The National Minimum Wage: Key issues for the 2015 Parliament

Over the course of the previous Parliament, the real (inflation-adjusted) value of the NMW fell, reflecting a series of recommendations by the Low Pay Commission (LPC) that sought to avoid pricing workers out of jobs at a time when inflation had been running above average wage growth.

The October 2014 increase in the NMW was the first real terms rise in five years and the LPC has said that in future it expects “a new phase – of bigger increases than in recent years.”

The major parties too have committed to increasing the NMW in the 2015 Parliament; but how far they can make up ground lost over the past five years, without adversely affecting employment, will depend on the state of the wider economy, and in particular on productivity and wage growth.

Chart 1: The minimum wage

The minimum wage is well below what it would have been had it continued growing at its 1998-2007 rate; but it is closer to the average (median) wage than it has ever been.

Left-hand axis: inflation-adjusted minimum wage, £ per hour, right-hand axis: Minimum wage as a percentage of average (median) wage

The effect of increasing the NMW

Employment

There is a broad academic consensus, backed up by the Low Pay Commission, that the NMW to date has not had an adverse effect on employment. However, this does not mean that it can rise indefinitely without having an impact.

While the effect of modest rises in the NMW on employment in aggregate are likely to be small, localised impacts may be felt in certain areas, certain sectors and among certain age groups (especially the young).

Chart 2: Proportion of workers paid NMW

The minimum wage is most commonly paid in the retail and hospitality sectors.

Proportion of workers paid NMW, by sector, 2014

If the Government wished to ensure, as it has in the past, that the NMW should not harm employment in any part of the economy, it would therefore have to proceed with caution.

Concerns about the effect of the NMW on employment highlight its bluntness as an instrument to improve living standards: it establishes a firm floor for wages in the “naturally” lowest-paid sectors of the labour market, but it does not prevent employers in other sectors from paying workers less than they could.

As a 2013 report by the Resolution Foundation put it: “a single, national minimum wage will always be held back from achieving its full potential in some parts of the economy because of valid concern for employment effects in more vulnerable parts of the jobs market.”

Public finances

Raising the NMW could also affect the public finances: other things being equal, a rise in employee earnings leads to more revenue, in the form of additional income tax and national insurance contributions, and less spending on means-tested benefits and tax credits. The saving would be partly offset by an increase in the public sector pay bill. 

In practice, the impact on the public finances would also depend on how a higher NMW affected employment and the wider economy.

Research conducted by the Treasury in the last Parliament, which considered these effects in addition to changes in tax revenue and benefit expenditure, concluded that there were unlikely to be any large fiscal gains from increasing the NMW.

In-work poverty

Although a rise in the NMW would not be ineffective in tackling in-work poverty, neither would it be a panacea. This is partly because low incomes can be supplemented by tax credits, and as pay rises, these decrease.

Moreover, household incomes depend not only on the hourly rate of pay but on the number of hours worked per week: a significant proportion of households in poverty, particularly those containing part-time workers who are paid above the minimum wage, would directly not benefit from a higher NMW.

Paths for the NMW over this Parliament

There is consensus among the main parties that, after a period of below-inflation growth, the NMW should increase over the course of this Parliament. Just how fast it increases, and whether it makes up the ground “lost” by below-inflation rises in the past, is uncertain.

In making its recommendations, which past Governments have chosen to accept, the Low Pay Commission is likely to consider the strength of the economy, the state of the labour market and the rate of productivity and wage growth.

The Low Pay Commission (LPC)

Under the National Minimum Wage Act 1998, the LPC is required to offer recommendations to the Government on what the national minimum wage rates should be. Further detail on its responsibilities are contained in a remit given to it by the Government. The precise wording of this has varied from year to year, but it has generally required the LPC to base its recommendations for the NMW on what it believes the economy can bear without a significant adverse impact on employment. 

The LPC announces its recommendations on the NMW six months before they would come into force.  The Government must then accept or reject these. The previous Government twice increased the apprentice rates above the recommended rate of increase set by the LPC, but to date no Government has rejected the LPC's main recommendation for the main NMW rate.

If the Government wished to chart its own path for the NMW, it could ignore the LPC's recommendations or change its terms of reference. However, this could risk undermining the credibility of a well-respected framework and the broad acceptance of the merits of the NMW.

The Living Wage

Concerns that the minimum wage has become too low to provide a decent standard of living, and the continuing prevalence of in-work poverty, have led to growing interest in the idea of a “living wage”.

The living wage is an unofficial rate that, as well as being higher than the current NMW, is determined rather differently: while the NMW rate is “employer-focused”, based on what the labour market can bear without a significant effect on employment, the Living Wage is “employee-focused”, based on the income necessary for employees to afford an acceptable standard of living.

Enforcing the living wage rate as the national minimum wage would require a change to the LPC's remit, or a disregard by the Government for its recommendations, that none of the major parties is proposing. Instead, the focus has been on promoting the living wage and encouraging employers to pay it voluntarily.

Party Lines

• Conservative: support the NMW rising to above £8 by 2020, will encourage businesses to pay the Living Wage whenever they can afford it
• Greens: target a NMW of £10 per hour by 2020
• Labour: increase the NMW to more than £8 an hour by October 2019 and introduce Make Work Pay contracts to provide tax rebates to firms becoming Living Wage employers
• Liberal Democrats: ask the LPC to look at ways of increasing the NMW without damaging employment
• SNP: will vote to increase the minimum wage to £8.70 by 2020
• UKIP: will enforce the NMW