Assessing the impact of the National Living Wage

Deborah Moon, HR Consultant, considers the main findings of a new report into the impact of the National Living Wage, which provides some useful early indicators for HR professionals to inform their future thinking on this issue.

The former Chancellor, George Osborne, took many people by surprise when, as part of his Summer Budget speech on 8 July 2015, he announced the introduction of the new compulsory National Living Wage (NLW) to be implemented from April 2016, declaring at that time that “Britain deserves a pay rise”. This was greeted with a variety of reactions, from those welcoming a much-needed boost to many employees’ pay packets, to those expressing concerns about the impact on employers and employment, and others pointing out that its level would still be below the level of the voluntary living wage as defined by the Living Wage Foundation.

In the period leading up to the NLW’s introduction, concerns continued to be expressed about its potential impact, with a range of assessments and predictions about the estimated costs to employers and the actions they might take to manage these. Much of the focus was on those industries and sectors which would be particularly affected, eg hospitality, retail and social care. In the case of the latter, particular concerns were raised by both the Local Government Association and care providers, with the former estimating that councils would have to find more than £1 billion a year by 2020/21 to cover the costs of the NLW, both for directly employed staff and for the costs to care providers. Concerns were also raised about the impact on the public sector and local government wage bill more widely, particularly given the funding pressures and constraints which continue to apply to them.

Have these predicted concerns become a reality and how have employers reacted to and managed the actual effect of the NLW? A report by the Resolution Foundation, published in July 2016, The First 100 Days: Early Evidence on the Impact of the National Living Wage, has considered its initial impact and how employers have responded.

Background

The NLW applies to workers aged 25 and over — the wages of younger workers continue to be underpinned by the National Minimum Wage (NMW). In effect, the NLW has become a new, higher “tier” for the NMW. The initial starting rate for the NLW was set at £7.20 per hour, with the Government’s aim that it would be over £9 per hour by 2020. This rate is currently 50p per hour higher than the adult NMW rate which applied from 1 October last year, ie £6.70 per hour.

The Low Pay Commission (LPC) was asked by the Government to set out how the NLW would reach 60% of median earnings by 2020 — forecasts at that time indicated this would mean the NLW would reach the Government’s target of over £9 by that date. The Government also published a new remit for the LPC: to ensure the rate of the NLW is set at a sustainable level and continues to take account of broader economic conditions, the LPC’s remit requires it to set the NLW in a way that reflects the growth in median earnings. The LPC’s remit in relation to the NMW remains unchanged. The date of any increases to the NLW and NMW have now been aligned so that both will take effect in April of the relevant year, commencing in 2017.

The voluntary living wage (which a number of employers, including within local government and the wider public sector, have adopted), its underlying purpose, approach and the campaign by the Living Wage Foundation to promote it, remains and is unaffected by the NLW. Understandably, the similar terminology has led to some confusion between the two. The methodologies used by the Living Wage Unit (which calculates the London Living Wage — currently £9.40 per hour) and the Centre for Research in Social Policy at Loughborough University (which calculates the out of London rate — currently £8.25 per hour) are different from that of the NLW. Interestingly, the Resolution Foundation has recently published another report calling for new ways of calculating this higher voluntary living wage rate if it is to deliver on its aim of raising living standards and differentiating itself from the NLW. It is understood that this report will be submitted to the Living Wage Commission which is expected to respond in September.

As the Resolution Foundation report reflects, the increase in the “wage floor” for those over age 24, effected by the NLW, represents a “significant boost” to some of the UK’s lowest paid workers. The initial prediction was that around 4.5 million employees would benefit this year. The relative impact of the NLW will also increase over time — the initial projection was that around six million employees would gain a pre-tax average increase in pay of £760 by 2020.

But while many have welcomed this improvement to the earnings of the country’s lowest paid workers, the resulting costs to employers need to be taken into account — the report considers how employers have responded so far, as well as looking at the initial impact on employment growth and the wage bill. It advises that, due to the time “lag” with which relevant data becomes available, it is not yet possible to give a clear picture of employer reaction and that, even when this is available, it will only provide a “partial assessment”, as business responses are likely to evolve over time as the NLW “beds in” and the scale of its impact widens. Nonetheless, it is considered this type of early impact assessment remains worthwhile, taking account of both the period leading up to the NLW’s introduction and the three-month period thereafter.

