How did firms pay for the big pay rise in 2016? Through productivity and price rises, not job losses

2016 marked the introduction of a big, controversial new player on the political economy scene, whose influence is set to grow and grow over the next four years. No, this isn’t a blog about President-Elect Trump. For millions of low earners across the UK, another development has had an even bigger impact. The National Living Wage (NLW) delivered an annual wage boost of nearly 11 per cent for the lowest earners in Britain when introduced last April.

But while it’s been less divisive than some of the other events of 2016, the NLW has sparked debate too. Pay rises don’t come for free and there have been warnings of negative side effects, from job losses to the removal of other perks. So, six months on from its introduction, how have employers responded to the new higher wage floor? A new RF report, including a survey of 800 employers in four low-paying sectors, sheds new light on firms’ initial response, and how that might evolve in the coming years.

First, it’s worth noting that even in low-paying sectors, half of the firms we surveyed hadn’t seen their wage bill rise as a result of the NLW. Just under half said that the NLW added to their wage bill, though that share rose to almost six in ten employers in the hospitality sector. Many more firms will be affected however as the NLW approaches its target rate of 60 per cent of typical pay in 2020 (currently forecast by the OBR to be £8.80).

Focusing on those firms who were affected, the good news is that a range of approaches have been used to cope with the higher wage bill so far, including price rises and boosting productivity (or at least trying to), without major employment effects. Fears of job losses have proved wide of the mark – with employment remaining around record highs and less than one per cent of affected firms opting for redundancies.

The kinds of responses employers are opting for also varies by sector. Price rises have been particularly common among cleaning organisations (where labour makes up the bulk of costs), as opposed to retailers who remain embroiled in the long-running supermarket price wars and have a more diverse cost base. Food processing firms on the other hand were more likely to invest in technology. Much of that investment was seeking to make existing staff more productive while some was intended to directly replace human labour.

Though less common than prices or productivity, some employers had made changes to employment. Just over one in four of affected firms had offered fewer hours to staff, slowed their recruitment or employed more workers on zero-hours or casual contracts. This too varied by sector with one in three hospitality employers making such changes.

In the lifetime of the policy however, it’s still early days. A full assessment of its impact will take longer than six months. That’s especially true as a substantial increase in the wage floor, taking the UK into uncharted territory, comes at the same time as the Brexit process and related changes such as the depreciation in sterling and restrictions on low skill immigration. The interaction of these elements, as well as the broader economic environment, will be crucial. For instance on price rises, though the NLW may have played a small role in higher prices in affected sectors over the last year, the main driver of the uptick in CPI in recent months has been oil prices. Will price pressures in the coming months from a weaker pound mean firms are better or worse positioned to pass on their higher labour costs?

And perhaps the most important question for the UK economy is the extent the long-promised productivity recovery ever appears. Two-thirds of firms affected by the NLW have taken some steps to boost their productivity. These good intentions are of course welcome and in some sectors they may pay bigger dividends than others. But some may find it difficult to offset much of the cost of the NLW and others – particularly smaller employers – are less likely to have tried.

The OBR’s forecasts suggest 2017 may see the return of the pay squeeze with earnings struggling to return to pre-crisis levels even by 2020. The NLW should be a welcome protection against this for the lowest earners. And while its link to median pay should mean it rises at a sustainable pace for employers, keeping an eye firmly trained on how the reaction of employers in low-paying sectors evolves will be crucial.