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It's time to increase the National Living Wage to help with the cost of living

26 September 2022

Attila Lindner why it is possible to increase the National Living Wage during a time of high inflation and recession.

Policy Lab

Attila Lindner, Associate Professor, University College London

If you have questions about the paper or wish to speak directly with the authors, please contact j.baggaley@ucl.ac.uk (UCL Policy Lab).

Soaring energy prices and high inflation affects all of us. And the cost-of-living crisis is leaving millions of households struggling to meet basic needs. In this economic context, it is natural to ask: how should policymakers respond to the imminent social crises?

Soaring energy prices and high inflation make everyday life difficult for millions of households. These pressures are set to continue well into 2024. We must examine all the tools to alleviate the imminent social crisis. 

One such tool is wages. And in particular, increasing wages for those on low incomes.

Making use of the National Living Wage

The National Living Wage has helped improve the standard of living for millions of workers in the United Kingdom. The policy's goal is to allow workers to afford a decent standard of living. And any increase in the National Living Wage has an immediate effect on workers, helping millions of households to cope with the cost-of-living crises.

Yet, in the current economic crisis, many are concerned that a further increase in wages could pile pressure on vulnerable firms, which could respond by laying off low-wage workers. If those job losses are significant, the policy could end up doing more harm than good. 

Whether these fears about employment are materialised or not is an empirical question which we aim to answer.

Examining the risks

In the last 30 years, ample evidence has been produced suggesting that the policies like the National Living Wage do not lead to significant disemployment effects (e.g. Cengiz et al., 2019). This has been confirmed in the UK context recently by a study from the Institute of Fiscal Studies (Cribb et al 2021). Nevertheless, the wage floor might have a different impact in a recessionary than in a boom environment.

What does the existing evidence tell us about this?

The following figure shows the relationship between the employment impact of the minimum wage floor and the local unemployment rate. To create this graph, we studied 130 prominent state-level minimum wage changes instituted between 1979 and 2016 in the United States and calculated the observed employment change in response to the policy. Then we divide minimum wage changes into ten groups based on the local unemployment rate at the time of the minimum wage changes and calculate the average employment change in that group.

Graph

The graph shows that employment change is close to zero in all ten groups and suggests that the impact of the policy is unrelated to the local unemployment rate. If anything, the employment change is more damaging in the booming period (when unemployment is small) and more positive in the recessionary period (when unemployment is significant). Still, overall the policy impact seems to be close to zero whenever the unemployment rate is between 4-10%. The current UK unemployment rate is around 4%, so even if there is a substantial increase from that, we expect that the living wage will have a limited employment effect.

Therefore, the existing evidence suggests that the policy's negative consequences will be limited. So living wages mainly contribute to higher wages, and employment changes will likely be limited. Nevertheless, if employment does not change, what does the living wage does?

Why it works

First, most empirical studies agree that part of the living wage is passed through to consumers (see e.g. Harasztos and Lindner, 2019). This might be worrying as we want to avoid further pressure on prices. Nevertheless, given the low share of the low-wage workers in the total production (around 5% of the GDP), even a substantial increase in the living wage (e.g. 20%) would increase inflation by 0.2%. Given that the current inflation is close to 10%, such a slight increase would be hardly recognised by most people.

Second, it would also alleviate firms’ labour market power. As energy prices soar, commuting becomes more costly, dramatically reducing many low-wage workers' ability to travel for work. Therefore, the increase in living wage can be used to offset the increased labour market power from higher energy prices. This benefit of living wages makes it a handy tool in the current environment to fight against the cost-of-living crisis.