In addition, and as the report reflects, the economic and business context has shifted considerably in the wake of the outcome of the recent EU referendum. The report suggests that consideration of the impact during the relatively limited period since April 2016 will be “crucial for disentangling the NLW’s effects from wider post-Brexit shifts in confidence, demand and employer business models”. Indeed, the report goes on to consider the impact of Brexit for the future trajectory of the NLW (see below).

The report refers back to an earlier survey of employers undertaken with the CIPD in September 2015, which found that the most common intention from firms to meet the NLW “challenge” was to raise productivity. However, the accompanying case studies indicated that many firms were unclear about how such ambitions would be realised. The need to raise productivity in the UK has been an ongoing theme for some time now, and the report indicates that recent figures on this have continued to “disappoint”. It suggests that the ability of employers to achieve their stated intentions “remains open to question”.

The report combines official data with a bespoke survey to provide a better indication of employers’ reactions to the announcement and implementation of the NLW in this initial period and to consider their plans for the future.

Impact on employment growth

The “impact analysis” of the report considers the effect on employment growth in the period since the NLW was first announced. The Office for National Statistics labour market statistics have demonstrated the rapid growth in overall employment rates which has taken place recently and the report refers to this, particularly in respect of the 12-month period to April 2016, as well as the sharp rise since the “post-financial crisis trough in 2011.” However, it then suggests that, on closer examination, it would appear that this growth has “plateaued” in recent months, with employment and unemployment rates “broadly flat” since November 2015. Although this does not completely align with the timing of the initial announcement of the NLW, it suggests this might be consistent with a “slowdown” in hiring prior to its actual introduction. While indicating the difficulty of drawing any firm conclusions from this, it suggests this may be indicative of employers “pulling back” on recruitment, even though overall levels of “work” in the UK have continued to increase. However, and contrary to anticipated fears, this does not suggest jobs have actually been lost as a result of the NLW.

The report then goes on to look at whether or not jobs which are more likely to be lower paid, eg those occupied by women, part-timers, younger and temporary workers, have been the main “drivers” behind this slowdown. It finds that, looking at this issue by employee and job characteristic, there is less evidence of a marked slowing for those most likely to gain from the NLW. For example, the employment rate fell for the 18–24 age group, who are not legally entitled to the NLW, and there was a significant slowing of growth among older workers. The rate of growth in female and part-time numbers slowed, but this trend was more marked among male and full-time employees.

The report also looks at this issue by sector, finding some “tentative indication” that this slowdown in jobs growth has been driven by reductions in lower-paying industries and occupations where the NLW is likely to hit hardest. Notwithstanding some caveats about the relevant statistics, it finds a “broadly flat” picture for employment in lower paying sectors in contrast to continued growth in middle and higher paying industries. However, the report cautions about the NLW’s role in this, reflecting that isolating its effect from other factors is not straightforward. In particular, it refers to the impact of “pre-referendum uncertainty and the associated delay of some spending and investment decisions” as a particular concern during this period. It draws on some business studies/reports in support of this, including from the Bank of England, with a reduction in employer confidence during this period due to a number of factors, including both the NLW and Brexit.

Increased wage bills

Although the reported fears of job losses arising from the NLW do not appear to have been borne out, early indicators are that its implementation is, perhaps not surprisingly, “on the minds of many employers”. Of course, there will be many firms and industries where the NLW will have only a limited, or negligible, effect as many employees working in those organisations will have earnings which are already above this new wage floor. The latest survey commissioned by the Resolution Foundation appears to confirm this, with only 35% of employers reporting that the NLW had increased their wage bill this year. The majority of these (21%) said it had increased to a “small extent”, 8% to “some extent” and 6% to a “large extent”. Sixteen per cent reported that the NLW had not yet impacted on their wage bill but expected it to do so in the future. However, the largest proportion, 43%, did not expect the NLW to ever increase their wage bill. These findings demonstrate that, while for many employers the NLW will have very little, or no, effect, those in lower paying sectors still face a challenge in meeting increasing employment costs.

How have employers responded?

The report then goes on to consider the different ways in which affected employers have responded in managing the increase to their wage bill. The responses to its survey indicate that the most popular response is to pass the cost on to customers through higher prices. It notes that a higher proportion of employers identified this in the most recent survey, compared to findings from that conducted prior to the NLW’s implementation (36% compared to 22% of previous respondents). It suggests this may be due to the “relative ease” of utilising this option compared to others, such as improving efficiency or reducing overtime and bonuses to staff.

The second most common response (29% of respondents) was to take lower profits or absorb the costs, with 12% indicating no action had been taken. The report suggests this may indicate that employers are “biding their time”, at least at present, and that they are able to manage the initial increase in costs through the adoption of relatively simple solutions while looking at more “transformative changes to their business model” in the longer-term.

