Does Living Wage Negatively Impact SMEs?

Will the forced changes have an impact on UK businesses?


The British national minimum wage was first introduced in 1999, almost a hundred years after the idea was first put forward by the Fabian society. It has had a profound impact on pay. Straight off the bat, it gave over one million workers an average pay rise of 10-15%. Since then, there has been an increased clamor to establish the so-called ‘living wage’, with the minimum wage considered insufficient to survive on. After almost twenty years of the Low Pay Commission setting minimum wage at a level based on the criteria of it not harming employment, the government has introduced a so-called ‘national living wage’. As of the 1 April 2016, all employers will have to pay employees aged 25 and over £7.20 per hour, 50p more than the £6.70 minimum wage rate that came in last October. The national living wage will then rise gradually to £9 an hour by 2020.

The immediate reaction to the announcement in July was mixed, to say the least. Many critics focused on the fact that it is not actually the living wage, which is set according to how much a household needs to make ends meet, and is still actually much more than the new rate at £9.40 an hour in London and £8.25 outside. Businesses and various bodies like the Federation of Small Businesses (FSB) have also been up in arms, claiming that the move will hit profit margins and neuter their ability to employ people, leading to less hiring and potential redundancies.

The debate around minimum wage has been raging since the 1990s, when people like Alan Walters – Margaret Thatcher’s economic guru – argued that that it would lower employment, writing that it was ‘utter nonsense’ to argue that jobs might not be lost. The business community’s reaction was similarly negative this time around, with warnings that it would bring the care sector to near collapse, and industries that operate under tight margins anyway, such as food and drink manufacturers, would simply not be able to pay. The credit rating agency Moody’s also warned that the net result could be higher prices for shoppers.

In a survey of 1,000 small enterprises by MarketInvoice, 27% said they believe the national living wage would have the biggest effect on their business of any event this year. Another survey from the FSB found that 38% of small employers expected it to have a negative impact, with wages at more than half of all employers expected to rise, forcing many of them to seek savings through improved productivity.

John Allan, chairman of the FSB, noted that: ‘The FSB has been supportive of gradual increases in the national minimum wage in recent years, to reflect the improvement in the economy and the fact that more of our members are raising wages. However, the introduction of a new, significantly higher rate (the national living wage) – 70p more than the existing adult rate – will pose big challenges for many small firms, particularly those in the hospitality, retail and social care sectors where low pay is common and margins tight. Companies in contract service sectors, that are already locked into long-term contracts, will also be negatively affected – given the short time in which to adapt.’

However, there is also a wealth of evidence suggesting that minimum wage comes at no cost to jobs, and actually has many benefits to businesses. Obviously, an increase in the wage bill will tighten margins, but the financial costs of Living Wage adoption can be offset by cost mitigation strategies, and should be considered alongside investment commitments designed to create value. It should also help deal with the UK’s productivity crisis, which has been a tremendous source of concern over the past several years.

There are a number of other potential benefits that businesses can realize from implementing the Living Wage, including financial savings such as a reduction in staff turnover, increased worker morale and loyalty, lower rates of absenteeism, better recruitment opportunities and reputational benefits.

A recent government survey supports this, with 88% saying it would make staff more productive, 86% of respondents saying the move would boost staff morale, and 82% saying customers were likely to return if the business paid the right rates. Historical evidence also suggests that fears in a rise of the minimum wage are unfounded. A famous 1990 study, by David Card and Alan Krueger, compared fast food employment in New Jersey and Pennsylvania after one state increased its minimum wage and the other didn’t. They didn’t find a significant effect on employment. Another paper in the British Journal of Industrial Relations examined 1,494 estimates of the employment effect of US minimum wage rises published in 64 different papers. They also found that there was virtually no employment effect from minimum wage rises. In total, the UK Low Pay Commission has now commissioned over 130 pieces of research from accomplished academic economists, which finds minimum wages boost workers’ pay, but doesn’t harm employment.

This seems to fly in the face of common sense and the economists’ competitive ideal. The costs of switching between firms and the variety of workers’ preferences mean that employers have considerable discretion in wage setting, and a carefully set minimum wage would not necessarily cost jobs - and may even boost employment as recruits are found for previously hard-to-fill vacancies.

Many businesses have already implemented the proper living wage anyway. For some small businesses, it will undoubtedly prove to be a challenge. There are strategies that can be put in place to mitigate against increases in the short term, such as hiring people under 25 and re-arranging shift patterns, but the value created by increased productivity and morale among current workers should not be underestimated in the long term, and businesses should also ensure that these are still realized.


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