LPC).  This probably means above-inflation increases in the NLW rate for at least the next four years.

The report is based upon questions placed in CIPD’s Autumn 2015 Labour Market Outlook survey, combined with case studies of 14 employers likely to be affected by the introduction of the NLW.  The survey was carried out in September, just a couple of months after the NLW was announced, so it captures initial reactions.  The case studies captured the emerging thinking of employers in more detail.  So these are expectations and plans that are contingent on how informed organisations are about the NLW and how prepared they are for its introduction.

Our initial analysis of the survey results showed that just over half of employers (54%) expect the NLW to have some impact on their staff costs, with almost a fifth (18%) expecting the impact on costs to be large.  The expected impact varies greatly by industry, as shown in the chart below.

The proportion of employers expecting the NLW to have an impact on staff costs is greatest in manufacturing; health and social work; hotels, catering and leisure; and wholesale and retail (in practice, mainly retail).  With the exception of manufacturing (which is only just above the average), these industry groupings correspond broadly with the LPC’s definition of low-paying industries.  In other words, the industries most affected by the existing NMW are also those expecting the impact of the NLW to be greatest.

Note that health and social work, as defined here, includes the NHS, and the proportion of employers expecting an effect on costs is actually higher in the public sector (70%) than in the private sector (65%).  This seems counter-intuitive given that concerns about the affordability of the NMW in the care sector typically focus on private providers.  However, private sector firms are much more likely to describe the expected impact on costs as large.  Public sector employers may have just a few affected employees or may be thinking about the impact on the costs of contractors.

Employers who expected the NLW to have some impact were then given a list of possible ways in which they might respond to its introduction and asked to identify up to three responses which they thought were most likely to be adopted by their organisation.  Over a quarter of employers thought it was too soon to say but, for the remainder, improving efficiency and productivity is the most common response (30%).  There is some variation in response according to the perceived impact on costs, as shown in the chart below.

  

Organisations expecting the impact to be significant are a little less likely to identify improving productivity as an option and are somewhat more likely to say they will attempt to pass the costs onto customers or back onto employees by reducing overtime and bonuses, reducing hours or employment, or substituting employees eligible for the NLW with employees aged under 25.  The differences are not great but they are consistent.

The employer case studies took a more detailed and critical approach to these responses, probing employers on their plans.  On productivity, it may be the case that good intentions will not always turn into reality.  Intentions need to be backed up by knowledge (of the options for increasing productivity and how to achieve them); the capability to deliver them (which include vision, leadership, resources for investment and management skills); and action (making the time to step back from day-to-day pressures).

One of the recommendations made in the report is that policy makers give greater priority to improving productivity in these low-paying sectors.  Unsurprisingly, low-paid sectors tend to have relatively low labour productivity.  The chart below shows ONS data for average output per hour worked in various service industries.

Productivity is lowest in ‘accommodation and food’ – which corresponds with hospitality, hotels and restaurants etc., ‘arts, entertainment and recreation’, and ‘administrative and support services’ (which includes agency workers).  Social care workers and cleaners are in ‘other services’ – another low productivity grouping.  Productivity for ‘wholesale, retail etc.’ is higher but this includes relatively capital-intensive and higher-skilled segments such as motor repair.

International comparisons are limited but the data below, from 2009, cover wholesale and retail, hotels and restaurants, which together comprise the largest low-paid sectors.

Average labour productivity appears to be on a par with Spain and Italy, but lags France and the USA by 20% or more, not too different from the overall productivity gap with these countries.

This gap might not be due to UK firms in these industries being less efficient in their use of capital and labour.  An influential McKinsey's report from 1998 suggested that factors such as land use planning regulations might be the reasons why the UK has lower labour productivity than the US and France in food retail and hotels.  UK firms in these sectors had by necessity chosen relatively high-density, labour-intensive business models.

These low-paid sectors are all experiencing different types of challenge and disruption.  Hotels face competition from accommodation sharing platforms such as AirBnB that are taking market share and limiting hotels' pricing power.  Earlier this week the British Retail Consortium published a report suggesting that retail could lose nearly 900,000 jobs by 2020 due to the growth of online shopping and the consequent pressure to rationalise store networks.

The latter report is interesting because it also predicts these jobs will be more productive and higher paid.  Now, if you lose a quarter of employees, the average productivity of the remainder will go up as a matter of arithmetic.  And retail workers may be better paid in 2020 than they are now, but that might only be due to the NLW.  Whether those jobs will be more satisfying or meaningful is less clear.  The BRC report shows that retail jobs have traditionally been attractive to people looking for convenient hours in a convenient location, with pay not a driving factor.  What if the retail job of the future is more likely to involve working in a massive shed by the side of a motorway helping robots to move goods around, one where performance management is an automated message instructing you that you are taking too long to complete your task?  The sector could find its traditional ability to recruit and retain employees evaporates.

It’s a reminder that, in practice, we don’t want any old productivity improvement.  If the NLW led to an increase in average labour productivity by destroying 500,000 jobs, no-one would call it a success.  Sweating assets by pushing people ever harder in their (paid) working time is often unproductive and inevitably unsustainable.  The “right” type of productivity growth arises from people working smarter, not harder, faster or for longer (unless they want to work more hours).  That requires investment in people’s skills and giving them the tools and the autonomy to use their skills productively.

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