Recent years have seen poor wage growth, with real wages falling for many workers. In addition, government cuts and benefit freezes since 2010 have contributed towards decreasing standards of living for many. Low income households also face the prospect of (possibly watered down) cuts to tax credits over the coming years. The big task the chancellor has set himself is to move from a ‘high welfare, low wage economy’ to a ‘high wage, low welfare economy’.
As part of this, there is to be a new national living wage, which will replace the minimum wage for those aged 25 and over. In 2016-17, that will mean a rise from £6.70 to £7.20 an hour, with a planned rise to around £9.35 by 2020. Yet this week the Living Wage Foundation announced that the hourly wage required to maintain a basic cost of living had risen, to £9.40 in London and £8.25 elsewhere. Despite its name, the ‘national living wage’ is likely to fall rather short of actual living wage rate. Yet it would be dangerous to consider accelerating the national living wage further.
The national living wage is a key prong of George Osborne’s aim to move to a high wage low welfare economy. Yet we need much more than this if we are to reduce in-work poverty, which is increasing. In recent years the number of households in poverty and in work has overtaken the number of workless households in poverty.
Minimum wages can be a rather blunt tool. If workers lack bargaining power – say, for example, their employment choices are dominated by one or two very large firms – then it may well be the case that they are underpaid relative to the value that they bring to their employers. In these types of situations, a minimum wage can be an effective and low risk way of pushing up living standards.
But if low wages are instead a symptom of poor productivity, then pushing up the minimum that firms pay risks shorter hours for low earners, increased unemployment, and lower incomes for many families – the very opposite of what we want to achieve. We know that the UK’s productivity is very poor by international standards – output per hour worked is around 25 per cent higher in France, Germany and the United States. Meanwhile, poor skills hold back many in low pay from being able to progress into higher paying jobs.
In this situation, how firms react to higher wages – and the support government provides alongside – is crucial. To raise productivity we need to help lower earners by improving skills. Another potential strategy is to change the ways in which jobs are designed, to help workers make the most of their talents. In effect, if we can ensure that productivity rises in line with wage increases, we can reduce the risk that firms decide to simply make do with fewer workers.
But we should also not forget that wage growth alone may not be enough to reduce in-work poverty. As we have demonstrated elsewhere, for many family types wages would have to be much higher to make up for the planned cuts to tax credits. Even if businesses choose to raise wages beyond the national living wage, say to match the voluntary living wage, not all families would be better off once cuts to tax credits are taken into account. A family with two earners working full-time would be slightly better off as a result. However, the two-earner model is not possible for all families: some may struggle to get full-time jobs; others may have caring commitments or other barriers that stand in the way. A one earner couple with two children, claiming tax credits but not housing benefit, would still be significantly worse off, even with a much higher wage. Barriers to work need to be seriously tackled if we are to truly shift to the high wage low welfare economy that George Osborne wants.
So how do we help raise the incomes of those in work and reduce in-work poverty? We are likely to need several types of solution. Getting employers to pay the living wage can help where low earners are not getting their fair share – for instance where their bargaining position is weak. But where wages are low because of poor productivity we need to target skills improvements, or else risk rising unemployment. It is crucial that some family types get additional support, whether through tax credits or more focused measures to reduce barriers to work.
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Nida Broughton is chief economist at Social Market Foundation. Ben Richards is a researcher at Social Market Foundation
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