Insight on the current state of the economy and how it relates to Dorset by Nigel F Jump, Chief Economist of Strategic Economics Ltd (a Dorset Company) and Professor in Regional Economic Development at Bournemouth University. See: www.strategiceconomics.co.uk
The government surprised many UK economy watchers with its announcement in the July Budget that it would implement a “living wage” policy. From April 2016, Chancellor George Osborne said there will be a new, compulsory living wage that will be paid to workers aged 25 and above.
Initially, it will be set at £7.20 an hour, with a target of it reaching more than £9 an hour by 2020. Part-time and full-time workers will get it. Workers under 25 will still get the minimum wage, currently to be increased to £6.70 an hour from next month (October 2015). The Low Pay Commission will review and recommend what the living wage will be for April each year thereafter.
The Living Wage will give a significant pay rise (7.5% in percentage terms and 50p an hour) to six million workers. Those who keep their jobs and hours will see a welcome rise in incomes and spending power.
But, the Office of Budget Responsibility estimates that it will forfeit 60,000 jobs and reduce hours worked by four million a week. A lot of business comment has concluded that the Living Wage policy is a “gamble” that will cut employment opportunities for low-paid people because it will undermine profitability for many vulnerable SME businesses.
What is the economics here? Well, in simple terms, yes, an increase in labour costs tends to reduce employment, increase prices and reduce overall economic activity. It is not, however, quite that simple. It depends where you are starting from and heading to.
First, timing is everything. If wage rates are increased when the economy is strong, (i.e. good growth in orders, outputs and incomes generally), then the change can be absorbed by many firms with relatively little disruption to investment and product or service plans and activity levels.
Second, sector is everything. Lots of firms and business groups are complaining and worried about the Living Wage’s effects on profit margins in a non-inflationary environment when cost increases can not be passed on to customers along the supply chain. It is true that it is harder to absorb in some industries than others. Of relevance for Dorset here, is the impact on, low-paid jobs and services in, amongst others, the leisure industry (catering and tourism etc) and on health and social care.
Perhaps, however, a shift in value shares from profits to wages is warranted right now. Since the Great Recession of 2008+, wages have gone up very slowly if at all for many workers. It could be argued that some rebalancing of income shares from profits to wages is overdue and merely starts to restore a fairer and more economically positive situation. Since living wage recipients will tend to spend rather than save, it might even stimulate more consumption and, thereby, help economic growth. In the end, then, business may well get back the Living Wage pay increase through higher sales!
Third, scale is everything. Economies adjust to new realities in time. In the short term, there may be an adverse shock but, eventually, the effects of the new Living wage will depend on how it is going to be raised thereafter – presumably in line with trends in other real earnings to attain and maintain the desired 60% of median earnings target.
To an extent, the Living Wage will replace internal, annual wage bargaining for many companies once it is part of the annual fabric. However, the worry is that taking the market out of the basis of labour costs creates a rigidity that will not always be appropriate. In due course, it could mean a higher ‘natural rate of unemployment’, as observed in some of our peer countries. Whether that is a price worth paying is as much a political as an economic question.
Fourth, productivity is everything. The real questions are will low-wage workers respond to being paid more by working harder and better? Will firms seek other ways to manage costs – fewer jobs in the short term but a boost to capital investment and productivity in the long term? Given the UK’s parlous productivity record, any incentive to invest in more productive working practices from the higher costs of the Living Wage, might yield positive net benefits over time.
Generally, market economists do not like imposed as opposed to market-determined prices. Moreover, the history of state imposed wages is mixed – there are examples of rapid absorption and of unwelcome disruption.
The problem with this particular policy is it looks like it might impose a big wage increase for firms in a year when growth may be slowing. In 2016/17, therefore, it may have a dampening effect on jobs and growth compared with what otherwise might have happened. In time, however, I would expect the economy to adjust well, with the higher wages boosting productivity and sales.
As is so often the case, it is a bit of ‘on the one hand this’ and ‘on the other hand that’. It will be interesting to see how the policy adapts to changing economic circumstances in the year ahead.
Professor Nigel F Jump, September 2015
