Living wages are an increasingly common policy tool for reducing poverty and improving the living standards of low-income workers. But until recently, there has been little evidence on how living wage clauses effect the largest spender in the economy – the government. This column utilises data from a firm operating in the low-pay service sector with hundreds of establishments across the UK. The authors find that the living wage policy was a relatively successful way to increase wages and reduce within-establishment wage inequality without incurring significant negative employment effects.
Minimum wages are one of the most widely used labour market interventions globally, existing in more than 170 countries (United Nations 2024). ‘Living wages’ are also becoming more common in modern labour markets. A living wage is the wage required to meet a minimum standard of living based on a carefully chosen consumption bundle, and it is typically higher than the mandated minimum wage floor. Living wages are increasingly advocated as a policy tool to reduce poverty, narrow income inequality, and improve the living standards of low-income workers. In the US, MIT’s Department of Urban Studies and Planning has developed a living wage calculator covering a wide range of areas. In the UK, the Living Wage Foundation – a campaign organisation that calculates a living wage for London and the rest of the UK – has accredited more than 15,000 employers as Living Wage Employers. Figure 1 presents the living wage rates for London and the rest of the UK from 2011 to 2019, illustrating that they were consistently higher than the nationally mandated minimum wage by a large margin.
Figure 1 UK living and minimum wage rates
Notes: Figure presents hourly pay rates for the London Living Wage (LLW), UK Living Wage (UKLW), National Living Wage (NLW), and the National Minimum Wage (NMW Adult Rate) for 2011 to 2019. NLW was introduced in April 2016 for workers aged 25 and over; from then onwards, the NMW adult rate is for 21 to 24–year–olds.
Living wages have been implemented in some US cities (Dube and Lindner 2021), and some progressive firms have voluntarily chosen to pay them to their lowest-paid workers. They are also being increasingly adopted by local and national governments in procurement contracts as part of their environmental, social, and corporate governance (ESG) clauses. Several local authorities in England and Scotland have integrated living wages into their policies, while the Welsh government has pledged to provide them for all social care workers. In the US, living wages were mandated through an executive order issued by President Biden.
The late 1990s and early 2000s saw the introduction of numerous living wage ordinances in the US, particularly at the city level, sparking a wave of academic research. These studies often focused on the typical margins of adjustment to wage floors – wages and employment. Findings on employment effects were mixed, ranging from no impact (Brenner et al. 2002, Lester 2011) to slight job losses alongside modest poverty reductions (Neumark et al. 2012). However, until recently there has been little evidence on the impact of living wage-related clauses for the largest spender in the economy: the government.
The natural experiment
In a recent paper (Datta and Machin 2024), we aim to fill this gap by utilising a rich and unique dataset from a firm operating in the low-pay service sector, with hundreds of establishments across the UK. 1 Notably, many of these establishments held local procurement contracts with government units that adopted living wage clauses during our study period (2011–2019). This creates a ‘natural experiment’ setting, allowing us to compare establishments affected by the adoption of the Living Wage Foundation’s living wage clause with control establishments that were not, across a wide range of outcomes, in our data. Just under half of the establishments went from untreated to treated with the living wage over the study period.
The richness of the data enables us to examine a broad set of adjustment margins, from traditional measures such as wages and employment to a range of novel and less frequently studied outcomes. These include wage profile coarseness, within-establishment labour substitution across job types, promotions, the use of zero-hours contracts, consumer prices, establishment closures, and output quality as measured by Google reviews.
The impact
We begin by documenting the fact that wage distributions change fundamentally once an establishment is bound by a living wage clause. Figure 2 presents the wage distributions before and after enaction of a living wage clause for establishments treated in 2017, split by London and the rest of the UK. Both pairs of figures demonstrate the striking impact on wages, which increase and become more concentrated around the living wage rate. 2 Overall wages increase by 4% on average for treated establishments, but we find important heterogenous impacts by types of workers. Entry-level workers (bottom-rung employees) 3 saw wage increases of 6.5%, while their supervisors and managers saw very little change in their wages. We also find a coarsening of the wage profile, with affected establishments dropping on average two of their 11 pay points.
Figure 2 Wage distributions pre and post treatment, all, 2017
Notes: Graph shows pre- and post-treatment hourly wage histograms for all core workers in 21 treatments occurring in 2017 (16 in London and five in the Rest of UK).
We find a small positive impact on overall employment, suggesting that establishments were able to hire more workers with the higher wages. This effect becomes particularly pronounced when examining the differential impact on entry-level workers and supervisors. Figure 3 illustrates how the introduction of the living wage affected relative wages and employment composition. Entry-level wages increased by 5.9% relative to supervisor and manager wages, while the ratio of entry-level to supervisory and managerial workers rose by 8.2%. Despite this, we find no change in the promotion rate for entry-level workers or the use of zero-hours contracts. We also find little impact across establishment performance margins – consumer prices, establishment closure, and quality scores all remain unaffected.
Figure 3 Labour-labour substitution event study
Notes: Graph reports the estimated coefficient from a Sun and Abraham (2023) event study model for living wage treatment.
Such a compositional effect is at odds with a perfectly competitive labour market, where we would usually expect labour inputs that saw an increase in relative costs to experience a drop in relative demand. The results indicate that the firm must have significant labour market power, and that entry workers and supervisors are not easily substituted for one another. It is this mechanism that allows the living wage policy to be relatively successful in delivering the goal of increasing wages and reducing within-establishment wage inequality without causing significant negative employment effects.
Research on wage floors above minimum wages has high policy relevance for low-wage workers the world over, and matters to whether their earnings deliver above subsistence level living standards and consumption. This is all the more relevant in the context of the real wage stagnation that has characterised the UK labour market over the past 15 years, with increasing numbers of employers now having accredited pay policies featuring the lowest within-company wage rate above mandated minimum wages.
Source : VOXeu
