The National Minimum Wage: Report of the Low Pay Commission

June 1998 saw the publication of the report of the Low Pay Commission, set up by the UK's Labour Government to recommend the level of the forthcoming National Minimum Wage (NMW). It recommended an adult NMW of GBP 3.70 an hour from June 2000, with an initial rate of GBP 3.60 from April 1999.

One of the key commitments of the Labour Government which came to power in May 1997 (UK9704125F) is the introduction of a National Minimum Wage (NMW). The Low Pay Commission (LPC) was appointed in July 1997 (UK9711177F) to recommend the level of the NMW, and it published its report in June 1998 (The National Minimum Wage: First report of the Low Pay Commission) The LPC's main recommendations - an adult hourly NMW of GBP 3.70 from June 2000, with an initial rate of GBP 3.60 from April 1999 - were trailed in advance, and there was a widely reported debate within the Government on one key issue, the minimum rate for those aged 18-21. The Chancellor of the Exchequer, Gordon Brown, was reported as favouring a relatively low rate of GBP 3 per hour, which might even cover workers aged over 21. The LPC's terms of reference required it to recommend rates lower than the adult rate for those aged up to 25, and it recommended GBP 3.20 as a "development rate", with the adult rate starting at the age of 21.

In the event, Margaret Beckett, President of the Board of Trade, announced on 18 June that the initial development rate would be GBP 3 with effect from April 1999, but that it would rise to the GBP 3.20 level in June 2000. That aside, the Government welcomed "all of the Commission's key recommendations". In particular, the main adult rate would be GBP 3.60 per hour, though there was no commitment to raising the level to the recommended GBP 3.70 in 2000. Ms Beckett also announced that the LPC would be kept in being to monitor and evaluate the effects of the NMW. We here analyse the LPC's work and the estimated effects of the NMW.

The LPC and its work

The LPC is chaired by Professor George Bain, vice-chancellor of the Queen's University, Belfast. It has eight other members, comprising three employers, three trade unionists and two academics. Importantly for a controversial issue of this kind, its recommendations were agreed by all nine members.

As well as reviewing over 500 written submissions and hearing oral evidence, members of the Commission conducted visits throughout the country. "We have met", says Professor Bain in his foreword, "overloaded advice services, committed managers sometimes in struggling businesses, and low-paid workers and unemployed young people on bleak estates".

This effort to understand the realities of low pay is reflected in the LPC's report, which is liberally illustrated with quotations from evidence and from the Commission's own inquiries. It escapes the dryness of many official documents.

The report is long (285 pages) and detailed. It includes analysis of the pattern of low pay, discussion of the definition of the minimum wage and its level, and consideration of potential effects. It also contains a comprehensive summary of research evidence of the employment effects of minimum wage systems. The report even offers a "best practice" model for how payslips should be amended to display the NMW and sufficient details to allow employees to confirm whether they have received the statutory minimum.

Recommendations

Definition of pay

The LPC's aim was to define the NMW so that it will be "transparent to workers, easy for employers to comply with, and straightforward to enforce" (para. 4.3). It considered a range of options as to what to include. At one extreme, some unions argued that only basic pay should count, but the Commission noted than in several industries that would be affected by the NMW, notably clothing, piecework is widely used: to leave out of account normal piecework earnings would be unrealistic. At the other extreme, some employers wanted to include all earnings, including overtime and other bonus payments. The Commission felt that this would be too all-embracing. It argues that all pay for "standard" work should be included. Incentive pay should be included, with pieceworkers being paid "no less than the National Minimum Wage on average for the pay reference period" (para. 4.13). Shiftwork and other premium payments should be included. As for tips and gratuities, these should be included where there is a centrally organised system for distributing them through the payroll, but excluded where they comprise cash payments direct from customer to the employee.

The pay reference period should be the normal pay period up to a maximum of a month. Earnings during the period, including normal incentive components but excluding overtime and other premia, would be divided by total hours worked to produce an hourly rate that could be compared to the NMW.

Coverage

The LPC argues that "we must ensure that we do not cut across [apprenticeship and other] important means by which young people acquire skills which will equip them for well-paid work" (para. 5.16). It thus recommends that all 16 and 17 year olds and all those on formal apprenticeships should be exempt from the NMW.

Reflecting many studies in other countries, which find that minimum wages have significant effects on youth labour markets, the Commission also concludes that it would risk employment opportunities for young people if they were to be covered by the adult NMW. "To avoid the threat of making youth unemployment worse, and losing valuable employer investment in young workers" (para. 5.48), there should be a development rate for all 18-20 year olds. This rate should also apply for a maximum of six months to those aged 21 and over "who are beginning a new job with a new employer and who are on accredited training" (para. 5.53).

Level

In recommending a level for the NMW, the LPC took account of six factors: pay differentials; cost to business; competitiveness; prices; employment; and public sector finances. On the first, for example, its report considers arguments that an NMW will have "knock-on" effects on higher-paid workers. The report notes that evidence in other countries finds a pay "spike" at the level of the minimum, so that the earnings distribution is compressed; it cites contemporary evidence on pay structures that suggests that the structures are flexible; and it uses its own interviews to indicate the pressures to restore differentials would be limited.

Three considerations seem to have been influential in setting the specific rate. First, until 1993 several low-wage sectors were covered by Wages Council s (UK9703112F), and up-rating the average Wages Council rate gives one benchmark. However, about half of all workers covered by the NMW, in sectors such as security and contract cleaning, were not covered by Wages Councils; and wage dispersion has increased since 1993, so that there may be more very low-paid workers than in that year. Thus an NMW might be lower than the up-rated Wages Councils figures. Second, there is the value of the NMW as a proportion of average earnings, and how this compares with the situation in other countries. The recommended rate puts the UK in the middle of the international range. Third, there is the direct effect on wage costs.

