Productivity and the National Living Wage

The CIPD and the Resolution Foundation are collaborating on a piece of research into the impact of the National Living Wage (NLW). According to their first study over half of the country’s employers expect to be affected by it. Around a third said they would meet the increased cost by improving productivity and 22 percent said they would take lower profits. Only 15 percent said they would lay off workers or slow down recruitment.

That all sounds promising but, as Matt Whittaker points out, the productivity increase needed to cover the cost of the NLW could be pretty steep. As you might expect, there is a strong relationship between rising minimum wages and rising productivity. Most countries in the OECD have not strayed very far from this line of best fit.

Screen Shot 2015-11-20 at 16.17.15In the absence of any productivity growth, the proposed NLW would move some way from the line (the green circle) by 2016 and quite a long way (the purple circle) by 2020. The arrows indicate the size of the productivity increase that would be needed to get the NLW back to its current distance from the line. The purple arrow implies productivity growth of 6.6 percent per year.

This is far from an exact science. As Matt says, it really is uncharted territory. No-one has tried a minimum wage hike on this scale before. Nevertheless, it gives us a good starting point for estimating the sort of productivity gains that might be needed to cover the NLW.

Now here’s the problem. 6.6 percent per year is a huge amount. Increasing productivity is extremely difficult to do in a single year. Pulling off a 6.6 percent productivity improvement year-on-year for half a decade would probably require some form of sorcery. As Matt says, average productivity growth in the UK between 1991 until the crash was around 2.2 percent per year. Productivity growth is also more difficult in service industries where most of the lower paid jobs are. As this Bank of England report shows, it’s difficult to find many examples of sustained productivity gains much higher than about 3 percent per year. Getting even half way to 6.6 percent looks unlikely.

Screen Shot 2015-11-20 at 16.50.14

Furthermore, many of the employers likely to be most affected by the NLW are small firms. As this Resolution Foundation report shows, small and micro businesses will see the highest rises in their wage bills.

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Despite the prime minister’s claim that small businesses are the economy’s magic ingredient, many of these companies took a severe hit during the recession. Britain’s small firms are not in great shape and have, if anything, seen more of a productivity fall than larger businesses. Turnover per worker for firms with under 50 employees has been on the slide for some years.

Screen Shot 2015-11-16 at 09.54.47

Chart by New Policy Institute.

As UKCES reported earlier this year, there is a long tail of poorly managed businesses among Britain’s small employers. It is doubtful that they have the ability or the capacity to make the sort of productivity improvements needed to cover the cost of the NLW.

For the same reason, taking lower profits won’t be an option for many either as they are probably not taking very much out now. People often assume that all business owners are minted but many don’t pay themselves that much more than they pay their workers. The leader of the gang of cleaners I spoke to recently reckoned she took home less. A survey of small shop owners a couple of years ago found that 55 percent of them earned less than the minimum wage.

At around the same time as the NLW comes in, small business owners will have to deal with a tax on dividends and the obligation to enrol their employees in a pension scheme. And all this is before I’ve even considered the specific pressure faced by the care sector, which deserves a post of its own.

In my admittedly mischievous and slightly flippant post a couple of weeks ago, I raised the prospect of the NLW kick-starting a productivity boost and digging the chancellor out of his fiscal hole. In reality, though, this looks very unlikely. It’s difficult to see how the level of productivity increase required could be achieved, particularly by the sort of employers that need it most. As anyone who has tried it will know, talking about productivity improvement is easy. Actually doing it is teeth-grindlingly hard.

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4 Responses to Productivity and the National Living Wage

  1. Jim Rose says:

    Great post. Does the chart of productivity include New Zealand?

  2. thenextwavefutures says:

    Two quick observations, without going to check any data.
    [1], Increasing the minimum wage only affects a minority of the workforce, so the overall requirement isn’t for productivity increases that equal the minimum wage rise, but productivity increases that match the increase in the overall wage bill. Lidl – in a low wage sector – calculated that paying all employees would cost it £9m on overall UK revenues of £4 BILLION, which in terms of being funded through productivity gains is a rounding error — less than 0.25%.
    [2] UK prouctivity has been pretty flat, and that has correlated pretty strongly with flat or declining wages. If wages influence investment decisions, the prospect of rising minimum wages should encourage employers (at least in theory) to invest to reduce the need for use of labour that is unproductive (which either translates into higher unemployment but more producitve businesses, as the CBI claims, or productive growth).

  3. Bob says:

    Or even better introduce a Job Guarantee at the living wage:
    http://www.3spoken.co.uk/2015/11/job-guarantee-jobs-for-people.html
    Any thoughts Rick? It will improve demand and deals with unemployment.

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