The impact of employment legislation on small firms

A persistent complaint by UK employers is the burden imposed on them by employment regulations. Small firms are felt to be particularly seriously affected. A study published in September 2003, based on qualitative research in 18 small firms, finds that the effects of employment legislation on small firms can be small. The reasons for this lie in the nature of different employment laws and the ways in which their effects in practice are shaped by firms’ market context and internal processes.

It is widely argued that employment legislation raises firms’ labour costs and adds to their administrative burdens (UK0310102N). The effects on small firms may be particularly acute for reasons including their limited administrative resources and their economic vulnerability. There are also potential positive effects, for example if regulations stimulate improved disciplinary procedures or a better work-life balance. The debate on these matters in the UK has sharpened with a range of recent laws governing minimum wages, working time, parental leave, and trade union recognition. A recent study (The impact of employment legislation on small firms: a case study analysis, Paul Edwards, Monder Ram and John Black, DTI, Employment Research Series No. 20) commissioned by the Department of Trade and Industry (DTI) and published in September 2003, set out to provide a detailed qualitative picture of the impact of employment legislation on the employment decisions and practices of small firms (see UK0002157F for earlier research).

The law and how it affects firms

Three main variables affecting how law shapes practice were identified in the research. First, the nature of laws varies. Some laws, for example on the National Minimum Wage (NMW) (UK9904196F), have universal coverage, whereas others (eg on unfair dismissal) come into play only when a firm takes a specific action. It was also expected that longer-established laws, for example on maternity leave (introduced in 1975), would be more embedded in practice than recent legislation, centrally the NMW and the Working Time Regulations (WTR) (UK9810154F), introduced in 1999 and 1998 respectively. Finally, laws in relation to collective rather than individual matters, mainly on trade union recognition (UK0007183F) and strikes, were predicted to have little purchase among small firms.

Second, the market context may affect firms’ ease of response. The greater the financial and competitive pressure that firms face, the more difficult it will be for them to absorb any costs of regulation. By contrast, firms in stronger positions may be able not only to absorb costs but also to use the law as a stimulus to modernisation.

Third, adjustment processes within firms were expected to cushion the impact of the law. For example the 'informality' of small firms could mean that maternity leave and issues related to the work-life balance are handled through face-to-face arrangements rather than requiring formal administrative systems.

The study also distinguished three distinct forms of effect. These were:

  • direct effects (where behaviour changes because of a legal requirement);
  • indirect effects (where the law acts to encourage a new practice, for example closer recording of hours of work by the existence of the WTR); and
  • 'affinity effects' (where there is no specific link between law and practice, but the two are moving in parallel directions).

Research design

Three sectors were included in the research. To address the impact of the WTR, a sector with long hours of work - management consultancy - was included. Care homes (ie for elderly people and similar groups) were chosen because of their need to provide round-the-clock service, so that working hours are an important theme, albeit in a different business context. In manufacturing, two subsectors were chosen: food manufacture, for its relatively low pay; and the locks industry, as a traditional sector facing international competition.

In each sector, six firms were identified. Eight of the firms had fewer than 20 employees; the remaining 10 employed between 20 and 50 people. Overall, 101 interviews were conducted with managers and workers between September 2001 and February 2002.

Nature of regulation - direct and indirect effects

Experience of laws on trade union recognition and strikes was not reported in the firms examined. With regard to laws governing individual rights, older ones on maternity leave were largely taken for granted. Few firms reported direct experience, and where there was such experience the issue was handled informally. No experience of parental leave, which was introduced in 1999 (UK9912144F) was reported.

Some firms had experience of cases going to employment tribunals. This tended to encourage a formalisation and 'proceduralisation' of the handling of discipline.

The WTR had few effects. Most firms had working hours schedules that meant that the main provisions of the Regulations governing maximum hours of work and night work did not apply. Where the Regulations applied, their introduction had not been controversial, and no significant record-keeping costs were reported.

The NMW had a direct effect in one firm, which decided that administering the NMW in respect of its home-workers would be difficult, and the workers concerned were brought into the factory. There were significant indirect effects in the care homes, as discussed below.

Market context

The care homes examined in the research were facing funding pressures as a result of the level of income which they received from social services departments. Regulations on standards of patient care and staff training imposed additional pressures. With rises in wages in other sectors as a result of the NMW, several homes faced substantial recruitment and retention problems. The main adjustment mechanism was the working of long hours by managers.

In manufacturing firms, labour supply issues were not significant. Some of the firms were moving towards higher value-added products, sometimes accompanied by the introduction of new technology. In such contexts, the negative aspects of legislation could be absorbed. Positive effects were rare and mainly of an 'affinity' kind. For example, one firm was changing its policy on work-life issues; legislation here was characterised as a 'wake-up call'.

Among the consultancies, several had chosen consciously to avoid a 'high-pressure' approach. This meant that pressures to work long hours were limited.

Adjustment within the firm

Informality operated in almost all the firms in relation to the handling of maternity leave and time off for family needs. There were very few formal rules on these matters, and the study argues that there was a distinct flexibility, based on personal ties, that would often be absent in larger firms.

Costs and benefits

On costs of regulatory compliance, there was no evidence that managerial decision-making was constrained by the existence of regulations. The main effects were largely of an administrative nature and, given the limited overall effects of regulation, they were felt to be small. Firms found it hard to produce concrete estimates of these costs, since they did not engage in the necessary detailed accounting.

The benefits of regulation were identified mainly by firms adopting a strategy of producing higher-value goods or services. The benefits were mainly seen in terms of encouragement, for example the 'wake-up call' cited above. In addition, a broader 'affinity' effect can be identified, in that regulations were consistent with the ways in which some firms were moving. Examples include a firm which felt that a flexible approach to family needs brought it business benefits.


The study argues that there is no single effect of law on small firms as a group, since individual laws differ and their effect is shaped by market conditions and adjustment processes within firms. It suggests an approach to law that is sensitive to context: sectors most likely to suffer negative effects could be identified and possibly given special attention, while situations where the law might encourage modernisation could also be targeted for action.

As a qualitative analysis, this study cannot estimate effects on small firms as a whole. However, a representative survey, also for the DTI and published in 2002, found that employment laws were far from being the main constraint faced by firms, with market competition being the main influence. A recent general review of evidence on UK productivity also concludes that regulatory restrictions are not a significant factor. The present study confirms the role of the market, suggesting that where conditions are unfavourable employment laws may be an additional consideration but that elsewhere negative effects may be slight. It also suggests that positive effects tend to be small and that for these to be greater would require a much broader range of business support measures. (Paul Edwards, IRRU)

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