As mentioned previously, the findings from the pre-implementation survey indicated that the favoured response at that time was to raise productivity/increase efficiency — the findings from this more recent survey contrast somewhat with this. In order to explore this further, employers were asked about a number of specific options on how they might go about boosting productivity. After raising prices and absorbing lower profits, the following three options were the most popular responses.

  • Asking workers to do more, whether in terms of effort, the complexity of tasks carried out or range of tasks required of them.

  • Investing more in training, developing a more highly skilled workforce that is capable of greater output.

  • Investing more in technology, either “labour enhancing” (allowing workers to become more productive) or “labour-replacing” (requiring fewer hours of labour as technology enables that to be done more efficiently).

However, as the report reflects, the extent to which these initiatives will offset the costs of the NLW remains to be seen. The CIPD and other commentators have consistently argued that employers need to invest more in workforce training and development to assist in addressing the UK’s productivity challenge. While it is encouraging that many appear to be intending to do so, the extent to which they have clear plans on how to deliver this in practice is less certain. It is also worrying that 8% of the survey respondents reported they had cancelled or reduced investment plans.

The types of actions identified above suggest a more positive approach to managing the costs of the NLW. However, there may also be actions that have a more negative effect on employees and the report goes on to consider the incidence of these, such as slowing or abandoning recruitment, reducing the number of hours worked or making employees redundant. Responses indicate some evidence of a reduction in hours but actual job losses have been more limited (which is consistent with previous experience following the introduction of the NMW).

There have been a number of relatively high-profile media reports of some employers, including major ones such as B&Q, Tesco, and Marks and Spencer, taking action to reduce other aspects of the reward/employment package through changes to overtime or other premium rates and other terms and conditions. These have prompted some critical comments from a number of quarters, including the then Chancellor, despite denials from the relevant companies that such actions were in any way related to the NLW. The Resolution Foundation survey indicates there appears to be a limited reliance on these types of actions, with only 8% of respondents identifying this as an option, indicating this may be more difficult or problematic to implement in reality.

Given the NLW applies to workers aged 25 and over, there had also been some suggestions that employers might look to recruiting more younger workers to avoid having to pay the higher rate (not necessarily a bad thing, of course, although employers would not necessarily be doing so for the right reasons). The Resolution Foundation survey indicates that 8% of respondents had hired more workers under 25 to avoid paying the NLW, with some employers differentiating wage rates by age, in accordance with NMW bands, but others less inclined to do so. Indeed, there are also some employers (including local government employers within the NJC) who have decided to apply the new NLW to all workers, irrespective of age, for example, due to the practical implications of having differentiated wage rates for the same job.

Longer-term responses

While the above give some indicators of how employers have responded thus far to the NLW, there is clearly a need to plan for the longer term. Survey respondents were therefore also asked how they plan to respond over the next five years, not just in respect of the NLW but also taking into account other increases in employment costs, such as those arising from the apprenticeship levy (which, in itself, has been attracting some criticism) and from pension auto-enrolment.

Responses indicate a shift from taking lower profits (unlikely to be sustainable in the longer term) but not much change in the proportion of those intending to use price rises as a way of managing these costs. As the report reflects, this suggests that the consumer may bear more of the “burden” of the NLW’s higher pay rates than perhaps had been expected (in contrast with the experience of the NMW).

Encouragingly, the share of respondents planning enhancements to productivity does increase, through greater investment in training, technology and/or getting more out of the workforce. This is, perhaps, not surprising as employers will have more time to plan on how to adapt and make changes in their business and operating models over the longer term.

Of course, as the report reflects, this must be seen as a dynamic and changing perspective, as employers take time to finalise and consolidate their plans, taking account of the wider economic and political context and the reactions and responses of their competitors. And, of course, as experience would appear to suggest, employers do not necessarily follow through on their stated intentions!

The Brexit effect

As mentioned previously, there has been a significant shift in the UK’s economic and political context since the somewhat unexpected outcome from the EU referendum. Future economic and employment prospects are now much more uncertain, with predicted falls in the value of real wages and future pay growth. Statistics for pay awards made in the first six months of 2016 indicate that increases continue to remain subdued and are likely to do so for the foreseeable future. This is a particularly important consideration for the NLW and its potential future trajectory, given the explicit link with the median wage of those aged 25 and over. As the report indicates, although the NLW target figure of £9 by 2020 has often been referred to, the stated ambition is, in fact, 60% of the median wage for over 24s. The figure of £9 is (was) an estimate of the predicted rate in 2020, based on OBR projections for wage growth over that period. This means that the 2020 target figure was always likely to fluctuate as wage growth predictions are updated. This can be evidenced by the revised forecasts since the NLW was first announced — from an initial starting point of £9.35, it has been progressively revised downwards, the most recent being £9 at the time of the March 2016 Budget.

