The UK National Minimum Wage's Impact on Productivity
| Author | Richard Croucher,Thomas Lange,Marian Rizov |
| Published date | 01 October 2016 |
| DOI | http://doi.org/10.1111/1467-8551.12171 |
| Date | 01 October 2016 |
British Journal of Management, Vol. 27, 819–835 (2016)
DOI: 10.1111/1467-8551.12171
The UK National Minimum Wage’s Impact
on Productivity
Marian Rizov, Richard Croucher1and Thomas Lange2
Lincoln International Business School, Lincoln, UK, 1Middlesex University Business School, London, UK, and
2Australian Catholic University,Melbourne, Australia
Corresponding author email: r.croucher@mdx.ac.uk
Low pay poses issues for managers internationally. We examine productivity in low-
paying sectors in Britain, since the introductionof the National Minimum Wage (NMW).
We use a multiple channel analytical strategy, emphasizing the wage incentives chan-
nel and linking it to a model of unobserved productivity. We estimate firm-specific
productivity measures and aggregate them to the levelof low-paying sectors. Dierence-
in-dierences analysis illustrates that the NMW positivelyaected aggregate low-paying
sector productivity. These findings highlight increased wage incentiveeects with implica-
tions for management practice and public policy since ‘living’ wages may be productivity
enhancing.
Introduction
We examine the impact of the National Mini-
mum Wage (NMW) on productivity, building on
the British Journal of Management’s first virtual
edition: Employee responses to changing work
practices (Frynas and Croucher, 2015). Managing
wages at the bottom of the distribution and the
relationship between eciency and equity are in-
creasing concerns for managers and governments
internationally. Debates around the recent intro-
duction of a national minimum wage in Germany,
discussions of the level of state and federal minima
in the USA, calls for a European minimum wage
and low pay concerns in multinational corpora-
tion supply chains pose significant issues for man-
agers. So, too, do British calls for organizations
voluntarily to implement ‘living wages’(Atkinson,
2015). Meanwhile, productivity concerns preoc-
cupy British commentators (Atkinson, 2015). Yet
evidence on the minimum wage−productivity
link is scarce and inconclusive. Existing studies
(e.g. Croucher and Rizov, 2012; Galindo-Rueda
and Pereira, 2004; Riley and Rosazza-Bondibene,
2015) use labour productivity measures and in-
dustry level data (Forth and O’Mahony, 2003).
The NMW’s impact on total factor productiv-
ity has not previously been explicitly studied with
micro data. However, some recent indirect evi-
dence on wages,employment and profits in the UK
(Bernini and Riley, 2016) and case studies in the
USA (Hirsch, Kaufman and Zelenska, 2015) sug-
gest that minimum wages may raise total factor
productivity.
In the UK, the impact of minimum wages
on firms has commonly been studied from neo-
classical perspectives. Wage increases raise firms’
marginal costs, inducing them to reduce mark-ups
(e.g. Draca, Machin and Van Reenen, 2011;
Galindo-Rueda and Pereira, 2004; Riley and
Rosazza-Bondibene, 2015), making firms appear
less productive. However, firms experiencing
high factor costs may pass some on as higher
output prices, fully compensating for mark-ups
(Wadsworth, 2010). The extent of labour market
competition also has important implications for
input prices and productivity (Dickens, Machin
and Manning, 1999; Machin and Manning, 1994).
For large (monopsonistic) firms, minimum wages
can reduce marginal costs, increasing demand for
labour and in turn increasing output and, possi-
bly, productivity. In competitive labour markets,
minimum wages will bring higher costs; capital-
for-labour substitution would be the prevailing
© 2016 The Authors British Journalof Management published by John Wiley & Sons Ltd on behalf of British Academy
of Management. Published by John Wiley & Sons Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main
Street, Malden, MA, 02148, USA.
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820 M. Rizov, R. Croucher and T. Lange
adjustment mechanism, leading possibly to pro-
ductivity improvements (Machin and Manning,
1994). Clearly, neo-classical models’ predictions
depend on assumptions influenced by market
conditions.
Weinvestigate the issues from an alternative,be-
havioural stance.1Several early theoretical studies
on the implications of eciency wages link wage
increases and higher productivity (e.g. Lazear,
1981; Salop, 1979; Shapiro and Stiglitz, 1984).
