UK: National Living Wage – Bad News For Business Or A Blessing In Disguise?

When Chancellor George Osborne introduced the National Living Wage (NLW) last summer, he confidently asserted that this would help move the UK "to a higher wage, lower tax, lower welfare society". Despite his positive words and vision for the economy, the NLW has sharply divided businesses and spawned a flurry of negative headlines. From drastic job cuts and price hikes to total economic collapse, businesses concerned about the NLW's impact on profits have generated all kinds of doomsday predictions. This article considers the potential impact of the NLW on UK employers and whether businesses could gain from this ostensibly radical shift in public policy.  

NLW: an introduction

A discussion on the NLW often gives rise to confusion due to the existence of other similar terminology, namely the National Minimum Wage (NMW) and the Living Wage. The table below provides a comparison of these three types of wages:

The key point is that the NLW will operate alongside the NMW when it comes into force in April 2016 by prescribing a higher minimum wage for workers aged 25 and above. Furthermore, unlike the Living Wage, the NLW and NMW are compulsory, and employers will break the law if they fail to pay these wages.

Government's rationale for the NLW

According to the statistics compiled by the Organisation for Economic Co-operation and Development (OECD), there are more people in the UK on low pay (defined as workers earning less than two-thirds of median earnings) than in many other advanced economies. In particular, approximately one in five UK workers is low paid, compared to an average of only one in six among the other 33 OECD countries. Furthermore, the UK's minimum wage has been steady at between 46% and 47% of median earnings since 2007; this means that the minimum wage is worth less than half of the UK's average earnings. This is especially surprising as seemingly less developed economies, such as Romania and Turkey, have achieved greater income equality than the UK. By introducing the NLW, the Government is striving to close the gap with other countries and to propel the UK from its current mid-table position to the top tier (see bar graph below).

The NLW can also be attributed to the Government's commitment to reward work and back aspirations. Indeed, George Osborne stated that the Budget seeks to "build an economy where people get a fair day's pay for a fair day's work by earning more and keeping more of what they earn". The Government estimates that some 2.7 million low-wage workers will benefit directly from the introduction of the NLW, whilst the Office for Budget Responsibility predicts that a further 3.25 million people could also see an increase in wages. By 2020, a worker aged over 25 working 35 hours a week and previously earning the NMW will see his/her gross wages increase by approximately a third compared to 2015-2016, or £5,200 a year in cash terms.

Potential impact

The impact of the NLW on an employer will depend on the makeup of its workforce. For larger firms with a high proportion of unskilled workers (e.g. check-out staff, cleaners and waiters), the cost of paying the NLW will be significantly higher than for firms with a small proportion of unskilled low-paid staff. Consequently, certain sectors, such as retail, hospitality, social care, agriculture, and manufacturing, will find it more challenging to absorb the wage increase. For example, Next, the high-street fashion retailer, has estimated that the NLW will cost it £27 million a year from 2016 until the end of the decade. For the cut-price pub chain JD Wetherspoon, the NLW could reduce the company's pre-tax profits by as much as 21%, according to an analyst at Morgan Stanley. In total, the NLW is set to cost employers more than £1.1 billion when it comes into force, according to the Government's advisory body, the Regulatory Policy Committee.

In addition to a rise in workers' basic pay, the NLW will also increase the cost of providing other employee benefits geared to basic pay, such as sick pay, holiday pay, bonuses and pension contributions. To meet these additional costs, employers may need to readjust these benefits and risk damaging employee relations, or consider taking more drastic measures. For instance, according to a survey by the Resolution Foundation and the CIPD, 16% of the respondents said they would reduce overtime and bonuses, while 15% said they would reduce the number of employees through redundancies or slower recruitment. Officially, the Office for Budget Responsibility estimated that 60,000 jobs will be lost as a result of the NLW.

In a separate survey by the Confederation of British Industry, 20% of respondents planned to reduce employee benefits such as staff discounts and subsidised canteens, while approximately a third (and 50% in the retail and hospitality sectors) planned to increase cost to customers to pay for higher wages. Indeed, Tesco and John Lewis have already announced that changes will be made to staff perks whilst JD Wetherspoon, Costa Coffee, Next and the Best Western hotel group plan to raise prices. Perhaps more worryingly, some businesses have suggested that they will try to bypass the legislation by taking on more under-25s despite the increased exposure to age discrimination claims.

