Questions and answers about coronavirus and the UK economy
Questions and answers about coronavirus and the UK economy

How might increases in the UK minimum wage affect jobs, work and pay?

Modest rises in minimum wage rates came into effect in the UK on 1 April 2021. Although rates have been uprated year-on-year since 1999, with little evidence of negative employment effects, the Covid-19 crisis makes the impact of these increases on jobs and pay highly uncertain.

On 1 April 2021, the rates of the UK’s minimum wage increased. For workers aged 22 and under, this involved changes to the National Minimum Wage. For those aged 23 or over, this was through a rise in the National Living Wage (NLW).

New minimum wage rates are proposed each year by the Low Pay Commission. There is an explicit government target for the National Living Wage – two-thirds of the national median wage by 2024, conditional on wider economic conditions. For the other rates, the commission is asked to propose wages as high as possible without damaging employment prospects. A key constraining factor is that firms may respond to increased labour costs by replacing low-wage jobs with technology or other capital investments that cost them less.

The commission set out its proposals in October 2020 – in the middle of the pandemic and just before the second lockdown. Modest increases were recommended for 2021 to mitigate any significant risk of driving up unemployment. While relatively small, the rates are still set to grow faster than prices under the current plan. The latest 12-month consumer price inflation rate was 0.7%, suggesting the purchasing power of low-wage workers stands to increase.

This particular increase gives workers aged 23 and 24, who are newly covered by the National Living Wage, pay increases of nearly 9%. This is a substantial rise, especially at a time of a public sector pay freeze and a proposed wage increase for NHS nurses of only 1%.

Figure 1: Table of wage rate recommendations by the Low Pay Commission

Age/Group2020 rate2021 rateIncrease
NLW (25+)£8.72£8.912.2%
23 – 24£8.20£8.918.9%
21 – 22£8.20£8.362.0%
18 – 20£6.45£6.561.7%
16 – 17£4.55£4.621.5%
Apprentice rate£4.15£4.303.6%
Source: Gov.uk

How will wages be affected by the minimum wage increases?

Excluding those on furlough, 1.83 million workers were paid at or below the minimum wage in 2020. These workers will be directly affected by the rate increases: 48% work in the retail, hospitality, or cleaning and maintenance sectors. In these industries, respectively 19%, 29% and 30% of workers are paid at the minimum wage, and will be directly affected by the changes (Francis-Devine, 2020).

Workers currently paid more than the minimum wage may also see their wages increase due to a spillover effect. This could occur from employers wanting to keep the wages of their workers differentiated.

For example, suppose that in March 2021, a restaurant pays dishwashers £8.72 per hour and waiters £9.00 per hour. Following April’s National Minimum Wage increase, the restaurant is obliged to pay dishwashers £8.91 – only £0.09 less than waiters. They may choose to increase the wages of waiters to reflect the differences in skill and effort required for each role. In this case, changes at the bottom end of the wage structure could have effects on wages throughout the organisation as the firm aims to retain differentiation in pay.

Although previous research has found some evidence of positive spillover effects at the lower end of the income distribution (for the bottom 30% in particular), the current state of the economy is likely to dampen wage pressures (Avram and Harkness, 2019). But the absence of such effects higher up the income distribution suggests that minimum wage increases can help reduce wage inequality.

What does the evidence say about the potential consequences of increasing the National Minimum Wage?

Employment

The traditional view is that minimum wage increases would lead to rises in unemployment. But more recent research – such as a famous study of New Jersey’s 1992 minimum wage hike (Card and Krueger, 1994) – has shown that there are limited increases in unemployment following such wage rises.

Two reviews of the evidence (or meta-analyses) for the UK find no significant overall employment effect, even during periods of recession (Hafner et al, 2016; Leonard et al, 2014). Instead, employers seem to absorb minimum wage increases through a combination of higher prices, lower profits and increased worker productivity, rather than cutting jobs (Forth et al, 2020).

Prices

According to a recent survey, 21-23% of firms said they had responded to past minimum wage increases by raising their prices (Forth et al, 2020). But the overall effect on the inflation rate is likely to be small.

One study suggests that for a wage rise of 10%, prices are likely to increase by around 0.23-1.1% (Frontier Economics, 2020). But price rises in sectors with a lot of low-wage workers – such as domestic services, hotel services and restaurant or takeaway meals ­– are likely to be greater (Wadsworth, 2010). And as the UK begins to unwind its lockdown measures, a surge in demand for hospitality services such as pubs and restaurants could add to inflationary pressure in this sector.

Profits

Similarly, 31-34% of firms report reduced profits in response to minimum wage increases (Forth et al, 2020). Historically, this is supported by evidence on the introduction of the National Minimum Wage in 1999 (Draca et al, 2011). Now, 30% of the members of the Federation of Small Businesses said they expect that they will need to reduce their profits due to the latest minimum wage increase (Low Pay Commission, 2020).

But the pandemic – and the third lockdown – may have since had a substantial impact on firms’ ability to absorb the change in low-wage sectors. When the Low Pay Commission recommended the new rates in October 2020, less than a quarter of hospitality workers were furloughed. This compares with 56% in January 2021 (Hutton and Foley, 2021).

In a sector such as hospitality – which has the highest proportion of firms with less than three months of cash reserves and a moderate to severe risk of insolvency – firms may not be able to reduce profits any further without going under (Low Pay Commission, 2020).

Productivity

Another key factor is productivity: 24-26% of firms say that they had increased productivity following rises in the minimum wage (Forth et al, 2020). There is little robust evidence, but firms may invest more in training for their workers if they ‘cost’ more. Higher wages may also improve the morale of employees, causing them to exert more effort – the ‘efficiency wages’ theory.

There is a concern that employers will not be able to increase productivity but increase work intensification – the range and scope of work employees are asked to do – which is not sustainable as it may eventually have an impact on the wellbeing of employees.

What are the takeaway points from a rise in the minimum wage?

Assessing the impact of the minimum wage increases is particularly difficult given the unusual economic conditions resulting from Covid-19. But the rise will be positive news for low-wage workers who are in work. This group will see real-wage increases – particularly for 23-24-year-olds, whose wages could increase by up to 9%.

Yet sectors that employ a larger share of low-wage workers – such as hospitality, retail, and cleaning and maintenance – have been hit hard during lockdown, reducing their capacity to absorb wage increases through lower profits. But the true effects of the minimum wage on these industries may not unfold until after the furlough scheme – which is keeping many of these employers afloat – ends in September.

There is evidence to suggest that increasing the minimum wage does not have negative effects on employment, even during recessions. As firms may not have the ability to reduce profits any further, it seems likely that they will respond to the minimum wage increase by adjusting their prices and investigating how best to make their workers more productive.

Where can I find out more?

Who are experts on this question?

Author: Andre Couture
Photo by Dan Rentea from Shutterstock
Recent Questions
View all articles
Do you have a question surrounding any of these topics? Or are you an economist and have an answer?
Ask a Question
OR
Submit Evidence