The national living wage (NLW) is an obligatory minimum wage rate implemented in the UK on 1st April 2016 for all workers over age 25, with the previous National Minimum Wage (NMW) rate still applying for workers under age 25. The inaugural NLW was £7.20, rose to today’s rate of £7.50 and is set to increase to £7.83 in April 2018. The government introduced the NLW to ensure that low-wage workers reap a significant share of the gains in growth, ensuring “work pays”, leading to these workers being less reliant on wage supplementation through benefit payments. The new policy, instead of altering the existing policy (NMW), specifically targets workers who are presumably employed on a long-term low wage. They are unlikely to participate in further education or training, unlike those in younger age brackets who are temporarily receiving a minimum wage. It is vital for policymakers to consider the policies effects on the variety of labour markets that may exist.
The impact of the NLW depends on one’s views of labour markets; being perfectly competitive, or believing firms possess some degree of monopsony power. Firstly, the analysis for a perfectly competitive labour market (See Appendix Figure 1A). The NLW functions as a price floor in the market, leading to a rise in wages from W to W1. Following this, labour supply increases to Q2 as more workers supply their labour at the new wage. However, there is a contraction in the labour demand to Q1 as less firms can afford to employ as many workers; possibly switching to a more capital intensive production due to the relative cost of labour increasing. An excess supply of labour occurs at W1 leading to a fall in the level of employment of Q1 – Q2. Unemployment levels have increased following the introduction of the NLW; some workers have lost their jobs and more people have become active in the labour market because the benefit of work has increased. The magnitude of the impact the NLW depends upon the elasticity of demand and supply: more elastic labour demand leads to a larger fall in the level of employment with firms choosing to hire less workers. Conversely, more elastic labour supply induces ‘inactive’ members of the workforce into the labour market, causing higher levels of unemployment. However, different effects occur when applying the policy to a monopsony market.
Monopsonies have a marginal cost curve greater than the average cost curve at every level, because firms must attract new workers to the industry by paying them a higher wage than what is currently offered. Firms must then pay their existing workers the same wage offered to the additional worker which means the cost of employing an additional worker is greater than just the wage they will be paid. Initially, a monopsony pays workers W2 and employs Q2 workers (See Appendix Figure 2A). A minimum wage is then set at W1 causing the firm’s marginal cost curve to be constant at the level of W1, until employment reaches Q1. Firms then employ Q1 of labour as they must pay all their existing employees at least W1, regardless of how much labour they employ. At this point, Marginal Revenue Product (MRP) is equal to Marginal Cost. Following the introduction of the NLW, employment in a monopsony labour market increases from Q2 to Q1 with wages also increasing from W2 to W1.
However, there are also substantial flaws in this ideology. Firstly, monopsonies usually operate in industries which employ skilled labour such as train drivers and doctors. Thus, any NLW imposed would not only be lower than the MRP of labour in the market, but also lower than the restricted wage that monopsonies are exploiting at, below W2. Therefore, the NLW would be ineffective in this circumstance. Moreover, monopsony situations occur in the public sector with the government acting as the monopsony such as, the NHS for nurses. In this case the government has a direct ability to solve the labour market failure by increasing the wage and employment. As they are not a profit maximising institution, they have no incentive to restrict employment. Hence, the NLW would be an unnecessary policy in the public sector.
Although economic theory criticises the NLW, it has already positively impacted income since its implementation. In 2016, the income of a quarter of affected employees aged 25 or over increased and the Office for Budget Responsibility (OBR) estimates this will amount to £11 per week by 2020. The OBR also suggested that the NLW will create jobs, predicting 60,000 fewer jobs because of the NLW; but approximately one million formed by 2020. This is supported by the Office for National Statistics, who found that the NLW led to a net positive change in employment and hours in Q2 of 2016. Card and Krueger further reinforced this; conducting a natural experiment they investigated the experiences of 410 fast-food restaurants in New Jersey and Pennsylvania following New Jersey's minimum wage increase from $4.25 to $5.05 per hour. The difference-in-difference method analysed the effects of the minimum wage with neighbouring state, Pennsylvania, acting as the counterfactual. Although employment increased in New Jersey restaurants by 2.7%, there was no evidence that prices increased more in stores affected by the minimum wage.
