Category: Essential Economics for Business: Ch 08

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How to increase productivity – the key to economic growth

The productivity gap between the UK and its main competitors is significant. In 2024, compared to the UK, output per hour worked was 10.0% higher in France, 19.8% higher in Germany and 41.1% higher in the USA. These percentages are in purchasing-power parity terms: in other words, they reflect the purchasing power of the respective currencies – the pound, the euro and the US dollar.

GDP per hour worked (in PPP terms) is normally regarded as the best measure of labour productivity. An alternative measure is GDP per worker, but this does not take into account the length of the working year. Using this measure, the gap with the USA is even higher as workers in the USA work longer hours and have fewer days holiday per year than in the UK.

The productivity gap is not a new phenomenon. It has been substantial and growing over the past 20 years. (The exception was in 2020 during lockdowns when many of the least productive sectors, such as hospitality, were forced to close temporarily.)

The productivity gap is shown in the two figures. Both figures show labour productivity for the UK, France, Germany and the USA from 1995 to 2024.

Figure 1 shows output (GDP) per hour, measured in US dollars in PPP terms.

Figure 2 shows output (GDP) per hour relative to the UK, with the UK set at 100. The gap narrowed somewhat up to the early 2000s, but since then has widened.

Low UK productivity has been a source of concern for UK governments and business for many years. Not only does it constrain the growth in living standards, it also make the UK less attractive as a source of inward investment and less competitive internationally.

Part of the reason for low UK productivity compared to that in other countries is a low level of investment. As a proportion of GDP, the UK has persistently had the lowest, or almost the lowest, level of investment of its major competitors. This is illustrated in Table 1.

It is generally recognised by government, business and economists that if the economy is to be successful, the productivity gap must be closed. But there is no ‘quick fix’. The policies necessary to achieve increased productivity are long term. There is also a recognition that the productivity problem is a multi-faceted one and that to deal with it requires policy initiatives on a broad front: initiatives that encompass institutional changes as well as adjustments in policy.

So what can be done to improve productivity and how can this be achieved at the micro as well as the macro level?

Improving productivity: things that government can do

Encouraging investment. Over the years, UK governments have increased investment allowances, enabling firms to offset the cost of investment against pre-tax profit, thereby reducing their tax liability. For example, in the UK, companies can offset a multiple of research and development costs against corporation tax. The rate of relief for small and medium-sized enterprises (SMEs) allows companies that work in science and technology to deduct an extra 86% of their qualifying expenditure from their trading profit in addition to the normal 100% deduction: i.e. a total of 186% deduction. Meanwhile, since April 2016, larger companies have been able to claim a R&D expenditure credit, initially worth 11 per cent of R&D expenditures, then 12 per cent from 2018 and 13 per cent from 2020. This was then raised to 20 per cent from 2023.

Strengthening competition. A number of studies have revealed that, with increasing market share, business productivity growth slows. As a result, government policy sought to strengthen competition policy. The Competition Act 1998, which came into force in March 2000, and the Enterprise Act of 2002, enhanced the powers of the Office of Fair Trading (OFT) (a predecessor to the Competition and Markets Authority) in respect to dealing with anti-competitive practices. It was given the ability to impose large fines on firms which had been found guilty of exploiting a dominant market position. Today, one of the strategic goals of the Competition and Markets Authority (CMA) is the aim of ‘extending competition frontiers’ in order to improve the way competition works.

Encouraging an enterprise culture. The creation of an enterprise culture is seen as a crucial factor not only to encourage innovation but also to stimulate technological progress. Innovation and technological progress are crucial to sustaining growth and raising living standards. The UK government launched the Small Business Service in April 2000, later renamed Business and Industry. Its role is to co-ordinate small-business policy within government and liaise with business, providing advice and information. However, according to the OECD, there remains considerable scope for increasing the level of government support for entrepreneurship in the UK.

