How much will the minimum wage rise really cost business?

Is the minimum wage rising again?

Yes, there’s to be no respite this year. The Low Pay Commission – the quango that advises the Government on the level of the minimum wage – has decided that the adult rate will rise by an inflation-busting 5.9% in October 2006, to £5.35 an hour. This easily outstrips the rate of basic wage inflation, which is running at 3.8%, and is almost three times the rate of consumer price inflation.

Has it always gone up so quickly?

No. The adult rate started at £3.60 in April 1999 and went up roughly in line with average earnings between then and 2002. But the commission thought that fewer people were benefiting from it than intended, so the rate was upped sharply in subsequent years. Once the 2006 increase comes into effect, it will have risen by 27.4% in four years, compared with estimated wage inflation of 17% (see the graph, below).

At that rate, will I be on the minimum wage soon?

No, that’s what’s bothering businesses. Up until last year, almost all the impact has been on wages for the lowest-paid workers. That’s still quite a large number of people – the LPC reckons that the latest increase will affect 1.3 million employees. But there was no sign that it was driving up wages for higher-paid staff, as opponents originally feared would happen.
That now seems to be changing.

Why is it different this time?

There are complaints that, as a result of several years of above-inflation increases, the latest rise means many employers will also have to raise wages for staff higher up the wage scale. Otherwise the differentials between their pay grades and the minimum wage will become so small that more skilled staff will move to other employers who are prepared to give them higher wages. “When it was first introduced, the minimum wage had a catch-up effect with little impact further up the line. This year’s rise of almost 6% at the bottom is raising pay 6% all the way up the line,” says Bob Cotton, CEO of the British Hospitality Association, quoted in the FT.

Is there any more evidence to back that up?

It’s wise to be a bit cautious – there have been warnings of labour-market apocalypse since the minimum wage was introduced and so far they’ve proved alarmist. But this time, there seems to be at least the beginnings of a case for concern. There are clear signs that employers are feeling squeezed in the disappearance of the “mezzanine” rate of pay. When the minimum wage was first introduced, many businesses set their basic pay rate around 50p above the legal minimum, in order to attract staff. But this practice is reported almost to have disappeared, with businesses starting staff on the lowest level instead. Some firms are also tackling the problem of pay differentials being squeezed together by the simple expedient of getting rid of them. Tesco now has two pay grades instead of five and the Co-op has combined four retail-staff grades into one.

Who’s going to be worst hit by this?

Industries who employ a lot of low-paid, low-skilled staff, often on a casual basis, such as agriculture, hospitality and retail. But even industries that generally pay above the minimum are not immune – manufacturers organisation EEF says the increase in the minimum is beginning to have a knock-on effect on their floor rates of pay. Services that manufacturers contract out, such as cleaning and security, are also beginning to cost them more as a result of pay rises in those sectors. In geographical terms, businesses outside London and the southeast are likely to feel the pressure more, because a tight labour market in the south means many business already pay more than the minimum. The Federation of Small Businesses says that a third of its members in the northeast and a quarter in the northwest, Humberside and Yorkshire were affected after last year’s increase.

So is the future all doom and gloom?

There are a few brighter spots. Up until now, the impact of the minimum wage has been surprisingly benign. Unemployment has fallen sharply since 1999 and corporate profitability has risen. So, while this latest increase will probably have more of an effect than previous ones, labour markets and companies should be in decent shape to withstand it. Encouragingly, further increases at these rates are unlikely. The LPC’s latest report says that “the phase in which the LPC is committed to increases in the minimum wage above average earnings is over. Looking forward, we have no presumption that further increases above average earnings are required.”
But this year’s rise will almost certainly have one unwanted effect – the inflationary pressure of higher wages are yet another pointer towards higher interest rates.

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