Why a higher UK minimum wage fails to spur productivity

Six years ago, Britain began an experiment that was called “bold” by some economists and “reckless” by others. George Osborne, then Conservative chancellor, announced the minimum wage for over-25s would accelerate sharply to reach 60 per cent of median hourly pay by 2020. His decision of him was linked to his determination of him to cut welfare spending. But he also argued the intervention would boost the economy’s stubbornly poor productivity performance.

That argument about productivity has become increasingly popular since then as more countries contemplate higher wage floors. It is easy to see the allure in the notion that one good thing (better pay for those at the bottom) can lead to another (a stronger economy overall).

The idea is that if employers are no longer able to rely on cheap labor, they will have to invest more in capital or increase workforce productivity with better technology or training. It also has some empirical support. One paper has found that Germany’s minimum wage increased productivity after its introduction in 2015, albeit by driving some smaller companies out of business.

But the British experiment has not stuck to the script. TO review by the Low Pay Commission last week concluded the policy “did not improve productivity”. Industries and areas with a higher share of minimum wage workers did not experience faster productivity growth, relative to other areas, after the policy was introduced in 2016.

Why didn’t it work out? Surveys of employers showed they were keen to boost productivity initially, but their enthusiasm faded over time. More decided to simply accept lower profits or charge higher prices. Smaller companies, in particular, struggled to find money to invest. In surveys by the Federation of Small Businesses, the third most common response to the rising minimum wage was actually to cut or cancel investment as a way to cope with higher costs. The LPC review said some companies which did invest found the technology they used was inflexible or disliked by customers.

When I was reporting on the introduction of the higher minimum wage in 2016, I was struck by how many employers said they would make staff work harder rather than smarter. One hotel owner told me he would make the cleaners do more rooms per hour, for example. An employer survey in 2019 bore this out: 25 per cent of respondents had asked staff to do more tasks (the most popular “productivity-related” response) compared with 11 per cent which had automated tasks.

But this is a poor man’s version of productivity growth. It might work for a while, but people can only work so hard before they burn out or deliver a worse quality product or service. Low-paid work in the UK is already more stressful than it used to be. The share of employees who report that their work is “always” or “often” stressful rose from 30 per cent in 1989 to 38 per cent in 2015, according to the Resolution Foundation think-tank. But for people in jobs such as driving or care, the proportion has risen from 18 to 41 per cent.

Higher pay at the bottom has also compressed the wage ladder in some companies. Employers interviewed by the Chartered Institute of Personnel and Development said smaller pay differences between entry-level and supervisor jobs was making it harder to persuade workers to take on more training and responsibility. “What we get reported back is people saying, ‘I’m taking on all this extra responsibility, and that person who has just joined us in a lower-skilled role is on the same pay scale as me. Why should I bother? ‘” explained one executive at a leisure company with 3,400 staff.

None of this is to say Osborne’s minimum wage policy has been a failure. It successfully raised pay for people at the bottom of the labor market without causing high unemployment – a feat some economists doubted would be possible. The 50/10 ratio of pay – a measure of wage inequality for the bottom half of workers – fell by more between 2015 and 2019 than in the previous 17 years.

Minimum wages can put more money into the hands of workers who need it and will spend it. They can help address concerns about fairness and inequality. But these undeniable achievements aren’t completely costless. And they are not guaranteed to transform a country’s productivity growth, at least not when other trends and policy choices pull in the opposite direction. Spending on adult education in England, for example, was cut 49 per cent between 2009 and 2019.

If Britain is to be a “high pay, high productivity” economy, it will need more than the minimum wage to get there.

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