U52026 International Labour Markets

Country Case Study: Low Pay in the UK

Dr. Maureen Pike

Word Count: 2,171

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Introduction

The growth of low pay within the United Kingdom (UK) is an apparent issue in relation to

comparable developed economies. The implications have negatively affected both the individuals

receiving low pay as well as the society in which they live. Through the use of evidence and labour

market theory, the extent and significance of low pay in the United Kingdom will be examined with

the analysis of possible policy solutions addressing the issues that arise from low earnings.

Significance of Low Pay in Britain

Low pay is defined as the “gross hourly earnings below two thirds of the median pay” which, in

the UK as of April 2014, was £7.67 (Corlett and Gardiner, 2015). While low pay continues to be

an important part of the labour market, the ability to progress in work is crucial in minimising

income inequality within an economy (Ray et al., 2014). However, the UK’s earnings mobility is

below the OECD average, resulting in high levels of long term low pay, affecting 15% of the

employed (Figure 1) (Keese and Grubb, 2015). As the period between 2010 – 2020 will be the

Incidence of low pay in the long-term (%) Based on simulations of hourly wages over ten years among continuously employed persons

Figure 1 Source: (OECD, 2015a, p.2)

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worst decade for pay growth in almost a century, low pay does not look to decrease (Perraudin,

2016). While the level of low pay has not changed drastically since the 1980’s (Figure 2), one in

every five employees earn below the low wage threshold with 78% of 16 to 20 year olds and 38%

of 21 to 25 year olds on low pay (Ray et al., 2014).

The UK’s reliance on low paid, low skilled labour now constrains the UK’s level of output as the

2014 productivity per hour worked remained substantially lower than the OECD average and,

below France and Germany (Figure 3) (Schmuecker, 2014). Such differences can be attributed

to variations in job quality, skill utilisation and work organisation as such factors are crucial

determinants of output (Wright and Sissons, 2012).

Figure 2 Source: (OECD, 2016b)

Wage Levels: Percentage of Full Time Employees on Low Pay, 1970 -2014

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Firm Quality

The competitive business model used by many UK firms incentivises low quality goods and

services with low labour costs (Corlett and Gardiner, 2015). As the UK leaves much of the training

and investment outcomes to market conditions, public spending within the labour market is

miniscule in comparison to similar economies (Figure 4). Such flexibility lead to low levels of

employment progression, reduced competitive advantage and higher degrees of working poverty

(Lanning and Lawton, 2012).

GDP per hour worked 2014: Total, 2010=100

Figure 3 Source: (OECD, 2016d)

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Skill Utilisation

Due to factors such as technological innovation and globalization the demand for continues to

polarise as semi-skilled occupations are off-shored or replaced by capital (Economist, 2015)

(Manning, 2013). The reduction in the semi-skilled occupations has decreased the opportunities

for many qualified workers, furthering the misallocation of skills (Figure 5). As low pay is

predominantly associated with low and medium skilled occupations, the inequality will continue to

rise with the polarization of occupational earnings and the lack of progression within jobs (Corlett

and Gardiner, 2015).

Public spending on labour market from 2000 – 2013: Total as a percentage of GDP

Figure 4

Source:(OECD,2016f)

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Employment Protection

The risk of unemployment is greater for the low paid relative to other earners (OECD, 2015b).

Such implications will have negative effects on the individuals and society as unemployment tends

to restrict future work prospects, due to scarring effects, leading to state dependence.

While producing a more flexible labour market, the UK’s regulations and institutions are miniscule

in comparison to similar economies (Table 1). France implements the strongest protection for

Percentage of employee’s over and under-skilled, by Industry

Figure 5 Source: (Wright and Sissons, 2012)

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employees yet the lack of flexibility within their economy has led to an unemployment rate of 10%

when the UK’s unemployment is 6.1% (Jenkin, 2015). However, job quality differences between

the two countries are argued to contribute to the variations in productivity and wages as workers

in France have higher job security as well as skill utilisation (Jenkin, 2015).

