Living wage: Is there such a thing as a free pay rise?

A street cleaner An increase in the living wage could save the government a lot of money as the better-paid workers will pay more in tax

Should every employer pay a living wage?

You're likely to be hearing that question quite a lot in the coming days, with a KPMG survey today showing that nearly 5 million UK workers earn less than a living wage, and politicians and activists across the country gearing up for Living Wage Week from 4-10 November.

That's when you'll see the Mayor of London, Boris Johnson, announcing the new living wage for London, with great fanfare. You'll also see Labour showcase the big Labour councils across the country that are becoming living wage employers themselves.

Politicians of all stripes like the idea of private companies paying their lowest-paid workers a bit more, for moral reasons and also because it could save the government a shedload of cash.

In 2010 the Institute for Fiscal Studies calculated that bringing every private sector worker up to the living wage would raise total earnings (before tax) by around £12bn. Around half of that - £6bn - would go directly to the government, in higher tax revenues and lower benefit and tax credit payments.

That's a nice bit of spare change for the chancellor, especially one whose government wants to "make work pay". But no-one wants to be seen to be pushing new costs onto businesses at a tough time for the economy - let alone costing jobs. And it is private employers who would pay that extra £12bn (plus another £1.5bn in employers' national insurance contributions, for good measure).

Cost neutral?

So, when it comes to the living wage, politicians are really looking for a free lunch: or rather, a free pay rise. They want an increase in wages for people at the lower end of the pay spectrum that doesn't cost anyone any money.

Does such a miraculous thing exist? Many will be understandably sceptical. But KPMG claims that you can pay higher wages without paying higher costs.

"At KPMG, we have found that the improved motivation and performance, and the lower leaver and absentee rate amongst staff in receipt of a living wage means that the cost is offset and paying it is the right thing for our business."

Boris Johnson says the same thing about the many companies that have decided to pay the living wage in London.

Some will consider this far too good to be true. Others will think it makes sense that employers benefit from giving their workers a reason to value their job - and getting some good publicity, as well.

The key point is that the firms reporting these positive consequences are the firms that have chosen to pay this wage. So, presumably, they had done their sums beforehand and decided the benefits outweighed the costs.

What about everyone else? Can you pressure other low-wage companies to pay more, without costing jobs?

Economists used to say no: if employers have to pay more for labour, they use it less. Then, starting in the 1990s, academic evidence started to build up about the minimum wage, in the US and the UK, suggesting that, at the very bottom of the labour market, telling companies to pay people a little more did not actually cost jobs.

Another fear about the minimum wage was that it would lead to escalating pay demands from workers higher up the chain, eager to preserve the old differentials. But that doesn't seem to happen either. Pay rates at the lower end just get more compressed - with a lot of people bunched around the minimum rate (there's a summary of some of the key evidence here.)

However, these results apply to cases where the minimum wage stays pretty low - in other words, when it remains well below most definitions of the living wage. Even supporters of the minimum wage worry about the implications of pushing it a lot closer to that level.

Dark side

A few facts: the minimum wage has risen a bit faster than average earnings since it was introduced in 1999 and about twice as fast as inflation. Working full-time on the minimum wage you can earn about 53% of the median UK wage. In 1999 you would have earned about 46% of the median. (See this government report).

There is not much evidence that this rise in the minimum has cost jobs. Overall, we know that employment has grown in the past 2 years by 750,000, at a time when households and businesses were being squeezed.

But ministers also know that at least some of the 4.89 million earning less than a living wage are people who have recently "priced themselves into work" to avoid unemployment. In that sense, they are the dark side of Britain's "flexible" labour market, which has enabled employment to stay strong, even when our economy is flat.

This was brought out in recent research by economists at the Resolution Foundation (you see I have been doing my homework....) It found that higher unemployment was now having a much greater "chilling effect" on wages than in the past.

In the late 1980s and 1990s, a doubling of unemployment over six years would probably have led to the real wages of the average worker being about 7% lower than if unemployment had stayed the same. But things changed after 2002, the authors claim. Now, the same increase in joblessness would squeeze real wages for the average workers by 12%. Low paid workers have been most affected by this: for them, a doubling of unemployment means a real wage squeeze of 17%.

What does all this mean for the living wage? It means that politicians are going to carry on liking this campaign - but carefully. They are going to be nervous of anything that sounds like pressure on companies, and living wage employers will continue to be a self selecting group.

Around 3% of adult workers currently earn the minimum wage. If today's study is correct, far more - around 20% - earn somewhere between the minimum and a living wage.

Some, possibly many of those 4.89 million people could probably be paid more, saving the government money without hurting jobs or bankrupting their employers. But a free pay rise - for the government and for workers - is unlikely to be available for all of them. Is there such a thing as a free pay rise?

Stephanie Flanders Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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  • rate this

    Comment number 16.

