By introducing the NLW, the Government has set an upward trajectory that it wishes the UK economy to pursue – away from low productivity and low wages and towards a future where productivity, skills and pay are higher. The ambition is immense, as will be the challenge and opportunity for UK employers.

The challenge and who will be affected

The Low Pay Commission estimates that 3.3 million workers will be affected by the NLW by 2020, with the majority (1.8 million workers) affected in year 1 (2016) of the policy. Within this large group of workers, our analysis shows that the NLW will affect private sector employees much more severely than public sector workers.

Looked at from an employer’s perspective, the sectors most severely-affected include accommodation and food (hotels and restaurants); arts, entertainment and recreation; and wholesale and retail. In each of these sectors, more than half of the workplaces will be ‘severely affected’ (with half of their workers paid lower than the NLW). This is particularly marked in the accommodation and food industry where around nine in ten workplaces have half or more of their employees paid below the expected NLW rate for 2020.

New data analysis illustrates the nature of the challenge for UK employers. Severely-affected workplaces have higher wage bills than other employers meaning that it will be difficult to absorb the costs of higher hourly wages. The NLW also comes at a time when employers are facing other significant regulation and costs, including auto-enrolment of employees into workplace pensions and the Apprenticeships Levy.

Responding to the National Living Wage

The Government’s intention is that the NLW drives productivity improvements as well as higher wages. This will be the path to sustainable growth and better living standards rather than artificially high wages that the market cannot afford.

However, there is as yet little certainty as to how employers will respond. International evidence, domestic UK evidence from the experiences of the National Minimum Wage and early polling suggest that employers will look not only to productivity improvements but also to a mix of tactical steps. Some employers may seek to absorb the higher wages by reducing profits – though this is unlikely to be a sustainable approach in the longer-term given the large wage bills and low profit levels of many organisations in low pay sectors. Raising prices remains an option in some sectors especially where businesses do not face international competition. But, not only would it be undesirable for the NLW simply to drive up higher prices for groceries and other essentials, many severely-affected workplaces operate in competitive domestic markets, whilst others (such as social care providers) may not be able to persuade their clients (local authorities) to pay more. Employers can also seek to minimise and avoid (legally) the costs of the NLW such as through employing younger workers, reducing hours, squeezing pay differentials for workers above the wage floor, lowering pay for higher earners or reducing other non-pay benefits to workers. Such tactics may help employers adjust in the short-term, but all come with downsides in the longer-term.

For these reasons, increasing productivity as wages rise is fundamentally important. Our report charts three broad behaviours that could drive efficiency and productivity improvements to 2020:

Higher levels of capital and business investment in technology and machinery are areas where the UK economy has historically underperformed, especially in low paid sectors. Given that domestic competitors will also face similar wage pressures, a benign scenario where organisations invest in tandem to raise productivity levels is not unforeseeable. However, access to finance (especially for smaller organisations) and certainty about the future costs of the NLW are prerequisites. There are huge opportunities to address worryingly low skills levels among many parts of the affected workforce. Four in ten of directly-affected employees either have no qualifications at all or only GCSE-level qualifications. At the same time, workplaces that are severely affected by the NLW are less likely to have offered training in the past. High incidence of part-time work as well as a significant proportion (around a third) of affected workers aged over 50 means that the Government will have to look at its skills offer beyond apprenticeships for younger full-time staff. The NLW presents an opportunity to address established shortcomings in human resource management. The consequence of higher wages will be to encourage employers to move away from the high churn, low-skills operating model, towards an approach that maximises the latent skills of workers and attaches greater value to career and skills development. Skills under-utilisation is widespread in UK workplaces but particularly so in low-paying sectors such as retail. Greater focus on creative job design and better management could exploit existing skills better. Lowering the very high turnover rates among affected workplaces would also align incentives to invest in skills.

Next steps for government

Employers in low paid sectors face the prospect of increasing their wage bills substantially at the same time as they are seeking to invest in new processes, technology and better workplace skills. At an economy level, the speed of change may well present a once in a generation opportunity to drive innovation and new practices. The Government, therefore, should consider aiding investment between 2016 and 2020 via ‘Transition Finance’. Through ‘Transition Finance’, the Government could bring forward financing commitments to assist organisations as they seek to invest to create more efficient working practices and processes as wages rise. This could include working with the British Business Bank to look at how to temporarily expand access to finance schemes such as the Enterprise Finance Guarantee (EFG). This is especially important given the coalescing of other pressures on businesses – such as pension auto-enrolment and the Apprenticeships Levy – during the same years.

Finally, employers need certainty about the future of the NLW. While the Government has provided information on the broad upward trajectory of the NLW during this parliament, greater clarity will be needed so that employers have the confidence to make strategic decisions to invest and adapt. In the remit set for the Low Pay Commission, the Government established two goals: an ‘ambition’ for the NLW to hit 60% of median wages in 2020; and, an ‘objective’ that the NLW should reach £9 at the same stage. To be achieved, these twin objectives rely on sustained wage growth during this parliament but it may be possible to achieve one of these targets without the other. Successive down-grading of forecast earnings inflation (in nominal terms) means that there is a high likelihood that hitting the 60% target would not mean reaching the £9 target. In July 2015, the OBR forecast that 60% of median earnings would equate to a cash target of £9.35 in 2020, but this was downgraded to £9.30 (November 2015), to £9.16 (January 2016) and then to £9.00 (March 2016).[i] The uncertainty over earnings growth in the future means that it is quite likely that 60% of median earnings will not equate to £9 in 2020. The Government should confirm whether the £9 NLW cash target remains an objective so that employers can plan effectively.

ENDNOTES

[i] OBR, Supplementary forecast information release: Number of employees paid the National Living Wage (January 2016); OBR, Economic and fiscal outlook – March 2016 (2016); OBR, Economic and fiscal outlook – November 2015 (2015).