In addition to benefiting income and employment, the NLW could promote wage equality with research showing that more women are employed in lower paid professions compared to men. The Resolution Foundation predicts 3.7 million women will receive a pay rise by 2020 due to the NLW. The UK’s introduction of the NMW in 1999 showed similar effects, with the subsequent rises in the minimum wage resulting in women’s hourly pay converging towards that of men’s at the lowest wage percentiles in 2005. Also, the ‘skilled’ and ‘unskilled’ wage gap has reduced; in 2016, median earners received a 2% increase in weekly earnings, compared with increases of 4% and 6% for the bottom 10% and 5% of earners respectively, suggesting a reduction in income disparity from the policy.
The NLW could also generate higher productivity; if individuals perceive wages to be above their felt-fair level, they will reciprocate with increased effort due to ‘fair’ wage-induced incentives and behavioural effects. These include greater employee motivation and managerial incentives to improve organisational efficiency and training. Costly staff turnover may decrease, offsetting the rise in labour costs. Croucher and Rizov found labour productivity improving in all UK low-paying sectors since the NMW introduction, especially in larger firms. The strongest impact being in service sectors such as retail, cleaning and security (total factor productivity gains of 25%) where labour input is relatively important and in larger organisations (11% TFP improvement) where wage differentials are usually greater.
Though theory suggests that the effect of the NLW on GDP is ambiguous; it may stimulate growth if productivity is shifted towards highly-skilled sectors by inducing additional training for low-skilled workers. Sabia posited that if the NLW raises the earnings of low-skilled workers who keep their jobs—and these workers have a higher marginal propensity to consume than firm owners or low-skilled workers who lose their jobs—the NLW will result in higher GDP. Net income increases arising from the increase in gross wages should lead to increased consumer demand, a positive multiplier effect on GDP. Adverse employment effects may have the unintended consequence of greater economic growth if low-skilled workers who lose their jobs take up job training, or if firms substitute toward higher-skilled workers. If local labour markets are a monopsony, NLW could potentially increase employment, so GDP ceteris paribus.
Whilst the working age population grew rapidly over recent years, there is a suggestion that employment growth has slowed since the NLW was announced. Headline activity, employment and unemployment rates have seen little change since November 2015. For the employment rate, the trend holds for both the three-month moving average and the more volatile single month measure of employment. This could indicate a slowdown in hiring before the new wage floor comes into effect. (See Appendix Figure 1B and 2B). The plateau in employment comprises of a flatlining in employee numbers and a continued upward drift in self-employment suggesting employers have reduced recruitment. (See Appendix Figure 3B). Employment growth in the five months since November 2015 has slowed across all characteristics relative to the previous five month period. The employment rate fell for (18-24), while the rate of growth slowed significantly amongst older workers whilst temporary and full time positions also fell (See Appendix Figure 4B). This slowdown in job growth may have been driven by reductions in lower paying industries where the NLW is likely to bite hardest. The level of employment in lower paying sectors saw little change over the period, for example the hospitality and retail industries after Q3 2015, in contrast to continued growth in middle and higher paying industries (See Appendix Figure 5B).
Over 50% of firms, presently or in the future, face increased wage bills due to the NLW. 43% do not expect the NLW to raise their wage bill, but these firms had the least workers who were paid the NMW, so the effect would have been minimal regardless (See Appendix Figure 8B). 36% of employers passed the cost onto customers by raising prices, whilst 29% took lower profits or absorbed the costs. Assuming that the majority of firms respond in the same way, short run aggregate supply would fall, resulting in cost-push inflation (See Appendix Figure 9B). Although 12% said that no action had been taken, employers could be biding their time whilst considering transformative changes to business models such as outsourcing or offshoring due to the threat of Brexit. This would be favourable for many firms, as a vast amount of countries are abundant in workers with a lower minimum wage requirement. This could lead to mass unemployment in the UK with the loss of several industries including textiles and manufacturing.
The absence of reputable data has led to difficulties in assessing the nature of the effects produced by the NLW. To limit the negative impacts of the policy, the government must initiate training schemes to support the cyclically unemployed, as acquiring vital skills increases their competitiveness within the labour market. Firms’ ability to transfer rising labour costs into higher prices can lead to no rise in unemployment; although the unemployed will be worse off unless benefits are raised inline with inflation. The rising productivity of these workers allows firms to benefit from higher profits, potentially leading to higher wages. The NLW is inadequate in certain regions such as London because of the higher living costs. Therefore, regional living wages must be introduced. The deployment of the NLW as an independent policy will be insufficient in achieving the government’s goals, requiring complimentary policies to control the negative impacts.