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Economy watch: Why jobs may fall and prices go up due to the National Living Wage

By Esmond Birnie, PwC chief economist

One of the few genuine surprises in the summer 2015 Budget was the announcement of the National Living Wage (NLW). Due to be introduced at a level of £7.20 per hour in April 2016, for those aged 25 and above, the NLW will progressively rise to 60% of the UK median wage level in April 2020. But for those aged 21 to 24, the National Minimum Wage remains unchanged.

The Heenan-Anderson Commission on tackling social exclusion in Northern Ireland (NI) called the NLW a welcome step towards dealing with low pay, but conceded that further research was needed as to what its wider impact might be.

In July, the Office for Budget Responsibility (OBR) provided some analysis of Chancellor George Osborne's plan. Its "central" scenario - the one judged most likely - is that the impact on UK GDP would be marginal but UK employment by 2020 would be 60,000 less than would otherwise have been the case. OBR's central forecast was based on a particularly "moderate" view of the "price elasticity of demand for labour". But a more gloomy view, with a higher negative elasticity of demand, would imply an employment fall of 120,000. Effectively therefore, OBR is suggesting that the introduction of the NLW would "cost" between 60,000 and 120,000 jobs, lost or foregone.

Given that total employment here represents about 2.5% of the UK total (ie, about 800,000 compared to about 30m) pro rata, OBR's estimate implies a reduction in jobs in Northern Ireland of between about 1,500 and 3,000 depending on whether one uses the central OBR forecast or its gloomier one.

The Osborne plan is to increase the NLW to 60% of the level of median UK wages for those aged 25 and over by 2020. However, as NI wage levels are on average lower than in Great Britain, that implies a NLW higher than the NI median.

By implication therefore, the employment reduction in NI could also be higher than a simple pro rata estimation. A range of 2,000 to 4,000 job losses/foregone by 2020 is plausible.

The Annual Survey of Hourly Earnings - the most up-to-date official data on NI earnings - gives a snapshot of the situation in 2014 and we can estimate that while about 13% of employees in the UK would be directly impacted by the NLW, the proportion in Northern Ireland would be higher, at about 19%.

Of course, it is a simplification to assume that a snapshot on wage relativities in 2014 will apply to the situation in 2020.

In particular, it is unclear how far the rising level of the NLW will have a ripple effect, as workers already earning above the NLW try to preserve pay relativities. We can also imply the sectors likely to be most impacted: restaurants, pubs, cafes, hotels, retail and social care.

So, how can firms place themselves in the best position to accommodate the impact of the NLW, bearing in mind that they have about four-and-a-half years before it applies in full?

Firms could in fact respond in a number of ways, some of which were evidenced in the recent Bain Review for the Resolution Foundation. They could raise the prices of products and/or services to compensate for higher labour costs - assuming the market would allow it. Alternatively, they could accept lower profit margins, but that may not be an option in highly competitive sectors where profits are already slender.

They could raise productivity while maintaining existing levels of employment - assuming they have scope to expand sales significantly. Or they could produce the existing level of output while raising productivity. In this case, employment would fall and, as we've already seen, there is a strong possibility that the NLW will lead to a lower level of employment.

A lower level of employment would not be desirable. Another undesirable outcome would be if margin-strapped businesses began to operate in the so-called black economy.

Firms also have options as to how they handle the question of wage relativities. Other things being equal, introduction of the NLW would tend to compress these, but expect some resistance to this. Firms may wish to use expert advice to conduct job evaluations. Firms could also try to "pay for" the NLW through reducing any non-wage benefits given to staff.

The NLW is, of course, part of a wider approach to economic policy on the part of the Westminster Government. The Chancellor is keen to move away from a situation where the Exchequer carries so much of the burden of alleviating low pay through the welfare system and tax credits. That is the big picture, but businesses can have legitimate concerns around the process of introduction of the NLW and they do have some choices as to how to respond.

Of note is that the Chancellor views a 2% reduction in UK corporation tax rates by 2020 as part-compensation for the higher labour costs.

For its part, government and the public sector will face a direct challenge in those sectors where it determines the level of pay. NLW will imply a major increase in costs in residential and nursing care homes. This begs the question of whether there will be a corresponding increase in funding to the NI health budget, either through a re-allocation between the NI Departments or through an increase in the Executive's block grant from the Treasury.

As with most rabbits from Budget Day hats, the devil is in the detail and the NLW is likely to prove no exception.

In next week's Economy Watch, we hear from Neil Gibson of the Ulster University economic policy centre

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