Labour market· Low pay· Pay· Minimum wage Lifting the wage floor increases the urgency for securing productivity gains 18 November 2015 by Matthew Whittaker Matthew Whittaker The welcome introduction of a significantly higher wage floor from April 2016 is set to boost the pay of around 6 million workers. But it will pose adaptation challenges for employers, particularly in lower paying sectors such as retail and hospitality. A simple thought exercise implies that maintaining a broad adherence to the international relationship between productivity and wage floors would require the UK to raise output per hour by 6.6% a year over the next five years. The good news is that around one-third of firms say they will seek to boost productivity in response to rising wage costs. However, quite what form this will take remains unclear. The scale of the productivity challenge reinforces the importance of the government following up its bold announcement on the national living wage (NLW) with new ideas on just how the UK can shift towards being a high-pay, high-productivity economy. Today’s ONS update of the Annual Survey of Hours and Earnings (ASHE) confirms that – after falling sharply over the course of the economic downturn – pay growth returned in the 12 months to April 2015. It also served as a reminder of just how much wages vary across different sectors. This variation in itself is nothing new, but it is likely to take on new importance following the significant raising of the UK’s wage floor from next April. As the chart below shows, if introduced today, the new £7.20 NLW would be higher than the median in the hospitality sector and around 80% of the median in a number of other parts of the economy. Of course, by the time it arrives next April, we can expect median pay to have risen a little further in each of these industries – but it is clear the ‘bite’ of the NLW will continue to vary significantly and therefore pose particular challenges in lower paying sectors. New findings from a joint Resolution Foundation and CIPD survey show that over half (54%) of employers expect the NLW to have an effect on their wage bill. Not surprisingly given the above chart, that proportion rises to more than three-quarters in the retail (79%) and hospitality (77%) sectors. Employers have, of course, proved adept at adapting to previous changes in the wage floor. While the scale of next April’s change takes us into unchartered territory, today’s survey findings suggest that firms are planning to again apply some mix of flexing profits, pay, prices, productivity and employment. Raising productivity is set to be key. As the next chart suggests, there appears to be a positive correlation between productivity levels and minimum wages across the OECD: higher productivity countries are much more likely to have above average wage floors. This relationship is reflected in the upward sloping ‘line of best fit’. As the blue dots show, the UK has consistently sat slightly above this line. The sizeable minimum wage increase associated with the arrival of the NLW means that, in the absence of any productivity growth, its position would move significantly further away between 2015 and 2020. So how much would productivity need to rise in order for the UK to maintain its distance from the line of best fit? Looking first at the 2016 position, the proposed wage floor increase would require productivity growth of around 11% between 2015 and 2016. By 2020, the cumulative productivity gain from 2015 would need to rise above 37%, implying an average annual increase of 6.6%. Of course, there is no compulsion on the UK to match this line of best fit (and this picture ignores the under-25s for whom the wage floor will rise much less rapidly). Nevertheless, considering the scale of productivity gains required to broadly conform to this international relationship between productivity and wage floors represents a useful thought exercise. At the very least, it reinforces the importance of ending the UK’s six-year period of productivity stagnation. And the good news is that boosting productivity is the most oft-cited response in the CIPD/Resolution Foundation survey, with close to one-third (30%) of employers identifying it as one of the three most important things they intend to do. But the pace of productivity growth implied by our thought exercise is unprecedented: the annual average increase during the economic growth years of 1991-2008 was 2.2%. That points to two conclusions. First, firms are likely to need support in meeting the productivity challenge. And second, any productivity plan should look beyond the obvious forms of high-tech wizardry in high value-added sectors to encompass new forms of organisational approaches and business models in our most labour-absorbing industries. In the coming months we’ll be following up on our initial survey with CIPD to look in more depth at the practical steps firms can take to move towards higher-paying, higher-productivity business models. The government has taken a bold and welcome step in introducing a higher wage floor. Making it a success is likely to mean collaborating with firms who will have to pay the higher wages and exploring new ways of boosting productivity.