How we can end the low pay trap

British workers are still experiencing a concerted fall in living standards. An increase in the national minimum wage could help, but businesses, especially smaller firms generally tend to oppose a compulsory living wage. Lorena Papamanci outlines a possible solution.

Despite the economic recovery, the UK continues to fail its working population. Latest figures reveal that the number of workers on low pay has risen to 5.2m, up from 4.8m in 2012 and 3.4m in 2009. This equates to one in every five British workers earning less than the Living Wage (£8.80 per hour in London and £7.65 throughout the country). Furthermore, these statistics show that one in every eight workers in the UK that starts off on low pay, remains so for at least a year. 

Clearly, and despite the recent good news on the economy, British workers are still experiencing a concerted fall in living standards. For those trapped on low pay and poor working conditions, the opportunity lies in securing sustainable work contracts and undergoing personal and professional development. But employers rarely consider investing in human capital as a main priority for business success.

As a result, 73 per cent of those on low pay a decade ago had not managed to escape the low pay trap by 2012, and nearly half of those who had moved on to better contracts were yet again at risk of taking up low paid work by 2012. As well as harming people directly, low pay represents a drain on government finances. The annual cost to the Exchequer for workers paid less than the Living Wage is now £3.23 billion, which is mostly the result of in-work benefits and lost tax revenue.

Government needs to up its game, as getting people into work is only half the equation: it also needs to ensure that work actually pays.

What is more, stagnating wages and a constant squeeze on living standards are pushing more and more people into unsustainable debt. Outstanding personal debt in the UK has doubled in the last ten years to £1.4 trillion, with one in ten people struggling with arrears on mortgage, council tax, utility bills, rent and childcare.

In response, in September 2013 the Labour Party leader Ed Miliband announced that a potential Labour government would strengthen the minimum wage by linking it to average earnings. As a result of the independent report published earlier this month by Alan Buckle, Miliband argued that the framework for determining how the minimum wage is set must change dramatically. The announcement was part of the party’s ‘national mission’ to tackle low pay and suggested Labour would make the National Minimum Wage (NMW) a percentage of the average UK earnings.

NMW in its current form in no way ensures sustainable living for workers and, as a result, needs to be increased significantly (as we have argued previously). However, Labour’s policy recommendation received criticism from business groups, which reject increasing NMW on grounds of affordability, especially if set at an arbitrary level of average earnings. Instead, we argue that a more feasible approach would be to allow labour market entry at NMW level, which would then be followed by a compulsory sector-specific pay rise to living wage levels after one year on low pay. This wage increase could then be made affordable through a cut in corporation tax, thus firmly linking business tax-cuts with wage rises. 

Businesses, especially smaller firms, generally tend to oppose a compulsory living wage, as the inherent financial burden could lead to a decrease in employment. However, this scheme would not only postpone the ‘hit’ on finances for a year, during which time employers can assess skills and value added per employee, but it would also act as a trigger for worker motivation. Moreover, given the historic correlation between wages and living standards on one hand and productivity levels on the other, it should be expected that this progressive pay scheme would have a good chance of reversing the national productivity crisis.

As it currently stands, productivity levels in the UK are still 4.3 percentage points down from the pre-downturn peak in 2008. Labour productivity has yet to recover after 23 quarters, making this the worst and longest ever crisis for British workers. In comparison, according to ONS and OECD statistics released earlier this quarter, Germany, France and the US were over 30 percentage points more productive than the UK in 2012 and the average UK worker’s output has fallen to 16 per cent below the G7 average.

It is no surprise then that, for the first time, of the 13 million people living in poverty in the UK, the majority are in working families. Hence a new plan is needed: one that is responsive to workers’ inability to escape low pay and that is not harmful to business and the economy. Labour’s plan goes a long way in changing that narrative, yet a lack of real support from businesses raises questions over the feasibility of these noble plans. Government needs to up its game, as getting people into work is only half the equation: it also needs to ensure that work actually pays.