    Instead of employers paying a living wage, shouldn't we resolve these 2 ridiculous situations first :-

    - lower-paid people paying tax and NI whilst simultaneously claiming tax credits
    - someone on ten grand paying more tax in a year than a multi-million turnover international coffee chain with a shop on every high street

  • rate this

    Comment number 15.

    Banning "Zero hours" contracts would be a good start. There are MANY jobs, all of them poorly paid, where this rip-off (American-inspired) allows companies to minimise thier costs, at the expense of the most vulnerable workers.
    Unless MPs were willing to have the same system - no attendance in Parliament, no pay!

  • rate this

    Comment number 14.


    "Our greedy society worships the profit motive. The bankers do it, the MPs scamming their expenses do it, the profiteering developers and landlords do it.."

    Yeah it's called capitalism and it's why we live in the world we do. If you want to, go live in a yurt in a non-capitalist society, no-one is stopping you.. North Korea awaits you with baited breath.

  • rate this

    Comment number 13.

    The question is simple:

    Do return whole swathes of our "plebeian" population to the poverty and workhouses of the Dickensian era, or do we find some way to progress beyond the long-predicted failure of capitalism?

    The preference of our hereditary wealthy Cabinet is clear in their language and actions; I suggest affording consideration to the wider populous might return a preferable solution.

  • rate this

    Comment number 12.

    Make the minimum wage a proper living wage, and scrap tax credits. This will release many DSS civil servents who could then work in productive work (true waelth generation jobs). This will give an large differential between those on State Benefit and those working, and stop the tax payer subsidising the bad employer. change the tax threshold to the new minimum wage + a few thousand pounds,

  • rate this

    Comment number 11.

    What politicians do not tell us is that lots of people on low wages = a competitive economy. The UK is in an open global trading system. It increases overall wealth. But for years the UK has underspent on R&D. So workers wages have to be kept "competitive" - which is a polite word for "kept very low" so businesses do not relocate abroad - see Ford decision to move a factory to Turkey.

  • rate this

    Comment number 10.

    Can you put 'Living wage' in quote marks please? This an invented concept from a bunch of socialists who still haven't matured past the 'magic money tree' stage. The way to deal with low wages is for the State to BACK OFF. Stop subsidising low wages via housing and other benefits. And, if we define people as living in poverty STOP TAXING THEM! Remove the State from work, let the market decide

  • rate this

    Comment number 9.

    How about giving wage rises to us, the 'little people', so that we can actually afford to live a decent, human life? I'm sick of bosses, 'executives' and the rest of the already-rich getting more money than they deserve to be getting. This is why I don't like capitalism - it encourages and perpetuates greed and inhumanity.

  • rate this

    Comment number 8.

    With everyone on at least a living wage, society would be a more contented and more pleasant place for all. Vandalism and crime reduced, jails less full, less fiddling, less poverty and less class divide.

    Only those who care only for themselves and the already priviledged would argue otherwise.

  • rate this

    Comment number 7.

    I would like to see the cost of things (energy, food) etc come down, rather than just paying more to absorb the increase in living costs. Harder problem to tackle I imagine.

  • rate this

    Comment number 6.

    Employers should pay a living wage - why should the taxpayer be subsidising private companies with working tax credits. If all those earning less than a living wage were taken out of the tax system employers would not need to pay a huge deal more to make a difference. This would cut costs for the government through the loss of all the administration.that is currently used to make these payments.

  • rate this

    Comment number 5.

    Our greedy society worships the profit motive. The bankers do it, the MPs scamming their expenses do it, the profiteering developers and landlords do it, and we do it when we buy in cheap imports made by people in factories we'd never wish our children in.

  • rate this

    Comment number 4.

    wages are one firms costs and other firms incomes
    we are not half way through the longest recession ever recorded
    have not regained half the fall in GDP since 2008
    financial crisis-debt deflation were acute restraints on demand
    but the developed world has spent 30 years chronically undermining
    demand as wages have fallen as a % of GDP
    for growth firms have to sell more
    who is doing more buying?

  • rate this

    Comment number 3.

    There's no such thing as a Free Pay Rise. If an employer thinks you should be paid more money then they usually expect you to take on more work to justify the increase in salary. And besides, a any 'cost of living' increase is usually wiped out by the tax man.

  • rate this

    Comment number 2.

    Adam Smith perfectly explained this to William Wilberforce in his fight against slavery, take the free workers used on the olympics,
    If they had been fed ,sheltered and watered profiteering would have been reduced,but hostelries,pubs, café's, restaurants would have gained,poverty is bad economics,we already have enough money in the system

  • rate this

    Comment number 1.

    Bad idea - living wage will lead to higher unemployment as firms outsource more and more work to the self employed. Many firms & businesses will simply pass on the burden of the living wage escalation to their customers & so a living wage will fairly easily be avoided & be inflationary - & very few people will be better off. Living wage will at same time lift millions above 'benefits threshold'.


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