Living wage: Is there such a thing as a free pay rise?

An increase in the living wage could save the government a lot of money as the better-paid workers will pay more in tax

Should every employer pay a living wage?

You're likely to be hearing that question quite a lot in the coming days, with a KPMG survey today showing that nearly 5 million UK workers earn less than a living wage, and politicians and activists across the country gearing up for Living Wage Week from 4-10 November.

That's when you'll see the Mayor of London, Boris Johnson, announcing the new living wage for London, with great fanfare. You'll also see Labour showcase the big Labour councils across the country that are becoming living wage employers themselves.

Politicians of all stripes like the idea of private companies paying their lowest-paid workers a bit more, for moral reasons and also because it could save the government a shedload of cash.

In 2010 the Institute for Fiscal Studies calculated that bringing every private sector worker up to the living wage would raise total earnings (before tax) by around £12bn. Around half of that - £6bn - would go directly to the government, in higher tax revenues and lower benefit and tax credit payments.

That's a nice bit of spare change for the chancellor, especially one whose government wants to "make work pay". But no-one wants to be seen to be pushing new costs onto businesses at a tough time for the economy - let alone costing jobs. And it is private employers who would pay that extra £12bn (plus another £1.5bn in employers' national insurance contributions, for good measure).

Cost neutral?

So, when it comes to the living wage, politicians are really looking for a free lunch: or rather, a free pay rise. They want an increase in wages for people at the lower end of the pay spectrum that doesn't cost anyone any money.

Does such a miraculous thing exist? Many will be understandably sceptical. But KPMG claims that you can pay higher wages without paying higher costs.

"At KPMG, we have found that the improved motivation and performance, and the lower leaver and absentee rate amongst staff in receipt of a living wage means that the cost is offset and paying it is the right thing for our business."

Boris Johnson says the same thing about the many companies that have decided to pay the living wage in London.

Some will consider this far too good to be true. Others will think it makes sense that employers benefit from giving their workers a reason to value their job - and getting some good publicity, as well.

The key point is that the firms reporting these positive consequences are the firms that have chosen to pay this wage. So, presumably, they had done their sums beforehand and decided the benefits outweighed the costs.

What about everyone else? Can you pressure other low-wage companies to pay more, without costing jobs?

Economists used to say no: if employers have to pay more for labour, they use it less. Then, starting in the 1990s, academic evidence started to build up about the minimum wage, in the US and the UK, suggesting that, at the very bottom of the labour market, telling companies to pay people a little more did not actually cost jobs.

Another fear about the minimum wage was that it would lead to escalating pay demands from workers higher up the chain, eager to preserve the old differentials. But that doesn't seem to happen either. Pay rates at the lower end just get more compressed - with a lot of people bunched around the minimum rate (there's a summary of some of the key evidence here.)

However, these results apply to cases where the minimum wage stays pretty low - in other words, when it remains well below most definitions of the living wage. Even supporters of the minimum wage worry about the implications of pushing it a lot closer to that level.

Dark side

A few facts: the minimum wage has risen a bit faster than average earnings since it was introduced in 1999 and about twice as fast as inflation. Working full-time on the minimum wage you can earn about 53% of the median UK wage. In 1999 you would have earned about 46% of the median. (See this government report).

There is not much evidence that this rise in the minimum has cost jobs. Overall, we know that employment has grown in the past 2 years by 750,000, at a time when households and businesses were being squeezed.

But ministers also know that at least some of the 4.89 million earning less than a living wage are people who have recently "priced themselves into work" to avoid unemployment. In that sense, they are the dark side of Britain's "flexible" labour market, which has enabled employment to stay strong, even when our economy is flat.

This was brought out in recent research by economists at the Resolution Foundation (you see I have been doing my homework....) It found that higher unemployment was now having a much greater "chilling effect" on wages than in the past.

In the late 1980s and 1990s, a doubling of unemployment over six years would probably have led to the real wages of the average worker being about 7% lower than if unemployment had stayed the same. But things changed after 2002, the authors claim. Now, the same increase in joblessness would squeeze real wages for the average workers by 12%. Low paid workers have been most affected by this: for them, a doubling of unemployment means a real wage squeeze of 17%.

What does all this mean for the living wage? It means that politicians are going to carry on liking this campaign - but carefully. They are going to be nervous of anything that sounds like pressure on companies, and living wage employers will continue to be a self selecting group.

Around 3% of adult workers currently earn the minimum wage. If today's study is correct, far more - around 20% - earn somewhere between the minimum and a living wage.

Some, possibly many of those 4.89 million people could probably be paid more, saving the government money without hurting jobs or bankrupting their employers. But a free pay rise - for the government and for workers - is unlikely to be available for all of them. Is there such a thing as a free pay rise?