Budget 2015: Living wage offers rabbit out the hat, but magic will be needed later

Protestors have their prayers answered? LIVING WAGE, CC BY-NC-ND

This was a bombshell of a budget, signalling direct interventions in the labour market that went far beyond what most observers were expecting.

The day was dominated by the introduction of what the chancellor, George Osborne, has termed the new National Living Wage to be applied to all those aged 25 or more and set initially at £7.20 an hour from April 2016. This represents a 7.5% increase over the October rate of the minimum wage and comes with a commitment to increase the new living wage by 25% by 2020.

This is one of the boldest interventions on wages at the bottom end of the labour market, affecting up to 6m employees, since the establishment of the Low Pay Commission and the introduction of National Minimum Wage in 1998.

This is in effect the grand trade-off between higher wages for the low paid and cuts to some working-age benefits signalled in a pre-budget speech by the prime minister, David Cameron. The narrative that many firms were, in effect, keeping wages lower than they otherwise would do because of generous in-work benefits has gained strength, even if the direct evidence is scant. Now, low-wage companies and sectors will have to take more of the strain in combating low pay.

PM takes a back seat today, but has already signalled changes. Martin Schulz, CC BY-NC-ND

Equally surprising, the government has also directly intervened by imposing a levy on large firms to help sustain the promised expansion in higher-quality apprenticeships. Governments in the past have hoped that a system of public support and persuasion would improve the collective training effort of UK firms, with at best mixed results. This significant policy departure signals a new impatience with the lack of progress and acknowledges the unspoken frustration of firms that do provide quality training with those that do not.

Devils and details

Of course, both of these big announcements may well prove to be less radical than they appear. The claim that low-wage households will be better off even when the complicated changes to tax and benefits are taken into account will be tested, not least by the independent Institute for Fiscal Studies. There is also more detail to come out – for example, what the implications of the change mean for the Low Pay Commission and minimum rates for those under 25.

There are two important known unknowns. The OBR has forecast that the loss of jobs from the new living wage will be 60,000 by 2020, a modest cost, though we do not know if the Low Pay Commission agrees with this assessment. Either way, it remains to be seen whether actual job losses are larger or smaller than expected, especially among small and medium-sized enterprises (SMEs). Similarly, we do not know whether the new levy system will increase the overall training effort of British companies.

Braced for cuts? corum_l, CC BY-NC-ND

The third big intervention was less surprising because it is familiar. The government announced a further period of pay restraint in the public sector, limiting pay awards to an average of 1% per annum. With pay in the private sector already rising at 3% and likely to go higher, the gap between public and public pay will widen significantly. We can expect increasing recruitment and retention difficulties and this will have to be addressed, expensively, at some point in the future.

The chancellor also made a commitment to create two million more jobs, compared with the OBR forecast of one million jobs over the next five years. This is puzzling. The reason why the OBR forecast for future job creation is slower than in the past five years is because the OBR expects productivity to recover. To meet the chancellor’s job commitment, either economic growth must be significantly faster or productivity growth significantly weaker than in the OBR forecast.