Improving productivity: things that organisations can do

In the podcast from the BBC’s The Bottom Line series, titled ‘Productivity: How Can British Business Work Smarter’ (see link below), Evan Davis and guests discuss what productivity really looks like in practice – from offices and factories, to call centres and operating theatres.’ The episode identifies a number of ways in which labour productivity can be improved. These include:

  • People could work harder;
  • Workers could be better trained and more skilled and thus able to produce more per hour;
  • Capital could be increased so that workers have more equipment or tools to enable them to produce more, or there could be greater automation, releasing labour to work on other tasks;
  • Workplaces could be arranged more efficiently so that less time is spent moving from task to task;
  • Systems could put in place to ensure that tasks are done correctly the first time and that time is not wasted having to repeat them or put them right;
  • Workers could be better incentivised to work efficiently, whether through direct pay or promotion prospects, or by increasing job satisfaction or by management being better attuned to what motivates workers and makes them feel valued;
  • Firms could move to higher-value products, so that workers produce a greater value of output per hour.

The three contributors to the programme discuss various initiatives in their organisations (an electronics manufacturer, NHS foundation trusts and a provider of office services to other organisations).

They also discuss the role that AI plays, or could play, in doing otherwise time-consuming tasks, such as recording and paying invoices and record keeping in offices; writing grants or producing policy documents; analysing X-ray results in hospitals and performing preliminary diagnoses when patients present with various symptoms; recording conversations/consultations and then sorting, summarising and transcribing them; building AI capabilities into machines or robots to enable them to respond to different specifications or circumstances; software development where AI writes the code. Often, there is a shortage of time for workers to do more creative things. AI can help release more time by doing a lot of the mundane tasks or allowing people to do them much quicker.

There are huge possibilities for increasing labour productivity at an organisational level. The successful organisations will be those that can grasp these possibilities – and in many cases they will be incentivised to so so as it will improve their profitability or other outcomes.

Podcast

Articles

Data

Questions

  1. In what different ways can productivity be measured? What is the most appropriate measure for assessing the effect of productivity on (a) GDP and (b) human welfare generally?
  2. Why has the UK had a lower level of labour productivity than France, Germany and the USA for many years? What can UK governments do to help close this gap?
  3. Find out how Japanese labour productivity has compared with that in the UK over the past 30 years and explain your findings.
  4. Research an organisation of your choice to find out ways in which labour productivity could be increased.
  5. Identify various ways in which AI can improve productivity. Will organisations be incentivised to adopt them?
  6. Has Brexit affected UK labour productivity and, if so, how and why?
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A four-day week – a solution to sluggish productivity growth? (Updated)

In a blog from March 2023 (reproduced below), we saw how there has been growing pressure around the world for employers to move to a four-day week. Increasing numbers of companies have adopted the model of 80% of the hours for 100% of the pay.

As we see below, the model adopted has varied across companies, depending on what was seen as most suitable for them. Some give everyone Friday off; others let staff choose which day to have off; others let staff work 80% of the hours on a flexible basis. Firms adopting the model have generally found that productivity and revenue have increased, as has employee well-being. To date, over 200 employers in the UK, employing more than 5000 people, have adopted a permanent four-day week.

This concept of 100-80-100, namely 100% of pay for 80% of hours, but 100% of output, has been trialled in several countries. In Germany, after trials over 2024, 73% of the companies involved plan to continue with the new model, with the remaining 27% either making minor tweaks or yet to decide. Generally hourly productivity rose, and in many cases total output also rose. As the fourth article below states:

The primary causal factor for this intriguing revelation was simple – efficiency became the priority. Reports from the trial showed that the frequency and duration of meetings was reduced by 60%, which makes sense to anyone who works in an office – many meetings could have been a simple email. 25% of companies tested introduced new digitised ways of managing their workflow to optimise efficiency.

Original post

In two previous posts, one at the end of 2019 and one in July 2021, we looked at moves around the world to introduce a four-day working week, with no increase in hours on the days worked and no reduction in weekly pay. Firms would gain if increased worker energy and motivation resulted in a gain in output. They would also gain if fewer hours resulted in lower costs.

