Minimum wages in the UK – how high can they go?

Originally published in Economic Review magazine which provides articles to make recent academic research accessible for A-level students, apply economic theory to real-world situations and sharpen students’ skills.

In the UK today, earnings inequality is substantially higher than it used to be. Weekly earnings for a worker at the 10th earnings percentile, meaning someone who earns less than 90% of workers, rose by around 70% between 1980 and 2019. By contrast, weekly earnings for a worker at the 90th earnings percentile (meaning someone who earns more than 90% of workers) rose by more than 100% during the same period. At the same time, a growing proportion of people in poverty in the UK are in a household with someone in paid work. This suggests that simply being in work may not be enough to guarantee that a family has enough income to live on.

The government supports people with low incomes so that they do not suffer extreme hardship. For example, Universal Credit is a benefit paid to families whose income is low relative to their needs. One of the key ways that the government has supported individuals in recent years has been by increasing the national minimum wage.

What are minimum wages?

A minimum wage is the lowest hourly wage that an employer can legally pay to its employees. This means that the amount a worker receives for an hour of work cannot be lower than the minimum wage the government specifies. Even though workers are paid in different ways, employers must make sure that they pay them the minimum wage.

In the UK, there are a number of different minimum wage rates. The minimum wage rate that applies to you depends on your age and whether you’re an apprentice. The highest minimum wage, called the National Living Wage, applies to any worker aged 23 and over, and is set at £10.42 for the current financial year (April 2023 to March 2024). Younger workers have a lower minimum wage – the minimum wage for workers aged between 18 and 20 is currently £7.49 per hour.

The minimum wage applies to all people classed as workers, this includes people working part-time, agency workers and casual workers (such as someone hired for a single day). There are some people, such as the self-employed and volunteers who are not entitled to the minimum wage. 

What are the reasons for and against minimum wages?

One reason that a government might want to introduce a minimum wage is to protect vulnerable workers from being exploited. Without a minimum wage, a company would be able to pay any amount so long as the worker is willing. A worker’s willingness will depend on the other job options available to them – if there are many firms looking to hire workers then they can choose the best offer they receive. If a worker does not have many job options, they may have no choice but to accept a very low wage. In cases like these, the minimum wage offers workers a degree of protection.

Minimum wage policies can also be a way for the government to reduce earnings inequality. An increase means that all people whose wage was previously below the level of the new minimum wage must have their wage increased. This brings the earnings of the lowest earners in the country closer to that of higher earners. It also helps to raise the incomes of minimum wage earners to allow them a better standard of living. 

Given these advantages you might think that it would be a good idea to set a very high minimum wage, so that low paid workers can be better rewarded for their effort and earnings inequality can be reduced. Economists generally caution against setting a minimum wage too high though, because economic models predict that doing so could lead to higher unemployment. The basic logic underlying this is simple, a company will only employ a worker if the value they provide is greater than the cost of paying them. A higher minimum wage means a higher cost of paying workers, and so makes it more likely that companies will decide not to hire them at all. Setting a very high minimum wage (e.g. £100 per hour) would almost certainly cause significant unemployment, as the cost of paying many workers will be more than the value firms get from hiring them.

Minimum wages in the UK

The first example of minimum wages in the UK was all the way back in 1909, when the government set up trade boards which set minimum wages for a few specific low-wage industries. There was no minimum wage which applied to all adult workers until 1999, when the government introduced the National Minimum Wage (NMW). This was a minimum wage for workers aged 18 and over, with the rate for those aged 22 or more set at £3.60 per hour.  The coverage of the NMW, the number of jobs paid the minimum wage, was 830,000 at the time of introduction. This comprised 3.4% of all jobs. 

The most important change since then came in 2016, when the government introduced the National Living Wage (NLW). Although it had a different name, this was really just a new, higher, minimum wage for adults aged 25 and over (the National Minimum Wage still applied to people below 25). Set at £7.20 per hour, it meant an increase of 50p (or 7.5%) compared to the previous level. When the NLW was introduced, the government also announced an ambitious target to increase the minimum wage to be equal to 60% of the median wage by 2020. This meant each year increasing the minimum wage by more than the amount that wages increased for the average worker. Until the pandemic, which caused a lot of disruption, that target looked as if it was going to be met. 

Although the pandemic may have slowed progress, the rise of the minimum wage has certainly not stopped. In 2021, the age threshold for the National Living Wage was lowered to 23 rather than 25, and there are further plans to lower it to 21 by 2024. There is a new target to see the minimum wage reach two-thirds of median earnings by 2024 as well. As part of this drive, the Chancellor Jeremy Hunt recently announced that the NLW would rise significantly again next year to at least £11 per hour. Even accounting for inflation, this will mean a roughly 70% rise in the minimum wage for workers aged 23 or more over the past 25 years.

What effect have these minimum wage policies had?

The significant expansions to the minimum wage have meant that far more people earn the minimum wage today than in the past. In 2015, around 1 million jobs for workers aged 25 or over were covered by the minimum wage. The introduction of the National Living Wage meant that this figure increased to more than 1.5 million in 2016. Just before the pandemic, 7% of employees were covered by either the NMW or the NLW, double the figure for 1999.

Unsurprisingly, increasing the minimum wage has increased the earnings of the lowest paid workers in the UK. This has resulted in reductions in some measures of wage inequality. The 90:10 ratio measures how much the highest paid workers (who earn more than 90% of workers) earn compared to the lowest paid workers (who earn more than 10% of workers), with a higher 90:10 ratio indicating more inequality. While wage inequality has generally been rising since the start of the 1980s, the 90:10 ratio for males has fallen substantially since 2016, because of the introduction of the NLW.

Despite these big changes, there is no strong evidence that higher minimum wage rates have led to higher unemployment. In fact, unemployment over recent years has been extremely low by historical standards. This is largely why successive governments have been happy to continue raising the minimum wage – their main worry that it will cause job loss so far seems to have been unfounded.

Where do we go from here?

During the 2000s and 2010s, the minimum wage has played an increasingly important role in supporting the incomes of low-paid workers and reducing wage inequality. Arguably, it is now the most important policy aiming to tackle these issues. Ambitious targets to increase the rate of the minimum wage by 2024 remain in place. The key question that remains is what minimum wage policy might look like in the future.

Decisions up to now have been guided by findings that the minimum wage can be set quite high without causing much unemployment. Indeed, this is exactly what has happened. Now though, the UK has one of the highest minimum wages in the world when compared to the average wage. There is not much research that tells us what might happen if we keep increasing the minimum wage further. It seems almost inevitable that there must be some level of the minimum wage that will lead companies to fire workers, the tricky part is working out what that might be.

Such high minimum wages have effects beyond just causing unemployment. Some employers have reported that they had to increase prices due to minimum wage increases, while for others it meant lower profits. It can also lead to wage compression, meaning smaller differences between different employees’ wages. If a worker’s manager only earns 20p per hour more than them, they may not think it is worth trying hard to get a promotion.
At the moment, it seems highly likely that minimum wages will at least be kept at their current levels and remain a crucial part of UK labour markets. Minimum wages have gone much higher than many predicted possible, but the question of how high they can go is now being asked more and more. The age of minimum wages may be nearing its end.