To help businesses manage the costs arising from the NLW, the Government plans to increase the new Employment Allowance, an annual allowance for offsetting national insurance contribution payments, by 50% to £3,000. According to George Osborne, this measure will enable small businesses to "employ four people full time on the new national living wage and pay no national insurance at all". In addition, corporation tax will be cut by 2% to 18% by 2020, but this will likely be cold comfort to employers in the agriculture, charity and public sectors.

Potential benefits

Whilst many businesses have openly slammed the predicted high costs and damaging effects of the NLW, the potential benefits of paying the NLW are seldom discussed. It is interesting to note that, when the NMW was first introduced in 1999, it too faced a barrage of complaints and sparked all kinds of apocalyptic warnings. However, the NMW was ultimately adopted without any major economic problems and is now regarded as a vital protection for lower-paid employees.

In January 2015, the University of Strathclyde and the Living Wage Foundation jointly published a report demonstrating the long-term business benefits of paying above the current minimum wage. The report covered more than 327,000 staff and utilised real-life case studies from five major accredited Living Wage employers including KPMG, Barclays and Aviva. In particular, the report found that implementing the Living Wage:

• encouraged employers to re-evaluate their approaches to staffing and payment, resulting in more effective and efficient working patterns in the long-term;
• increased skills development among existing staff;
• increased staff performance and job satisfaction;
• increased staff retention and improved continuity of service, e.g. the turnover rate amongst KPMG's cleaning staff dropped from 44% to 27%;
• decreased rates of absence, e.g. absenteeism dropped by 10% at KPMG; and
• generated long-term reputational benefits for employers. 

Other comparative studies have produced similar positive results. For example, a study by researchers at the Queen Mary University of London and the London School of Hygiene and Tropical Medicine found that 50.3% of employees receiving the London Living Wage registered above average scores for psychological well-being, a sign of good morale, compared to 33.9% of employees who received lower wages. In addition, a different study by the Queen Mary University of London found that the implementation of the London Living Wage led to:

• 25% reduction in staff turnover;
• 54% of workers feeling more positive about their employment;
• 52% feeling more loyal towards their employer; and
• 17% indicating that their work was more productive.

In practice, the positive effects reported by these studies suggest that the initial costs of implementing the NLW could be outweighed by savings in recruitment and training costs; absenteeism alone costs the UK market £30 billion a year according to PwC. Therefore, businesses should carefully consider the long-term benefits of paying the NLW and refrain from making knee-jerk reactions to the new wage. Indeed, the above findings echo the results from a recent survey by the Department of Business, Innovation and Skills, in which 1,000 employers across Britain were asked whether the NLW would be good for businesses. This survey revealed that:

• 93% of employers supported the NLW;
• 88% said it would make staff more productive;
• 83% believed it would make staff more loyal towards their employer;
• 86% said it would boost staff morale; and
• 82% believed customers were likely to return if the business paid the right rates of pay.

Next steps

Some employers have treated the forthcoming changes as an opportunity to review their remuneration structure. By undertaking such a review, an employer is able to carefully examine its financial resources, gauge its ability to finance the NLW, and make appropriate adjustments to achieve greater efficiency. Tesco, for example, has recently reviewed its payment structure and decided to cut holiday and night-time bonuses. Similarly, Wilko is consulting with its staff on cutting Sunday, bank holiday and overtime pay, as well as bonuses.

Fines for failing to pay the correct wage will double in April, i.e. penalties will rise from 100% of unpaid wages to 200%, up to a maximum of £20,000 per underpaid worker. In addition, the Government will increase the enforcement budget and form a new team within HMRC to pursue criminal prosecutions against those who deliberately fail to pay the correct wages.  

The introduction of the NLW will no doubt be one of the most significant changes for UK employers. As the Government steps up its efforts to name and shame employers who fail to pay the NMW, the importance of preparing for the NLW cannot be overstated.

* This article was written by Virginia Allen with assistance from Ryan Cheung. 

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