Workers would be likely to gain from less stress and burnout and a better work–life balance. What is more, firms’ and workers’ carbon footprint could be reduced as less time was spent at work and in commuting.

If the same output could be produced with fewer hours worked, this would represent an increase in labour productivity measured in output per hour.

The UK’s poor productivity record since 2008

Since the financial crisis of 2007–8, the growth in UK productivity has been sluggish. This is illustrated in the chart, which looks at the production industries: i.e. it excludes services, where average productivity growth tends to be slower. The chart has been updated to 2024 Q2 – the latest data available. (Click here for a PowerPoint of the chart.)

Prior to the crisis, from 1998 to 2006, UK productivity in the production industries grew at an annual rate of 6.9%. From 2007 to the start of the pandemic in 2020, the average annual productivity growth rate in these industries was a mere 0.2%.

It grew rapidly for a short time at the start of the pandemic, but this was because many businesses temporarily shut down or went to part-time working, and many of these temporary job cuts were low-wage/low productivity jobs. If you take services, the effect was even stronger as sectors such as hospitality, leisure and retail were particularly affected and labour productivity in these sectors tends to be low. As industries opened up and took on more workers, so average productivity rapidly fell back. Since then productivity has flatlined.

If you project the average productivity growth rate from 1998 to 2007 of 6.9% forwards (see grey dashed line), then by 2024 Q3, output per hour in the production industries would have been 3.26 times higher than it actually was: a gap of 226%. This is a huge productivity gap.

Productivity in the UK is lower than in many other competitor countries. According to the ONS, output per hour in the UK in 2021 was $59.14 in the UK. This compares with an average of $64.93 for the G7 countries, $66.75 in France, £68.30 in Germany, $74.84 in the USA, $84.46 in Norway and $128.21 in Ireland. It is lower, however, in Italy ($54.59), Canada ($53.97) and Japan ($47.28).

As we saw in the blog, The UK’s poor productivity record, low UK productivity is caused by a number of factors, not least the lack of investment in physical capital, both by private companies and in public infrastructure, and the lack of investment in training. Other factors include short-termist attitudes of both politicians and management and generally poor management practices. But one cause is the poor motivation of many workers and the feeling of being overworked. One solution to this is the four-day week.

Latest evidence on the four-day week

Results have just been released of a pilot programme involving 61 companies and non-profit organisations in the UK and nearly 3000 workers. They took part in a six-month trial of a four-day week, with no increase in hours on the days worked and no loss in pay for employees – in other words, 100% of the pay for 80% of the time. The trial was a success, with 91% of organisations planning to continue with the four-day week and a further 4% leaning towards doing so.

The model adopted varied across companies, depending on what was seen as most suitable for them. Some gave everyone Friday off; others let staff choose which day to have off; others let staff work 80% of the hours on a flexible basis.

There was little difference in outcomes across different types of businesses. Compared with the same period last year, revenues rose by an average of 35%; sick days fell by two-thirds and 57% fewer staff left the firms. There were significant increases in well-being, with 39% saying they were less stressed, 40% that they were sleeping better; 75% that they had reduced levels of burnout and 54% that it was easier to achieve a good work–life balance. There were also positive environmental outcomes, with average commuting time falling by half an hour per week.

There is growing pressure around the world for employers to move to a four-day week and this pilot provides evidence that it significantly increases productivity and well-being.

Additional articles

Original set of articles

Questions

  1. What are the possible advantages of moving to a four-day week?
  2. What are the possible disadvantages of moving to a four-day week?
  3. What types of companies or organisations are (a) most likely, (b) least likely to gain from a four-day week?
  4. Why has the UK’s productivity growth been lower than that of many of its major competitors?
  5. Why, if you use a log scale on the vertical axis, is a constant rate of growth shown as a straight line? What would a constant rate of growth line look like if you used a normal arithmetical scale for the vertical axis?
  6. Find out what is meant by the ‘fourth industrial revolution’. Does this hold out the hope of significant productivity improvements in the near future? (See, for example, last link above.)
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Hybrid working: too much homework or the ‘new normal’?