Although the UK nears the natural rate of unemployment, the underemployment rate remains

31% higher than the EU average (Trade Union Congress, 2015) (Figure 6). The involuntary

temporary and part time employment within the UK amplifies the significance of low pay with 42%

of part time employees receiving low pay compared to only 13% of full time employees in 2014

(Corlett and Gardiner, 2015). Due to the immobility previously mentioned, “patterns of

employment initially viewed as temporary are becoming permanent” and therefore the earnings

inequality within the UK will continue to increase along with work poverty (Roberts, 2014).

However, the high levels of part time employment are also due to personal reasons and therefore,

incentivizing full time work must emphasised (OECD, 2015).

Table 1 Data Source: (OECD, 2016a) (OECD, 2016d)

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Policy Improvements

The immobility of low pay can be attributed to the way in which specific firms and sectors are

organised as these structures limit the resources necessary for career progression (Ray, et al.,

2014). While a negative connotation is associated with higher levels of regulation and institutional

involvement within the labour market, many northern European countries that obtain high levels

of employment protection also have greater innovation and training as well as higher levels of

labour productivity than the UK (Lanning and Lawton, 2012). The UK should immolate many of

these policies in order to enhance the progression in the work force through improving job quality.

Part-time employment rate 2013: Total as a percent of employment

Figure 6 Source: (OECD, 2016c)

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Trade Unions and Collective Bargaining

While in comparison to similar countries the UK’s trade union density is quite large, such

involvement has deteriorated since the 1970’s when 58% of workers were in a trade union and

82% of wages were set through collective bargaining (McVey, 2016). Such decreases can be

attributed to changes in the perceptions of net benefits and social attitudes in relation to trade

unions as well as changes in workforce organisation. As countries with high levels of collective

bargaining tend to have minimal wage dispersion and lower incidences of low pay, the UK

government should incentivise collective bargaining and trade union involvement assuming that

firms are noncompetitive due to frictions involved in the employment mobility (Jamieson, 2015).

The presence of monopsonies ensures that trade union involvement will not increase the levels

of unemployment significantly but will increase workers representation in employment prospects

and may increase wages in other areas of the labour market, encouraging competition on quality

instead of on price (Ray et al., 2014). However, trade union premiums have decreased if not

diminished in recent years. Therefore, the success of trade union involvement will depend upon

their ability to reform around the new service based labour market and away from the former blue

collar dominated market.

National Living Wage

The National Living Wage, implemented in April 2016, shifted the burden of low pay back towards

firms (The Economist, 2015). While many argue that a higher minimum wage will increase labor

costs, leading to a higher level of unemployment, the results of the National Living Wage are

ambiguous as it may lead to reduced risk of extreme low pay, decreases in earnings inequality in

the short run and improved productivity (OECD, 2015b). The effects of the increased wage floor

on competitive and monopsonistic firms are examined in Figures 7 and 8.

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ED EM Es

Key: SM: Labour supply in the labour market

Dm: Labour demand in the labour market

SFI: Labour Supply for an individual competitive firm given WC

SFII: Labour Supply for an individual competitive firm given the National Living Wage

MRPL: Marginal Revenue Product of Labour for an individual competitive firm

Wc: The wage at the equilibrium of the labour market and perfectly competitive firms.

WL: The National Living Wage

SFI: Labour Supply for an individual competitive firm given WC

SFII: Labour Supply for an individual competitive firm given the National Living Wage

EFi: Quantity of Labour employed by an individual competitive firm at wage rate Wc

EfII: Quantity of Labour employed by an individual competitive firm at the National Living Wage

EM: The level of employment at WC

ED: The labour demanded given the National Living Wage

ES: The labour supplied given the National Living Wage

ES – ED: Unemployment due to the introduction of the National Living Wage

EFII

EFI

MRPL

WL

Wc

Labour Market Perfectly Competitive Firm

Figure 7: The effect of the National Living Wage on a perfectly competitive firm

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Key:

WM: The wage set by a monopsony without any government regulation

WL: The minimum wage a monopsonist must charge under the National Living Wage

EM: The employment level under an unregulated labour market

EL: The employment level under the National Living Wage.

