The Household Impact of an Increased National Minimum Wage

What has your research on the minimum wage increase found?

In our Summer 2023 Outlook for UK Households, we examined the impact of low real wage growth on working families, especially those in the bottom half of the income distribution who earn up to £32,000 per year. At that point, our projection was that median real wages would fall by up to 6 per cent in the period from early 2022 to late 2024. However, the stronger increase in the National Minimum Wage (NMW) and the National Living Wage (NLW) mean that the same decrease does not apply to households in the bottom income decile (incomes up to about £15,000) who will see their median real wages only fall by about 2 per cent.

As expected, the effects of raising the NMW and the NLW are more substantial at the lower end of the income distribution. Interestingly, effects for households in the bottom decile are more limited, potentially because the benefits of higher wages accrue mainly to the in-work poor and not to the on-benefits poor. That said, we estimate that bottom decile households would see a 5-6 per cent rise in their consumption in 2023-24, relative to the previous NMW/NLW rates. This is likely because they anticipate higher incomes in the future even if their current incomes do not rise substantially, perhaps offset against lower benefits. This is not true for households in the second decile who are shielded less from the inflationary pressures as they do not receive the cost-of-living payment worth £900 and some of the other benefits.

We also showed that there are significant effects upon labour market choices and outcomes. Specifically, for households in the second bottom decile of the income distribution, the incentives to work and their ability to move into work are both affected positively. Both the inactivity rate and the unemployment rate for these households drop by 2-3 percentage points. Note that this impact is (statistically) significant only for households in the second decile, and the aggregate impact is therefore around 0.3 percentage points in either case. Also, before the higher wage rates were applied, inactivity and unemployment rates for second decile households were much higher than the UK average. Second decile households also experience some decrease in benefits income, but there is large heterogeneity in their experiences and this shortfall is not statistically significant at conventional levels.

How did you come to this conclusion?

We used NIESR’s microsimulation model LINDA (Lifetime INcome Distribution Analysis) to simulate the impact of the recent rise in national living wage and minimum wage on household finances and their labour supply. Effectively, we move wages at the lowest end of the distribution to the floor given by the uprated wage rates and observe its impact on household level choices as to: (a) how much to spend on consumption and what to save for a future rainy day; and (b) how many hours of labour to offer in gainful employment and therefore how many hours to spend in leisure.

These projections are underpinned by our macroeconomic forecast that the UK economy will avoid a recession in 2023 and 2024 but that it will follow a path of sluggish growth. We find that a higher NMW and NLW will not have an adverse impact on the labour market. The reasons are, first, that the economy is not operating at full capacity, second, that rising profit margins can absorb higher wages and, third, that productivity is not harmed by the increase in the NMW and the NLW.

Why does this matter for policy?

Raising the NMW and the NLW has a positive effect on the consumption and labour supply choices of households in the bottom two income deciles. Based on this evidence, the Chancellor’s announcement at the 2023 Conservative Party conference that the government would raise the NLW to at least £11 an hour from April 2024 onwards is a step in the right direction. Yet given permanently higher energy, food and housing costs as well as persistent inflation, we would recommend a higher increase of up to £11.43, in line with the recommendation from the Low Pay Commission in March 2023 and our research for the LPC in October 2023.

More generally, despite persistent price inflation and our projection that the rate of inflation will not revert to the target of 2 per cent until late 2025, our view is that the UK economy is able to accommodate strong wage growth (of about 6-7 per cent) in 2024 without generating a wage-price spiral that would keep inflation above 2 per cent in 2025 and thereafter.