During the pandemic, most people who were not furloughed were forced to work from home. After lockdown restrictions were lifted, many employers decided to continue with people working remotely, at least for some of the time.

Today, this hybrid model, whereby workers work partly from home or local workspaces and partly in the office/factory/warehouse etc., has become the ‘new normal’ for around 26% of the working population in Great Britain – up from around 10% at the end of the national lockdowns in the Spring of 2021.

Increasingly, however, employers who had introduced hybrid working are requiring their employees to return to the office, arguing that productivity and hence profits will rise as a result. Amazon is an example. Other employers, such as Asda, are increasing the time required in the office for hybrid workers.

Hybrid working had peaked at around 31% in November 2923 as the chart shows (click here for a PowerPoint). The chart is based on the December 20 database, Public opinions and social trends, Great Britain: working arrangements from the Office for National Statistics (see link under Data, below).

But why are some employers deciding that hybrid working is less profitable than working full time in the office. And does it apply to all employers and all employees or only certain types of firm and certain types of job?

The first thing to note is that hybrid work is more common among certain groups. These include older workers, parents, graduates and those with greater flexibility in scheduling their work, especially those in managerial or professional roles with greater flexibility. Certain types of work on the other hand do not lend themselves to hybrid work (or working completely from home, for that matter). Shop workers and those providing a direct service to customers, such as those working in the hospitality sector, cannot work remotely.

Benefits of hybrid working

For some employees and employers, hybrid working has brought significant benefits.

For employees, less time and money is spent on commuting, which accounts for nearly an hour’s worth of the average worker’s daily time. According to the ONS survey, respondents spent an additional 24 minutes per day on sleep and rest and 15 minutes on exercise, sports and other activities that improved well-being compared to those who worked on-site. Working at home can make juggling work and home life easier, especially when workers can work flexible hours during the day, allowing them to fit work around family commitments.

Employers benefit from a healthier and more motivated staff who are more productive and less likely to quit. Hybrid work, being attractive to many workers, could allow employers to attract and retain talented workers. Also, employees may work longer hours if they are keen to complete a task and are not ‘clocking off’ at a particular time. Working from home allows workers to concentrate (unless distracted by other family members!).

By contrast, office working can be very inefficient, especially in open offices, where chatty colleagues can be distracting and it is difficult to concentrate. What is more, employees who are slightly unwell may continue working at home but may feel unable to commute to the office. If they did, they could spread their illness to other colleagues. Not allowing people to work from home can create a problem of ‘presenteeism’, where people feeling under the weather turn up to work but are unproductive.

One of the biggest benefits to employers of hybrid work is that costs can be saved by having smaller offices and by spending less on heating, lighting and facilities.

With hybrid working, time spent on site can be devoted to collaborative tasks, such as meetings with colleagues and customers/suppliers and joint projects where face-to-face discussion is required, or at least desirable. Tasks can also be completed that required specialist equipment or software not available at home.

Problems of hybrid working

So, if hybrid working has benefits for both employers and employees, why are some employers moving back to a system where employees work entirely on site?

Some employers have found it hard to monitor and engage employees working from home. Workers may be easily distracted at home by other family members, especially if they don’t have a separate study/home office. People may feel detached from their co-workers on days they work from home. After a time, productivity may wane as workers find ways of minimising the amount of time actually working during declared work times.

Far from improving work-life balance, for some workers the boundaries between work and personal life can become blurred, which can erode the value of personal and family time. This can create a feeling of never escaping from work and be demotivating and reduce productivity. Employees may stay logged on longer and work evenings and weekends in order to complete tasks.

Unless carefully planned, on days when people do go into the office they might not work effectively. They may be less likely to have profitable ad hoc conversations with co-workers, and meetings may be harder to arrange. Misunderstandings and miscommunication can occur when some employees are in the office but others are at home.

