The UK’s minimum wage just grew up

The UK’s minimum wage turns 18 next year and already its life story is extraordinary. The Chancellor’s announcement this week of a National Living Wage of £9 an hour by 2020 means that, far from slumping into irrelevance, the policy has a newfound purpose as it enters adulthood.

So what should we make of the new settlement? If we judge the policy on its merits (and put to one side the accompanying deep cuts to tax credits, which others have dealt with well), five things stand out.

First, as has been pointed out, the chancellor’s new National Living Wage is not technically a living wage. That’s because the minimum wage (£6.50) and the living wage (£7.85 nationally and £9.15 in London) are not just different in their level — they’re different in kind. The minimum wage has always been an economic judgment about the labour market based on unemployment effects and agreed in social partnership with employers and unions. The living wage is an entirely different beast. It is based on standards of living, agreed through public focus groups, and is driven by the price of essentials and the adequacy of state support. Under these definitions the chancellor’s new creation is not a living wage; it’s an admirable attempt to raise the minimum wage closer towards the living wage.

What do these distinctions mean in practice? For one thing, they mean that, come 2020, Osborne’s new rate won’t be high enough to be a genuine ‘living wage’ — that is, it won’t be adequate for a basic minimum standard of living. In fact, it’s not impossible that the gap between the minimum wage and the ‘real’ living wage turns out to be wider in 2020 than it is today. My old colleagues at the Resolution Foundation have estimated that the ‘real’ Living Wage will reach around £10.30 in 2020, well above Osborne’s £9. This does not mean, as some have said, that the new policy is a gimmick — the gap will still be much narrower than if Osborne had not made these reforms. But it is important not to forget these figures because they mean the living wage campaign is still very much alive. Even with a £9 minimum wage there will still be a pressing and permanent need for an ethically-rooted, civil society campaign to push employers to pay more than the legal minimum.

Second, having got through these distinctions, we should not make the mistake of dismissing this as a hollow policy wheeze. If you take the Chancellor’s announcement for what it is — a raise in the minimum wage and a change in the way it is set — and judge it alone on its merits (still putting aside those tax credit cuts), this is a radical and hugely welcome reform from any reasonable perspective.

When it comes to the rate itself, £9 would be a big increase. In cash terms it means a faster pace of growth from now to 2020 than the minimum wage has seen to date. This remains true even if we focus just on the good years from 1999 to 2008. What this means in practice as we move towards 2020 will depend on how inflation and wage growth pans out. But there’s no denying that Osborne went big; the £9 figure must come close to the upper bound of what he could credibly have announced.

Yet the more radical aspect of the new settlement is not the rate itself but the new link the chancellor has established between the minimum wage and median pay. Osborne has committed to a minimum wage (for the over 25s) worth 60 per cent of the median wage. This links the wages of the lowest paid adults in our economy to the wages of those in the middle. In an open and flexible labour market like the UK that is a radical institutional reform. It won’t give us quite the highest minimum wage in the developed world; that honour will probably still fall to New Zealand or France. But there’s a case for saying that it gives us one of the world’s boldest frameworks for setting a minimum wage, albeit still far less ambitious than Australia’s system of sectoral minimum wages. Less than a generation after the Conservatives opposed the original minimum wage, this is a remarkable and welcome thing for the chancellor to have done.

Third, the chancellor is almost certainly right that the new £9 minimum wage will be affordable to businesses. The main reason for this is simple: it just doesn’t cost that much to pay very low paid workers a little more. Our original analysis back when I worked at the Resolution Foundation on George Bain’s review of the minimum wage, revealed how much it costs firms when the minimum wage goes up. The answer is surprisingly little. That’s because, in most sectors of the economy, very low paid people are a relatively small share of the workforce. And, by definition, they’re an even smaller share of the overall wage bill.

That’s not to say it will be easy for all employers everywhere to pay a £9 minimum wage. During the review our figures suggested that small firms would struggle most (hence the chancellor’s £700 million tax break for small firms in the form of a higher Employment Allowance). We also found that another pinch point is the young. This explains the chancellor’s decision to limit the new higher wage to those aged 25 and over, a reasonable judgment that reflects the academic evidence and means the new system won’t harm youth unemployment (if anything, it could help by making younger workers relatively more attractive).