MRPL: Marginal Revenue Product of Labour

ACL: Average Cost of Labour

MCL: Marginal Cost of Labour without labour market regulation

BCDM: New Marginal Cost of Labour under the National Living Wage

+ = Supernormal Profit under an unregulated labour market

= New Supernormal Profit under the National Living Wage

Figure 8: The effects of the National Living Wage on a Monopsonist

WL

WM

EM EL

MMRPL:

C

D

B

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The increase in the minimum wage for perfectly competitive firms will lead to the loss of firms in

the long run as the costs associated with production will exceed the profits and therefore the

unemployment rate will increase, ceteris paribus. However, for a monopsony, with a mandated

wage that is set below the profit maximising point, the marginal expense of labour will decrease

causing the firm to substitute labour for capital in the long run, ceteris paribus. While the minimum

wage increases earnings for those in low pay, if set too high, unemployment will rise resulting in

drastic unemployment rates similar to those of France.

While the National Living Wage of £7.20 for those 25 and over will decrease the incidence of low

pay, it will also affect the individual’s willingness to work. Assuming leisure is a normal good, an

increase in the wage will lead to a higher opportunity cost of leisure, increasing the hours worked

by those whose substitution effect outweighs the income effect (Figure 9). However, a higher

wage would make employees wealthier and thus may discourage them from working (Figure 10).

Therefore, while an increased minimum wage may reduce the incidence of low pay, the issue of

part time work may not be solved.

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Figure 9: The effects of an increase in the wage received by an individual after the introduction of the National Living Wage (Substitution effect > Income Effect)

Income (Y)

(£)

Y2

Y3

L1 HoursofLeisureperdayHoursofworkperday

L2

Key: AB= Old Budget line with a slope equal to -Wc or -Wm

AC= New Budget Line with the slope equal to -WL L1= Leisure Hours with the budget line AB L2= Leisure Hours with the budget line AC

Y1= (L1 x Wc) or (L1 X WM) Y2= (L2 x WL)

U1= Original Utility Curve with a slope equal to the marginal rate of substitution between leisure and income

U2= New Utility Curve with with a slope equal to the marginal rate of substitution between leisure and income

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Figure 10: The effects of an increase in the wage received by an individual after the introduction of the National Living Wage (Substitution effect < Income Effect)

Income (Y)

HoursofLeisureperdayHoursofworkperdayL1 L2

Y2

Y1

Key: AB= Old Budget line with a slope equal to -Wc or -Wm

AC= New Budget Line with the slope equal to -WL L1= Leisure Hours with the budget line AB L2= Leisure Hours with the budget line AC

Y1= (L1 x Wc) or (L1 X WM) Y2= (L2 x WL)

U1= Original Utility Curve with a slope equal to the marginal rate of substitution between leisure and income

U2= New Utility Curve with with a slope equal to the marginal rate of substitution between leisure and income

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Universal Credit

As a major contributer to low pay is the high level of part time employment for personal reasons,

the tax system must not discourage individuals from working more hours (OECD, 2015b). Recent

renovations to the tax system in the UK have focused on increasing hours worked and

occupational progression through the introduction of Universal Credit which replaces previous

benefits and tax credits, including the Housing Benefit and Child Tax Credit (Hirsch and Hartfree,

2013) (Brewer, et al., 2011). The new system will include an “in-work conditionality” which

emphasises the expectation that those on low pay should increase their hours worked or pursue

better paid positions, placing a higher burden on the employees (Ray et al., 2014). Additionally,

Universal Credit will lead to greater work participation for low income earners, especially single

adults and those with a partner who does not work, as the new participation tax rates encourage

full time employment (Figure 11). However, as a higher tax is associated with increased

participation of second earners, such earners incentive to work is weakened (Figure 12).