Some employers have found that the problems of hybrid working in their organisations have outweighed the benefits and that productivity has fallen. In justifying its ending of hybrid working from 1 January 2025, Amazon CEO, Andy Jessy, wrote in a memo to staff in September 2024:

To address the … issue of being better set up to invent, collaborate, and be connected enough to each other and our culture to deliver the absolute best for customers and the business, we’ve decided that we’re going to return to being in the office the way we were before the onset of COVID. When we look back over the last five years, we continue to believe that the advantages of being together in the office are significant.1

But is the solution to do as Amazon is doing and to abandon hybrid working and have a mass ‘return to the office’?

Improving hybrid working

There are ways of making hybrid working more effective so that the benefits can be maximised and the costs minimised.

Given that there are specific benefits from home working and other specific benefits from working on-site, it would be efficient to allocate time between home and office to maximise these benefits. The optimum balance is likely to vary from employer to employer, job to job and individual to individual.

Where work needs to be done in teams and where team meetings are an important element of that work, it would generally make sense for such meetings to be held in person, especially when there needs to be a lot of discussion. If the team requires a brief catch up, however, this may be more efficiently done online via Teams or Zoom.

Individual tasks, on the other hand, which don’t require consultation with colleagues or the use of specific workplace facilities, are often carried out more efficiently when there is minimum chance of interruption. For many workers, this would be at home rather than in an office – especially an open-plan office. For others without a protected work space at home or nearby, it might be better to come into the office.

The conclusion is that managers need to think carefully about the optimum distribution between home and office working and accept that a one-size-fits-all model may not be optimum for all types of job and all workers. Recognising the relative benefits and costs of working in different venues and over different hours may help to achieve the best balance, both for employers and for workers. A crucial element here is the appropriate use of incentives. Workers need to be motivated. Sometimes this may require careful monitoring, but often a more hands-off approach by management, with the focus more on output and listening to the concerns of workers, rather than on time spent, may result in greater productivity.

1Message from CEO Andy Jassy: Strengthening our culture and teams, Amazon News (16/9/24)

Articles

Data

Questions

  1. Why may hybrid working be better for (a) employees and (b) employers than purely home working or purely working in the office?
  2. Why are many firms deciding that workers who were formerly employed on a hybrid basis should now work entirely from the office?
  3. What types of job are better performed on site, or with only a small amount of time working from home?
  4. What types of job are better performed by working at home with just occasional days in the office?
  5. Does the profile of workers (by age, qualifications, seniority, experience, family commitments, etc) affect the likelihood that they will work from home at least some of the time?
  6. How would you set about measuring the marginal productivity of a worker working from home? Is it harder than measuring the marginal productivity of the same worker doing the same job but working in the office?
  7. How may working in the office increase network effects?
  8. How may behavioural economics help managers to understand the optimum balance of home and on-site working?
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Raising the minimum wage: its effects on poverty and employment

The first Budget of the new UK Labour government was announced on 30 October 2024. It contained a number of measures that will help to tackle inequality. These include extra spending on health and education. This will benefit households on lower incomes the most as a percentage of net income. Increases in tax, by contrast, will be paid predominantly by those on higher incomes. The Chart opposite (taken from the Budget Report) illustrates this. It shows that the poorest 10% will benefit from the largest percentage gain, while the richest 10% will be the only decile that loses.

But one of the major ways of tackling inequality and poverty was raising the minimum wage. The so-called ‘National Living Wage (NLW)’, paid to those aged 21 and over, will rise in April by 6.7% – from £11.44 to £12.41 per hour. The minimum wage paid to those aged 18 to 20 will rise 16.3% from £8.60 to £10.00 and for 16 and 17 year-olds and apprentices it will rise £18% from £6.40 to £7.55.

It has been an objective of governments for several years to relate the minimum wage to the median wage. In 2015, the Conservative Government set a target of raising the minimum wage rate to 60 per cent of median hourly earnings by 2020. When that target was hit a new one was set to reach two-thirds of median hourly earnings by 2024.