The uncertainty following the Brexit vote has made such forecasting more difficult — the report reflects that predicting future wage growth is “an exercise in crystal-ball gazing at the best of times”. Clearly Brexit has made that even more challenging!

Notwithstanding these caveats, the report goes on to provide an indication of the rate the NLW may have risen to by 2020, describing the methodology used for this purpose, including taking account of the three main scenarios of the post-Brexit options for the UK. It finds that each of these options would result in a lower NLW than the expected level, ie against a March 2016 “baseline” of £9.03 in nominal terms and £8.31 in real terms. These vary in terms of the size of the difference, from approximately 10p lower at the most optimistic end, to £7.91 in real terms at the most pessimistic.

The report makes clear that the figures presented should not be taken as a precise estimate, reinforcing the point that wage projections are “always inaccurate”, particularly in times of uncertainty such as now. But it also underlines the value of expressing the value of the NLW as a percentage of the typical hourly wage, rather than expressing this as a specified financial amount. This means that if wage growth more widely does not rise as expected, the “wage floor” does not continue to rise regardless. The ambition to achieve a wage floor of 60% of the median rate for workers aged 25 and over is already creating a number of challenges for employers — increasing the NLW when other pay rates are falling would add significantly to these.

The report refers to the important role of the Low Pay Commission in this regard, making “balanced judgments” and thereby helping ensure that minimum wage levels do not exacerbate the negative effects of other economic considerations, eg in relation to job losses.

The report goes on to consider what other effects the decision to leave the EU may have on the NLW. It refers to the “challenge” employers were already facing in terms of the effects of the NLW, combined with the apprenticeship levy and auto-enrolment, ending the era of having access to a “large pool of relatively cheap labour”. Clearly, one major outcome is likely to be the reduction in the availability of overseas workers, with a need for employers to develop alternative workforce strategies, particularly those in sectors heavily reliant on such workers, eg hospitality and agriculture. The eventual outcome will be dependent on the type of deal the UK is able to negotiate with the EU in terms of trade and the movement of people and the time it takes to conclude this. Undoubtedly, a range of options will need to be considered by employers, including greater use of technology and the development of a higher skilled workforce.

Where next for the NLW?

The report concludes that, based on the analysis of early indicators, the NLW does not appear to be leading to reduced employment opportunities. Neither does this appear to be a longer-term strategy for most employers. Rather, there will be a “diversity” of approaches, with differing consequences, including increased costs for consumers (potentially impacting on overall price inflation). The consequences of the vote in favour of leaving the EU has added an additional complexity to the NLW’s future trajectory, with potential for lower wage growth than was initially predicted. Such considerations reinforce the value of the role and expertise provided by the Low Pay Commission, helping inform employers’ strategies for managing any pay growth during these uncertain times.

Particular challenges will remain for local government and the wider public sector — the Brexit effect has already given rise to fears about a further squeeze on public sector spending in both the medium and longer term, as well as the potential impact of any restrictions in the movement of EU (and other overseas) workers, eg in relation to the NHS and social care, both of which are heavily reliant on this source of labour. Warnings about the viability of social care providers as they struggle to meet increasing labour costs and rising levels of demand continue to be made. In addition, there is a need for employers to consider how they manage future pay strategies to accommodate increases to the lowest pay levels, while still maintaining appropriate differentials for more senior workers and supporting attractive progression and career paths. In local government many will be looking to the approach taken by the national employers and the trade unions in managing future pay agreements and the future structure of the national pay spine.

While generally one could not argue that the ambition of a higher wage floor is undoubtedly desirable and can bring a number of positive effects, the path to achieving this is likely to be a challenging one and will require both innovation and pragmatism to avoid any unintended consequences.

References

The First 100 Days: Early Evidence on the Impact of the National Living Wage

Making the Living Wage: The Resolution Foundation Review of the Living Wage

Both are available at the Resolution Foundation website.

Deborah Moon is a Consultant in Human Resources and is a regular contributor to Croner-i HR for Local Government. Croner-i HR for Local Government is an online employment law and practice reference source designed specifically for HR Managers and their teams in local government.