While the new universal credit promotes greater labour market participation, providing greater

transparency in work opportunities to improve mobility and greater child care support must be

emphasized to further decrease the incidence of part time for personal reasons (Ray et al., 2014)

(Adema, 2011).

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PTR’s by earnings for those in couples whose partner does not work before and after introduction of Universal Credit

Figure 11 Source: (Brewer et al., 2011, p. 56)

PTR’s by earnings for those in couples whose partner works, before and after introduction of Universal Credit

Figure 12 Source: (Brewer, et al., 2011, p. 57) Source

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Human Capital

As human capital is a crucial determinant of earnings, further skill developments must be

emphasised as higher educational attainment and training opportunities are not evenly distributed

throughout society, especially in regards to those working in low wage, low quality occupations

(OECD, 2015b).

While the UK provides adequate financial support for individuals investing in higher education,

many are unaware of the returns and funding available for such investments (McNally, 2012).

Therefore, to increase the proportion of individuals pursuing higher levels of education, policy

incentives must increase the focus on career opportunities and provide information available in

schools and career centers.

With the growth of the knowledge economy, the gap between the high skilled and the rest has

widened. Therefore, the UK should emphasise a “well skilled society” that utilises individual

talents across all occupations (Lanning and Lawton, 2012). This includes providing high quality

educational facilities for individuals participating in GCSE and A-level qualifications in order to

improve their overall abilities. Higher quality education can be obtained by improving teaching

quality through setting higher qualification requirements for teachers and greater autonomy for

schools as provided in Finland and Germany (OECD, 2007). Such alterations will lead to a well

skilled society which enhances wages of the individuals affected, provides greater community

involvement, economic growth, and knowledge spillovers.

Additionally, vocational training is a valuable tool for improving one’s skill level yet such tends to

receive considerably fewer resources than academic education (OECD, 2007). As low qualified

individuals require higher levels of training than employees with greater skills, low skilled

labourers are less likely to receive necessary training (Ray, et al., 2014). The Train to Gain

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program, created in 2006, was implemented in order to address such underdevelopment by

offering eligible low paid employees funding for vocational training (Ray, et al., 2014). However,

employers tended to offer the same training provided without the subsidy, suggesting the program

was unsuccessful in improving progression prospects (Woodward, et al., 2010).

With the new government coalition of 2010, the Train and Gain program was cancelled with a

transfer of £250 million to the apprenticeship budget (Lanning and Lawton, 2012).

Apprenticeships reduce the costs of training and recruitment as the government subsidizes the

costs and provides tax incentives for employers participate in the scheme. In the Summer Budget

2015, the government announced a ‘3 million apprenticeships’ policy that will provide £3 billion in

benefits by 2020 (Delebarre, 2016). However, as the majority of apprenticeships for young people

are conducted in low pay and low progression industries, the significance of low pay remains an

issue. Therefore, in order to reduce the longevity of low pay, the government and employers

should develop a strategy that includes pay and career progression in industries providing

apprenticeship schemes (Millburn, et al., 2016).

Conclusion

Low pay poses a significant threat to the wellbeing of individuals and societies within the UK.

While the UK government has attempted to address the issue, much more can be done in order

to ensure the incidence of low pay decreases and progression throughout the labour market

improves. Policies that can reduce the occurance of low pay must focus on both the supply and

demand dilemmas in the labour market. While the National Living Wage and the Universal Credit

look to improve the job quality, such strides can be seen to subsidize but not effectively remove

the significance of low pay. Therefore, greater pressure must be placed on human capital,

employee representation and employers to improve organizational structure and employment

prospects to ensure that employees are benefiting from participating in the labour force.

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