The Labour government has set a new remit for the minimum wage (NLW). There are two floors. The first is the previously agreed one, that the NLW should be at least two-thirds of median hourly earnings; the second is that it should fully compensate for cost of living rises and for expected inflation up to March 2026. The new rate of £12.41 will meet both criteria. According to the Low Pay Commission, ‘Wages have risen faster than inflation over the past 12 months, and are forecast to continue to do so up to March 2026’. This makes the first floor the dominant one: meeting the first floor automatically meets the second.

How effective is the minimum wage in reducing poverty and inequality?

Figure 1 shows the growth in minimum wage rates since their introduction in 1999. The figures are real figures (i.e. after taking into account CPI inflation) and are expressed as an index, with 1999 = 100. The chart also shows the growth in real median hourly pay. (Click here for a Powerpoint.)

As you can see, the growth in real minimum wage rates has considerably exceeded the growth in real median hourly pay. This has had a substantial effect on raising the incomes of the poorest workers and thereby has helped to reduce poverty and inequality.

The UK minimum wage compares relatively favourably with other high-income economies. Figure 2 shows minimum wage rates in 12 high-income countries in 2023 – the latest year for which data are available. (Click here for a PowerPoint.) The red bars (striped) show hourly minimum wage rates in US dollars at purchasing-power parity (PPP) rates. PPP rates correct current exchange rates to reflect the purchasing power of each country’s currency. The blue bars (plain) show minimum wage rates as a percentage of the median wage rate. In 2023 the UK had the fourth highest minimum wage of the 12 countries on this measure (59.6%). As we have seen above, the 2025 rate is expected to be 2/3 of the median rate.

Minimum wages are just one mechanism for reducing poverty and inequality. Others include the use of the tax and benefit system to redistribute incomes. The direct provision of services, such as health, education and housing at affordable rents can make a significant difference and, as we have seen, have been a major focus of the October 2024 Budget.

The government has been criticised, however, for not removing the two-child limit to extra benefits in Universal Credit (introduced in 2017). The cap clearly disadvantages poor families with more than two children. What is more, for workers on Universal Credit, more than half of the gains from the higher minimum wages will lost because they will result in lower benefit entitlement. Also the freeze in (nominal) personal income tax allowances will mean more poor people will pay tax even with no rise in real incomes.

Effects on employment: analysis

A worry about raising the minimum wage rate is that it could reduce employment in firms already paying the minimum wage and thus facing a wage rise.

In the case of a firm operating in competitive labour and goods markets, the demand for low-skilled workers is relatively wage sensitive. Any rise in wage rates, and hence prices, by this firm alone would lead to a large fall in sales and hence in employment.

This is illustrated in Figure 3 (click here for a PowerPoint). Assume that the minimum wage is initially the equilibrium wage rate We. Now assume that the minimum wage is raised to Wmin. This will cause a surplus of labour (i.e. unemployment) of Q3 – Q2. Labour supply rises from Q1 to Q3 and the demand for labour falls from Q1 to Q2.

But, given that all firms face the minimum wage, individual employers are more able to pass on higher wages in higher prices, knowing that their competitors are doing the same. The quantity of labour demanded in any given market will not fall so much – the demand is less wage elastic; and the quantity of labour supplied in any given market will rise less – the supply is less wage elastic. Any unemployment will be less than that illustrated in Figure 3. If, at the same time, the economy expands so that the demand-for-labour curve shifts to the right, there may be no unemployment at all.

When employers have a degree of monopsony power, it is not even certain that they would want to reduce employment. This is illustrated in Figure 4: click here for a PowerPoint (you can skip this section if you are not familiar with the analysis).

Assume initially that there is no minimum wage. The supply of labour to the monopsony employer is given by curve SL1, which is also the average cost of labour ACL1. A higher employment by the firm will drive up the wage; a lower employment will drive it down. This gives a marginal cost of labour curve of MCL1. Profit-maximising employment will be Q1, where the marginal cost of labour equals the marginal revenue product of labour (MRPL). The wage, given by the SL1 (=ACL1) line will be W1.