On the basis of such considerations the LPC concludes that an hourly rate of GBP 3.70 in June 2000 would strike a reasonable balance between the need to protect employees and the dangers of raising business costs and lowering competitiveness. However, with a stress on prudence it recommends initially setting the rate at GBP 3.60 in April 1999. The development rate should start at GBP 3.20, rising to GBP 3.30.

Enforcement

Enforcement is considered under three heads. By being simple and well-known, the NMW would enjoy a considerable degree of self-enforcement. The amendment to payslips mentioned above would contribute here. On communication, the LPC rejects such ideas as that employers should be required to display notices about the NMW, but points to several voluntary actions of this kind which might be encouraged. Finally, the enforcement agency should be an existing agency such as the Contributions Agency (which deals with social security) and not a special inspectorate.

Effects

The LPC estimates that the NMW would affect about 2 million employees (9% of the working population). This would include homeworkers as well as those more conventionally employed. The greatest effect would be on young workers, with about one-fifth of 18-20 year olds being covered, and women, especially part-timers (of whom 22% would be covered).

The direct effect on the national wage bill is estimated as an increase of 0.6%. No estimates are offered of indirect effects arising from possible restorations of differentials. The sector facing the greatest impact is hospitality, where about a third of employees are likely to be affected and the paybill is estimated to rise by 3%.

Other possible effects are discussed under the head of choosing the rate of the NMW. A section of the report (paras 6.43 to 6.51) considers possible consequences in terms of economic efficiency. It has long been argued that an NMW will encourage firms to use labour more efficiently. The LPC is cautious, noting the many factors which affect performance and quoting the evidence of the Registered Nursing Home Association to the effect that staffing levels are already at a minimum and that there was no slack which could be eliminated. "The stimulus to efficiency could in time enhance performance," concludes the LPC (para. 6.52). The report also includes, in Appendix 10, a discussion of one possible means by which labour efficiency might be improved, the reduction of labour turnover. It concludes that the NMW could have two effects: raising the attractiveness of one job compared with another; and making work relatively more attractive than unemployment. Turnover might then fall.

Commentary

Many trade unions had argued for an NMW above GBP 4 an hour and also preferred the full adult rate to be paid at the age of 18. The rate of GBP 3.60 is around the level at which many employers were arguing that the effects would be manageable. This outcome reflects the watchwords of caution and pragmatism running through the LPC report. An NMW is a new departure for the UK, and it comes after two decades in which the dispersion of earnings increased and the ratio of youth to adult wages fell. In these circumstances the shock of a high NMW, in particular if it applied to all workers aged 18 and over, might have been considerable. As noted above, the Government's response was to lower the development rate to GBP 3 (and also to accept the GBP 3.60 adult rate without any commitment to raising it to the recommended GBP 3.70 in 2000).

In an interview with the Financial Times, Professor Bain argued that the job of the LPC was not to "do the unions' work for them" by setting a relatively high rate. It was, instead, to establish a pay floor. The minimum is a means of encouraging "feelings of belonging not to the margins, but to the mainstream of society" (LPC Report, para. 9.6).

The LPC and the Government stress that the NMW should not be seen in isolation. It has evident parallels with the Fairness at work white paper, published in May 1998 (UK9806129F), but it also relates to the "New Deal" proposals on helping unemployed people into the labour market (UK9707143F). These aim to help people aged 18-24 into the labour market, and the LPC was keen to avoid any disincentive for employers to become involved in training schemes under the New Deal (Report, paras 5.26-29). The NMW "can help create a labour market where the unemployed can more readily move into jobs" (Report, para. 9.5).

As noted above, the LPC succeeded in producing a unanimous report. In the light of unions' demands for a higher rate, employer concerns about pay costs and the Government's interests in controlling inflation and not upsetting the New Deal programme for young workers, this is a significant achievement.

Many large employers have already been adjusting their pay structures in anticipation of the NMW. The preparedness of smaller firms is harder to judge, but the LPC's view that there should not be major effects on employment or wage bills is based on substantial evidence. One of its most important arguments is that pay differentials can change over time, and it provides evidence on the point. Some unions have confirmed that they would not see the NMW as a reason to seek the restoration of differentials for the higher paid. However, there must be some concern that pay could be allowed to drift upwards. The management of pay structures is an important issue for employers.

The question of up-rating the NMW also remains open. The Government has started with the GBP 3.60 level with no commitment to further adjustment. The continuing work of the LPC will be important in assessing the NMW's effects.

What also remains to be seen is whether the NMW has more dynamic effects. In the words of Ms Beckett, "it will help create a better rewarded and more committed workforce, itself a force for driving up standards and helping competitiveness." Yet such effects will depend on the response of employers in terms of training and investment in new production methods, and the LPC makes no strong assertions as to likely effects. How far the NMW pushes employers towards more effective use of labour remains to be seen. (PK Edwards, IRRU)

Reference: The National Minimum Wage: First report of the Low Pay Commission, Cm 3976. is available through the Stationery Office, PO Box 276, London SW8 5DT. Fax orders: 44 (0) 171 873 8200. Price: GBP 21.60.

Useful? Interesting? Tell us what you think. Hide comments

Eurofound welcomes feedback and updates on this regulation

Add new comment