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Ian Brinkley
Economic Advisor
Ian Brinkley

The OECD Employment Outlook 2015 – Minimum wages and the Budget

Authors: Ian Brinkley Senior Economic Advisor

10 July 2015

The OECD Employment Outlook sets out some of the key conclusions on the operation of minimum wages from around the world.  They provide a timely and authoritative framework for analysing whether the Budget announcements on the minimum wage and benefits correspond to international best practice.

NMWs overall get a clean bill of health – they have in most countries proved successful in protecting the wages of the most vulnerable poorly paid employees in the workforce while having little or no adverse impact on their employment prospects.

But the report also shows how the effectiveness of the NMW cannot be judged alone, and certainly not by simplistic comparisons of levels across OECD economies. The interaction with the tax and benefit system (and in some countries collective bargaining systems) matters a great deal.

The weakness in the UK has been that for some most of the annual increase in the NMW is lost through higher taxes and lower benefit payments. A lone parent with two children in the UK gets less than 30 per cent of any increase in terms of higher income while in Spain it is over 90 per cent. The report also notes the limitations of NMWs – they are not very effective on their own at reducing poverty.  

The institutional arrangements for the setting of NMWs clearly varies, but the OECD suggests the best results are obtained where there is annual and transparent review involving the social partners and independent experts with a degree of independence from political interference.

So how does the Budget announcement measure up? The ambition cannot be faulted.  By 2020 the UK National Living Wage would be close to the current relative level of France. Nor can we fault the principle that it is better for people to be paid a higher wage than have to rely on in work benefits.

The Budget marks a big change in the relationship between the Low Pay Commission (LPC) and the Government and not for the better. This was political interference at its most blatant, effectively sweeping away the settlement agreed by the social partners as recently as March 2015. This is not in line with international best practice. There was no formal consultation with the Commission, presumably why the Office for Budget Responsibility (OBR) was asked to estimate the jobs impact even though this body has no expertise on low pay.

It has also created a more confusing landscape. We now have two benchmark voluntary Living Wage targets (one for London and one outside); a National Living Wage (in effect a re-badged National Minimum Wage) for those 25 or over; and the existing National Minimum wage rates for those under 25. How the latter will be set and restructured is unknown – presumably the next remit to the LPC will make it clearer what the Government wants the LPC to do. It is also not clear if the LPC will now operate to a new timetable, with implementation switching from October to April.

Higher NMWs tend to mean either lower profits, fewer jobs, higher prices or higher productivity. In practice, the impact will be felt through a combination of some or all of these channels. In the UK the primary impacts to date have been on profits, productivity, and prices rather than jobs. This may change. The OBR estimates that 66,000 jobs will be lost by 2020 – a modest but spuriously precise number. Given the uncertainties, a range of between zero and 170,000 might be more realistic. The implication must be little or no net job growth across the low pay industries, creating fewer opportunities for those whose entry point into the labour market is through low pay employment.

There could be winners and losers. The differential in wages between those over 25 and those under 25 must widen. This may help price some young people back into work, but it must also tempt some businesses to employ fewer older workers and more younger workers. Although in general the young are not good substitutes for the old, this is less true in low paid relatively unskilled work. If the substitution effect is big enough, all which will be achieved is a redistribution of job opportunities.

Winners and losers will also be created by the interaction between the NMW, tax and benefits – a critical area as the OECD report shows. I can see much work ahead for independent researchers and think-tanks in working out where exactly all the pieces will fall from 2016 onwards.

There is a big question of who pays in areas such as social care and some parts of the public sector where low paid jobs are common (eg teaching assistants in education). Most social care is provided by private and third sector organisations under contract to local government. With no further funds available from central government, local government can either hope that private sector providers can absorb the increase, increase the price of contracts, or accept some reduction in provision. If more cash has to be diverted to social care then even less will be available to spend elsewhere.

There may also be an increase in low income part time self-employment. Since 2010 there has been an explosive growth in self-employment in building services such as cleaning, much of it part time. The most plausible explanation is not a revival of entrepreneurial spirit, but a need to minimise labour costs. So we may see more people designated as self-employed to avoid paying the NLW.

The promised plan on productivity published today (July 10th) has suddenly become even more important. The more that the adjustment to higher pay can be delivered through changes in working practices, investment in skills, and effective ways of progression across the low pay sectors the less likely it is that we will see job losses and cuts in non-wage benefits. With fewer jobs in low pay sectors we urgently need to give people the skills they need to access job opportunities elsewhere. The OECD report shows this is a major challenge in the UK. If the productivity report falls short in this area, then we have a serious and major gap in policy alignment.

Were there better and alternative approaches? The Low Pay Commission was highly likely to be have gone back on the “escalator” (raising the NMW faster than average earnings) had it been left alone. This objective could have been re-enforced in the 2015 remit from the Government. Even if the LPC had been a little less ambitious than the Chancellor, it could have got to a position not that far from the desired outcome with less of a threat of job losses. The LPC could also, as we have urged, have been given a wider remit to develop a strategic approach to identifying causes and offering solutions to low pay including productivity and progression. That would however not have had the same political impact as a dramatic Budget announcement.

Overall, the Budget announcement on the NLW was good politics for the current Government. It was not good policy practice. The jury is still out on whether it will prove to be good economics.