In related but more behaviourally focused frame-
works, Akerlof (1982), Akerlof and Yellen (1990)
and Levine (1991) argue that perceived reciprocity
and fairness aect workers’ productivity. Fair
wage−eort theory (Akerlof and Yellen, 1990)
suggests that when workers receive less than the
wage they ‘deserve’, they reduce eort. In de-
termining their ‘fair wage’, individuals compare
themselves with others dependent on market con-
ditions, resulting in relative reductions in wage dif-
ferentials. Levine(1991) argues that reducing wage
dispersion can increase work team cohesiveness,
promoting productivity. We use these arguments in
developing our analytical strategy.
The UK’s introductionof the NMW constitutes
a relevant natural experiment. We propose that
introducing a minimum wage improved incentives
and thus productivity either through eciency
wage mechanisms or by aligning real and fair
wages. We model the link between total factor
productivity (TFP) and the NMW in a novel
way using a structural productivity estimation
approach based on Olley and Pakes (1996). Pre-
vious studies relating productivity to the NMW
employ a two-step analysis where in the first step
productivity is estimated without controlling for
the NMW’s eects and then, in a second step,
the NMW’s association with the productivity
measures is analysed. The productivity measures
estimated in the first step are likely to suer from
omitted variable bias. Our approach explicitly
models the unobserved productivity and directly
incorporates the eects of the NMW into an inte-
grated semiparametric estimation algorithm. Our
analysis therefore generates robust empirical evi-
1Lester (1960) oered the first institutional-behavioural
explanation of minimum wage eects on labour market
outcomes. Kaufman (2010) and Hirsch, Kaufman and
Zelenska (2015) extend Lester’s ideas, proposing a mul-
tiple channels of adjustment approach.
dence on the relationship between the introduction
of the NMW and improvedproductivity over time.
Selective literature review
Numerous studies on minimum wage eects use
neo-classical economics models. Eects on em-
ployment and wage distributions have been exten-
sively studied in the USA (e.g. Card and Krueger,
1994, 1995; DiNardo, Fortin and Lemieux, 1996;
Hirsch, Kaufman and Zelenska, 2015; Katz and
Krueger, 1992; Lee, 1999; Slonimczyk and Skott,
2012) and in the UK (e.g. Dickens, Machin and
Manning, 1999; Georgiadis, 2013; Machin and
Manning, 1994, 2004; Machin, Manning and
Rahman, 2003; Metcalf, 2002, 2008; Riley
and Rosazza-Bondibene, 2015; Stewart, 2002,
2004). Consensus exists that the overall eect on
employment is neutral and accompanies (modest)
wage distribution compression. Recently, Bernini
and Riley (2016) and Hirsch, Kaufman and
Zelenska (2015) both concluded that minimum-
wage-induced adjustments through channels
identified by neo-classical models are relatively
insignificant. They suggest that institutional-
behavioural models could have more explanatory
power.2Grimshaw (2013) advances similar views.
Therefore,our focus is on wage incentive eects,
which have been central in identifying sources of
increasing productivity atfir m and wider economy
level. Economists have developed eciency wage
(Shapiro and Stiglitz, 1984) and labour extraction
function (Bowles, 1985) models, where wages and
monitoring levels are traded o to elicit work-
ers’ eort.3Wages are set above the market clear-
ing wage, creating incentives for increased worker
eort due to the increased opportunity costs of
finding another job.4
2Hirsch, Kaufman and Zelenska (2015) argue that all
three main labour market models (competitive, monop-
sony and institutional-behavioural)capture important el-
ements regarding adjustment eects, making comparison
and empirical discrimination dicult.
3Georgiadis (2013) tests a shirkingmodel within eciency
wage theory by studying the NMW’s impact on the UK’s
care home industry.In his framework the NMW generates
an increase in the averagewage in an organization which
results in reduced supervision costs, and by implication
increased productivity.
4Unemployment has been seen as a crucial component
of the eciency wage incentive scheme to work. How-
© 2016 The Authors British Journalof Management published by John Wiley & Sons Ltd on behalf of British
Academy of Management.
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