So which businesses will struggle most to pay the new higher minimum wage? The chart below, again from the Bain review, shows how the impact of a higher minimum wage varies by sector. The vertical axis shows how exposed the sector is to the minimum wage — i.e. how low paid is the sector? The horizontal axis shows the wage share — i.e. how significant are wages as a driver of overall costs? Sectors towards the top right are those that struggle most when the minimum wage goes up — they are both low paid and labour intensive, meaning wages are a big driver of costs. Interestingly, the hardest hit sector is the government itself through residential care workers, many of whom already earn below today’s minimum wage. For most other sectors the change is easily absorbed.

Which sectors struggle most when the minimum wage goes up?

Fourth, we should acknowledge that, while a higher minimum wage is highly unlikely to cause significant unemployment, it is not without its risks. The main challenge is what it means for pay structures at the bottom end of the labour market — and, by implication, for pay progression. The chart below, again poached from the original Bain review, shows how the bottom end of the UK’s distribution of wages has changed since the minimum wage was introduced. The introduction of a legal wage floor did not lift the whole wage distribution, it squeezed it, meaning a bigger share of the workforce now sits on or just above the floor. The danger is that this leaves what you could call a wine glass labour market — a big group of minimum wage workers flat at the bottom, then a long thin gap, and then the rest. There’s no evidence that this has affected pay progression so far, but it is an obvious concern.

How has the UK minimum wage changed the bottom end of the jobs market?

Does this mean the new policy will do more harm than good? Absolutely not. But it does mean that a much higher minimum wage won’t work wonders on its own. Skills policy for example — and in particular the new apprenticeships levy — is much more relevant to the minimum wage than people realise. And there’s also a case for giving the Low Pay Commission, which will chart the UK’s path towards the 60 per cent figure, a broader role to complement the higher rate. For example, as it makes its way towards 60 per cent, the LPC should point out the blockages that are holding things up. Is there, for example, a risk of unemployment in social care because tight funding means Local Authorities can’t absorb the higher wage? If so, the LPC should say so, and the government should ease this constraint. Likewise the LPC could encourage some employers to go faster, naming sectors or cities that could move more quickly towards £9 (some sectors could frankly pay it tomorrow) or those that could afford to go beyond £9. After all, the minimum wage was never supposed to become a going rate. These details of implementation are important for integrating the policy into the government’s wider reforms.

Finally, the new settlement poses a genuine challenge for the LPC. When the chancellor walked out of the chamber on Wednesday with a smile on his face, David Norgrove, the LPC’s current chair, will not have looked so carefree. One challenge, largely overlooked, is that the income tax personal allowance will now be linked in law to the under 25s minimum wage (and not, it should be noted, the new National Living Wage). This gives the LPC a direct influence over fiscal policy in a way it has not had before. This is a whole new ball game and one can only assume the LPC will simply ignore the fiscal consequences of their decisions and stay focused squarely on the labour market implications.

The bigger change for the LPC, though, is the introduction of the long-range target. Asking the LPC to achieve a minimum wage of 60 per cent of median earnings shifts the logic of its work in a big way. Until now, the question the LPC has been faced with is: how high can we raise the minimum wage next year without risking any effect on unemployment? Now the question is: how quickly can we get to 60 per cent of the median wage, weighing up the downsides? This is a much more ambitious stance, and this shift is underlined by the fact that the OBR estimates that the new £9 minimum wage will cost 60,000 jobs — and the Treasury clearly thinks this is a price worth paying. This is, quite rightly, a different balance of concern between low pay and unemployment than the balance struck in the LPC’s earlier years, and the institution will have to adapt quickly to this new, more confident approach.

Will it do so? And is all of this worth the risk? Some people don’t think so, believing that any risk to the LPC’s independence is not worth running. Certainly I spoke to many people during the Bain review who felt the current settlement should be left well alone, not surprisingly including many past and current members of the LPC. The big concern was that the institution itself could fracture if its remit was overextended, destroying one of the UK’s most successful labour market institutions. As the founding chair of the LPC, George Bain was of course highly sensitive to this risk and, in the end, we felt that on balance the risk was manageable and worth taking. After all, which employer (or union for that matter) would want to be seen to wreck the minimum wage? We will see.

My hunch is that the concerns will prove overanxious and that, on the contrary, this marks the start of a bold new chapter in the life of the minimum wage. It is certainly an amazing story and a rare one in public policy — a policy measure pushed through against fierce opposition by politicians of the left, then consolidated through robust academic research and joint working between unions and employers, and now strengthened by politicians of the right. It is striking that tax credits, one of the minimum wage’s contemporaries from the class of 1997, have walked such a different political path.

(The obvious disclaimer: This piece is written in a personal capacity and doesn’t reflect the views of my day job, nor necessarily of my old colleagues at the Resolution Foundation.)