By John Bryson, Director of City-REDI

George Osbourne’s seventh Budget as Chancellor has within it an enigma and an omission. The enigma is the introduction of a new national minimum wage by a Conservative government. This was unexpected or perhaps surprising. It highlights an important characteristic of the new form of conservatism that is emerging – deregulation combined with micro-regulation. The introduction of a national minimum wage by a Conservative government can be seen as a strategy intended to undermine the Labour opposition. Nevertheless, this would be to play politics with the economy. Surely no British government or political party would play politics with the economy, or would they? The questions to consider are ‘what lies behind the introduction of a new national living wage?’ or perhaps ‘how do we unravel the enigma that is the new national Living Wage?’

The July budget side-lined the UK productivity puzzle that has been worrying politicians and economists but noted that a separate productivity plan would be announced on 10 July. This productivity plan is intended to reverse the long-term productivity problem across the UK and will secure living standards and a better quality of life. Matching the productivity of the US would raise Gross Domestic Product (GDP) by 31% and this would equate to around £21,000 per annum for every household in the UK. The productivity plan includes strategies to encourage firms to undertake investment in equipment and people and also for the development of a modern transport system and world class digital infrastructure. The productivity plan brings together existing policies and repackages them as a solution to the productivity puzzle. Nevertheless, it requires greater depth and needs to be informed by a better understanding of the processes that lie behind the UK productivity puzzle. The problem is that no one knows why the UK has a productivity puzzle. The puzzle may be mythical and reflect measurement problems or the economic structure of the UK, in other works, the variety of capitalism that has emerged within the UK. The productivity plan is an attempt to develop a solution to a partially understood problem.   

Productivity is defined as the quantity of goods and services produced per unit of labour or, in other words, output per hour worked. Productivity is a measure of efficiency as there is a direct relationship between the quantity and quality of inputs into a production process and the value of the outputs produced. Anything that increases the efficiency of the relationship between inputs and outputs will be reflected in improvements in productivity. Productivity growth is reflected in higher salaries, growth in the total tax take and improved living standards. Productivity growth also would contribute to overcoming the structural deficit in public sector finances. Productivity might be considered as a solution to many problems that ultimately would transform British society into a utopia. Nevertheless, productivity growth does not necessarily equate with increased human happiness or greater job satisfaction. 

The enigma and the omission are, in fact, linked; a strategy to partially address the productivity puzzle is hidden within the new living wage directive. One aspect of the enigma is that management teams across the UK are busy quantifying the exact cost of the new living wage on their business and developing strategies to reduce this impact. These strategies will lead to some unemployment as companies develop strategies to deliver the same quantity of output but with reduced labour inputs – and this will result in productivity growth. Alternatively prices will rise that will be reflected in inflation and ultimately an increase in interest rates. Another consequence will be increased employment opportunities for people under the age of 25.

There are many perverse consequences that will emerge from the new living wage and these represent an enigma that needs to be unravelled over the next seven years. All budgets have both positive and negative consequences. There is always a lag time between the budget and the emergence of these consequences. The living wage may be one of the most effective solutions to one element of the productivity puzzle as it encourages firms to develop novel solutions that will either raise output or reduce inputs. Only time will tell.