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Ian Brinkley
Economic Advisor
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Ian Brinkley

Don't mess with the minimum wage

Authors: Ian Brinkley Ian Brinkley

30 September 2013

The new rates for the National Minimum Wage (NMW) take effect tomorrow morning (1 October) against calls for much bigger rises in order to offset the fall in real wages, as prices rise faster than earnings. In addition, it has been suggested that some sectors – such as banking – could pay a higher national minimum wage.

The NMW has been a big success story. Widely opposed when it was introduced in 1997 (the first rate was set in 1999), it has become part of the furniture of a modern labour market with cross party support and widespread credibility with both employers and employees. Between 1999 and 2012 the NMW has increased by 72 per cent compared with average earnings growth of 59 per cent and RPI inflation of 49 per cent (34 per cent on the CPI measure). ‘’- Its ‘bite’ - as a share of median wages --reached its highest ever level in 2012. The NMW disproportionately benefits poorly paid women – and as the recent ONS analysis reminds us, women massively dominate employment in low pay industries. Yet, despite exhaustive research, there is no sign that it has adversely affected the jobs of the low paid.

But so far there has been little reflection on why it has been successful – and whether some of the changes proposed might undermine that success.The key has been the establishment of the Low Pay Commission (LPC) as a social partner institution – one where employers, trade unions, and independent experts come together to make the judgement on the rate, drawing on the best available evidence. Independent of government, it has always been unanimous in its recommendations and almost all those recommendations have been accepted by the government of the day.

The second key feature is that of a single national minimum wage for adults - with some lower rates for young people. This makes it simple to understand and enforce and more effective than the previous system of sector based Wages Councils. Over the years, the Commission has been lobbied to introduce special treatment and exemptions for some industries and groups which it has rightly rejected.

The third is the evidence base. The Commission has built up a huge amount of expertise, backed by an extensive programme of research. The Commission’s annual report is the most comprehensive examination of low pay and the impact of the NMW we have ever had and quite possibly one of the best in the OECD. This gives the Commission’s recommendations an authority that has proved hard to challenge.

There are parallels with the role of the LPC, the Monetary Policy Committee, and the Office for Budget Responsibility – bodies independent of government given the task of making difficult judgements within an agreed framework. It would be unthinkable to debate the future of monetary policy without considering the function and role of the MPC. Yet, much of the discussion about the future of the minimum wage has been conducted as if the LPC did not exist.

Some have argued that the NMW must be increased to take account of the fact that prices have increased faster than wages, a trend that pre-dates the recession. However, the judgement at the heart of the decision making process is to have the highest possible NMW that does not have significant adverse impacts on employment. Falling real wages is a general labour market problem which the NMW cannot easily solve.

If critics think the Commission has been consistently getting its judgement on the NMW wrong, then of course it could be raised safely without hitting jobs. But if they think the Commission have got it more or less right, then imposing a higher NMW than the Commission would have recommended runs a significant risk. Either way, an imposed settlement would fatally undermine the credibility and authority built up over many years.

Another approach might be to formally amend the remit of the Commission, requiring it to set a NMW that took explicit account of the cost of living as well as employment. This would however risk fundamentally changing the basis on which the NMW is set.

The Commission could also be asked in its annual guidance from ministers to give special attention to the fall in the real value of the NMW measured against prices. The Coalition has recently asked the LPC to examine what economic conditions would be required to increase the rate over the medium term. At first sight this looks a bit self-evident, as the better the economy and labour market performs the greater the scope to raise the NMW. But it could be broadened out to look at some of the root causes of low pay in a more systematic way and potentially lead to a widening of the LPC’s remit beyond setting the NMW.

It has also been suggested that the NMW should be higher in some high pay sectors, such as banking. It is hard to see how you can have a national rate which varies by sector. Nor is it obvious what criteria would be used in high pay industries – or indeed, which industries would be included and which would not. Once the principle of a single adult NMW is abandoned, the pressure to set NMWs by sector will increase, potentially paving the way for the return of sector bodies to set the rate (Wages Councils by another name).

The best suggestion for change, so far, is to increase the effective enforcement of the NMW through increasing resources and increased penalties, better targeting, and improving information plus guidance to both employers and employees. This is critical to its credibility and in combatting the worst forms of exploitation. Employers will support the NMW – but only if they are confident that competitors also have to pay it.

The NMW has been a big success story as a single national rate for adults delivered through effective social partnership. We should take a hard look at any proposal, however well-intentioned, which might put that success at risk.