How small firms are adjusting to the national minimum wage

As the first anniversary of the introduction of the UK's first national minimum wage approaches in April 2000, research covering sectors in which it was expected to have the most significant impact reveals the processes of adjustment within small firms.

The UK's first national minimum wage (NMW) was introduced in April 1999 against the backdrop of immense uncertainty over what its effects might be (UK9904196F). The Labour government aimed to introduce the NMW in such a way that it would bring substantial benefits to low paid workers without imposing undue burdens on business and the economy. It has generally been accepted by all parties (including the opposition Conservative Party) that the legislation has had few negative effects on employment. Despite this, very little is known about the mechanics of implementing the NMW within companies themselves. Research at the University of Warwick ("Pay, work organisation and ethnicity in small firms: evidence to the Low Pay Commission", Mark Gilman, Monder Ram and Paul Edwards, IRRU (1999)) is beginning to highlight some of the processes involved in small and medium-sized enterprises (SME s) in the printing, hotels and catering, and clothing sectors.

The national minimum wage in SMEs

The researchers spoke to employers and employees in 81 SMEs and to their various business associations prior to the introduction of the NMW.

Who was aware?

Only six companies said that they were not aware of the NMW, all from within the hotels and catering sector, while 80% of employees said that they knew about the NMW. However, knowledge of the exact rates and details of the regulations was extremely low among both employers and employees.

Three-quarters of the companies affected by the NMW said that they had received no information about preparation for it. Of those who had received such information, sources such as accountants and the press, rather than business associations, were the norm. Similarly, only 27% of employees said that their companies had provided information or had discussions with them about the NMW.

Who was affected?

Just under half of all companies said that they had at least some employees paid under the NMW rate. Some of these were not, however, considered to be permanent. In respect of permanent workers, just under half the companies said that the hourly pay of at least some of these workers was either below or exactly GBP 3.60, therefore suggesting that a "pay spike" at the minimum rate, noted in studies in the USA, has already come into being in the UK.

Of the employees interviewed, just over half thought that they would be directly affected by the NMW. The figure was higher for the clothing sector (58%) than hotels and catering (26%), and included only one of the printing companies.

Responses to NMW

A third of the relevant companies had made changes to their pay system in anticipation of the NMW - as indicated in the table below. This included one print company, 27% of the hotels and catering companies and 42% of the clothing companies. Some companies had put their rates up seemingly without any difficulties while others complained that it was not possible under their present conditions. These companies were usually in very competitive parts of their industry with very low profit margins etc.

Companies' reported responses to NMW
Changes in payment system made 35%
Changes in non-pay benefits made 5%
Aim to raise employee skills 37%
New technology introduced or planned 41%
Expect to subcontract work 26%
NMW expected to raise labour costs: .
A little 55%
A lot 13%
Possible to pass on costs in higher prices 26%

One implication of the findings summarised in the table is that, though firms may raise wages, they expect some compensating changes in terms of productivity as well as improved working practices. These changes could entail more effort on the part of employees. Some employers felt that a formerly acceptable balance, of low effort and low pay, could no longer be sustained, with the employees concerned simply having to work harder or be dismissed. However, in general such a sharp adjustment seems relatively rare.

Patterns of adjustment

Given that it is very early days for the NMW, a mix of responses is to be expected. It is still possible to identify various tendencies although in practice matters are likely to be less clear-cut than this. The situation may shift unpredictably and, crucially, individual firms are likely to engage in a mix of practices at the same time.

First, one response may be employer-employee collusion in ignoring the NMW. Where an employer is generally perceived to be "fair" by employees, and/or where employees perceive few alternative sources of employment, there may be little pressure from the workforce for payment of the NMW. Most of the survey workplaces outside of printing are also non-unionised, so little external pressure would be brought to bear from this quarter.

A second response, which may overlap with the first, is for firms to meet their new obligations, with no major consequences in terms of work organisation. This may be termed the minimalist response. The logic here turns on the amount of leeway which exists in any employment contract. For example, the research found some hotels paying substantially more than others in the vicinity for similar jobs; the fact that wages vary within local labour markets is now very well attested.

A third response is that of work intensification- that is, balancing a rise in pay with an increase in employee effort. The research found remarkably few employers making this a systematic response, though some were thinking of amending job duties. The fact that employees generally reported that they already worked hard and were subject to tight discipline would also suggest that there was limited space for adjustments here.

Finally, there may be efforts at work reorganisation, using new technologies or other means. There was a small number of firms which seemed to be taking this path.

The most popular paths are likely to be those of collusion and minimalism. In this sense, the "shock" of the NMW has not been a very large one, reflecting the level at which it was introduced and the economic conditions of the period. The research also found considerable variation within localities, with islands of poor conditions in a sea of relative prosperity. One should not therefore expect geographical or sectoral labour markets to respond in uniform ways.

What are the reasons for such responses?

A key finding was the leeway open to firms in the setting of pay. The fact that there is no "equilibrium market wage rate" but rather a "range of indeterminacy" (ie rather than the fixed equilibrium rate expected in orthodox economic theory, there is a range of rates, sometime varying as much as 20%) within which firms can chose their preferred rate of wages is well-attested in relation to large firms, but it is often assumed that in more perfectly competitive conditions the market will rule. This was not found to be the case.

Pay structures in the survey companies were extremely informal and sometimes crude. Information on pay rates tended to be gathered by word of mouth, and workers doing similar jobs might be paid different rates. The rarity of discussions of pay among workers added further to widening the range of indeterminacy and making pay relativities highly fluid.

The range of indeterminacy operated, however, around what is sometimes termed a "low wage/low skill" equilibrium and a lack of will by employers and employees to challenge this. Formal training was notable by its absence, but there was much informal training happening within individual companies. Employees were expected to add to their previous experience by learning on the job, but the drawback of this was that training was very narrow, making "upskilling" a difficult path for employers to follow.


The national minimum wage forms part of the government commitment to a "knowledge-driven economy" based on the promotion of competition backed up by a minimum set of standards that cut off the low pay route to competing. Yet the research outlined above highlights the diversity of awareness and practices within SMEs and a consequent wide range of responses to the NMW.

If the NMW is to have a positive "shock" effect, possibly contributing to forcing businesses into more efficient practices, it may well need to be set at a higher level. There were some cases where employers have responded by operating more efficiently. For example, in the clothing sector it has long been common practice to leave employees to earn whatever they want or can, regardless of any inefficiency. The advent of the minimum wage had caused some employers to seriously review this policy and employees had been informed that they would now have to work harder or they would have to leave. The more positive companies have also been taking advice on formal measurements and costing techniques rather than their previously more crude methods of work assessment. However, if the most popular paths continue to be collusion or minimalism the NMW may have little or no effect on employment but a negative one on efficiency, due to continuing low pay and labour intensification.

The government clearly has a fine balancing act to perform in the promotion of efficiency. While local business associations potentially could play a role in the identification and diffusion of good practice, the more important issue will continue to be the method and level of uprating the NMW (UK0001147N) without upsetting one or other of the social partner groups. (MW Gilman, IRRU)

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