Is the national living wage a solution to the UK’s productivity puzzle?

Mat Johnson and Jill Rubery from the University of Manchester’s Work and Equalities Institute argue that the UK needs to be more creative in its approach to addressing the challenges of low wages.

Productivity is often seen as a key driver of wage growth, and low productivity is often cited as a reason for sluggish wage growth in the UK. Output per hour and per worker fell sharply after the financial crisis and despite recent increases productivity growth is well below the pre-crisis trend.

In fact, it has been estimated that the UK’s productivity is so poor that the average German worker can produce in just under four days what it takes a British worker five days to produce.

But rather than laying the blame at the door of UK workers, perhaps it is time to look again at the role of minimum wages in spurring productivity increases.

For example, higher wages can in fact provide a ‘productivity shock’ that encourages employers to retain and invest in their workforce, and redesign working practices in order to make the business more productive overall. In short, as labour becomes more expensive employers have an incentive to use it more efficiently.

Higher wages and productivity

Higher wages can also raise aggregate productivity by forcing out of business those firms that derive a competitive advantage from paying below a market rate for labour – an approach actively pursued in Sweden during the post-war era.

Given the UK’s entrenched twin problems of low pay and low productivity, could recent increases in the national minimum wage provide this much needed ‘shock effect’ and put us on a different course for economic growth and upskilling? The current government certainly thinks so.

The National Living Wage (not to be confused with the ‘true’ voluntary living wage) was announced by the Chancellor in April 2015 following the snap general election in May 2015 that surprisingly returned a Conservative government.

Arguing that ‘Britain deserves a pay rise’, the new government was keen to show that it was the party of working families, and also wrong-footed the Labour party in the process by (mis)appropriating a popular motif of fair pay that had steadily been spreading across mostly Labour-controlled local councils since 2010. As of 1 April 2019, the rate for workers over 25 has now reached £8.21, meaning a large rise will be necessary next year in order to stay on target.

The new figure was in fact an hourly supplement of £0.50p on the minimum wage rate for workers aged 25 and over, equating to £7.20 (up from £6.50 the previous year).

This was one of the largest year on year increases and the government also announced (to the surprise of the widely respected Low Pay Commission) ambition for the NLW to reach 60% of median wages by 2020 (estimated to be around £9.35 per hour).

Beyond exploitation and sweating

This takes the remit of the minimum wage beyond its original narrow scope to tackle exploitation and sweating, and the new estimates for the NLW have a greater tolerance of job losses at the bottom of the labour market (up to 140,000 by 2020 plus a potential loss of working hours according to the Office for Budget Responsibility).

Although a wage floor with a higher ‘bite’ relative to median earnings is welcome from the perspective of protecting living standards and tackling wage inequality, in the UK context it is unlikely to provide a platform for productivity growth and upskilling for three main reasons.

The first is that wage increases may be offset by cuts to working hours, overtime and staff perks such as subsidised meals, and in low paying and labour-intensive sectors such as care work, catering and cleaning, productivity gains are likely to be driven by increased work intensity and staffing cuts rather than job redesign.

Many low paying firms also make extensive use of part-time workers who are less likely to have access to on the job training and progression routes through internal labour markets (Jenkins, S. (2004). Restructuring flexibility: case studies of part‐time female workers in six workplaces. Gender, Work & Organization, 11(3), 306-333.)

The second is the potential substitution effect as employers look to replace workers aged 25 and over with cheaper workers aged under 25 who effectively become the new ‘working poor’.

Segmented minimum wage rates are often justified on the assumption of young workers’ lower productivity and lower subsistence needs, but in reality, this is often a politically expedient decision to prioritise the needs (and electoral preferences) of certain groups in the labour market.

The wage compression effect

The third and most important reason is the likely wage compression effect arising from sharp rises at the bottom and the lack of collective bargaining or other forms of participative wage setting that would help to restore wage differentials higher up.

For example, the wage grid in France is designed to preserve wage differentials following increases in the wage floor (although in reality the results have been mixed), and in Germany, the statutory minimum is designed to provide a platform for supplementary negotiations between trade unions and employers to preserve skill-based wage hierarchies. 

In the UK the steep trajectory of growth in the adult NLW suggests that by 2020 the ‘bite’ in sectors such as cleaning, hospitality and hairdressing may reach close to 100% of median earnings, and around 1 in 5 of all workers will have their pay effectively set directly by government policy.

Therefore, in those sectors where the higher NLW will have the greatest impact on the absolute position of low paid workers, it may in fact become a de facto wage ceiling rather than a wage floor.

The lack of wage returns to training and skill development and the limited opportunities for workers (particularly in part-time roles) in low paying occupations to progress is often cited as a key reason for worker dissatisfaction and turnover which is likely to further undermine productivity growth and skill development.