Now assume that there is a minimum wage. Assume also that the initial minimum wage is at or below W1. The profit-maximising employment is thus Q1 at a wage rate of W1.

The minimum wage can be be raised as high as W2 and the firm will still want to employ as many workers as at W1. The point is that the firm can no longer drive down the wage rate by employing fewer workers, and so the ACL1 curve becomes horizontal at the new minimum wage and hence will be the same as the MCL curve (MCL2 = ACL2). Profit-maximising employment will be where the MRPL curve equals this horizontal MCL curve. The incentive to cut its workforce, therefore, has been removed.

Again, if we extend the analysis to the whole economy, a rise in the minimum wage will be partly passed on in higher prices or stimulate employers to increase labour productivity. The effect will be to shift the (MRPL) curve upwards to the right, thereby allowing the firm to pass on higher wages and reducing any incentive to reduce employment.

Effects on employment: evidence

There is little evidence that raising the minimum wage in stages will create unemployment, although it may cause some redeployment. In the Low Pay Commission’s 2019 report, 20 years of the National Minimum Wage (see link below), it stated that since 2000 it had commissioned more than 30 research projects looking at the NMW’s effects on hours and employment and had found no strong evidence of negative effects. Employers had adjusted to minimum wages in various ways. These included reducing profits, increasing prices and restructuring their business and workforce.

Along with our commissioned work, other economists have examined the employment effects of the NMW in the UK and have for the most part found no impact. This is consistent with international evidence suggesting that carefully set minimum wages do not have noticeable employment effects. While some jobs may be lost following a minimum wage increase, increasing employment elsewhere offsets this. (p.20)

There is general agreement, however, that a very large increase in minimum wages will impact on employment. This, however, should not be relevant to the rise in the NLW from £11.44 to £12.41 per hour in April 2025, which represents a real rise of around 4.5%. This at worst should have only a modest effect on employment and could be offset by economic growth.

What, however, has concerned commentators more is the rise in employers’ National Insurance contributions (NICs) that were announced in the Budget. In April 2025, the rate will increase from 13.8% to 15%. Employers’ NICs are paid for each employee on all wages above a certain annual threshold. This threshold will fall in April from £9100 to £5000. So the cost to an employer of an employee earning £38 000 per annum in 2024/25 would be £38 000 + ((£38 000 – £9100) × 0.138) = £41 988.20. For the year 2025/26 it will rise to £38 000 + ((£38 000 – £5000) × 0.15) = £42 950. This is a rise of 2.29%. (Note that £38 000 will be approximately the median wage in 2025/26.)

However, for employees on the new minimum wage, the percentage rise in employer NICs will be somewhat higher. A person on the new NLW of £12.41, working 40 hours per week and 52 weeks per year (assuming paid holidays), will earn an annual wage of £25 812.80. Under the old employer NIC rates, the employer would have paid (£25 812.80 + (£25 812.80 – £9100) × 0.138) = £28 119.17. For the year 2025/26, it will rise to £25 812.80 + ((£25 812.80 – £5000) × 0.15) = £28 934.72. This is a rise of 2.90%.

This larger percentage rise in employers’ wage costs for people on minimum wages than those on median wages, when combined with the rise in the NLW, could have an impact on the employment of those on minimum wages. Whether it does or not will depend on how rapid growth is and how much employers can absorb the extra costs through greater productivity and/or passing on the costs to their customers.

Articles

UK Government reports and information

Data

Questions

  1. How is the October 2024 Budget likely to affect the distribution of income?
  2. What are the benefits and limitations of statutory minimum wages in reducing (a) poverty and (b) inequality?
  3. Under what circumstances will a rise in the minimum wage lead or not lead to an increase in unemployment?
  4. Find out what is meant by the UK Real Living Wage (RLW) and distinguish it from the UK National Living Wage (NLW). Why is the RLW higher?
  5. Why is the median wage rather than the mean wage used in setting the NLW?