Posted on Wednesday 18 May 2016 by Ulster Business
When the Chancellor George Osborne introduced the National Living Wage (NLW), his intention was to shift the burden of coping with low pay and, by implication poverty, from the taxpayer to business. Putting more money into workers’ pockets, he argued, would inject additional spending power in the economy, so delivering a direct benefit back to business.
But legislating for a mandatory pay-rise without a proportionate increase in productivity was certain to have an impact in Northern Ireland.
So, in an attempt to quantify the impact of the NLW and other reward issues like the Apprenticeship Levy and Auto-Enrolment on workers’ pay and business performance, PwC invited a panel of business leaders and industry representatives to discuss just how the NLW wage would impact the regional economy.
Pay governance reform – or the start of a perfect storm?
“ …too many companies aren’t looking at the long-term implications of the NLW, Apprenticeship Levy and other payroll costs on their reward package, business model, supply chain and competitiveness. For the unprepared this will become a perfect storm of pay governance.”
While the NLW is the headline-grabber, employers are facing a number of issues that will potentially combine to impact on payroll costs; but top of the list comes the NLW.
Announced in the 2015 Summer Budget, the NLW came into force this April, setting a minimum hourly rate of £7.20 for workers aged 25 years and over, with further annual increases of 50 pence per hour, for the next four years. The terms of the NLW are clear, but analysis and implications for Northern Ireland are sparse.
What we do know is that the Office for Budget Responsibility (OBR) assessed the NLW at the UK-wide level and their most likely scenario was 60,000 fewer jobs by 2020, up to the worst case forecast of 120,000 fewer jobs by 2020. Applying the OBR formula pro rata to Northern Ireland implies that, by 2020, the region would have between 1,500 and 3,000 fewer jobs. But because wages here are lower than the UK average, up to 17% of employees in Northern Ireland could be directly impacted by the NLW compared to 12% in GB, so the impact on employment could be proportionately greater.
Then there’s the Apprenticeship Levy. From April next year there is a Payroll Levy of 0.5% for all businesses with a wage bill greater than £3m. Assuming average staff pay of £25k annually implies companies with at least 120 staff will be impacted - a significant number of Northern Ireland businesses.
On top of that comes Auto-Enrolment, where the minimum employer contribution moves from 2% in 2018 up to 3% in 2019. Finally, changes to holiday pay - to include variable pay like, commission and regular overtime - will impact as will gender pay gap reporting coming in 2017/18.
“When it comes to the domiciliary care sector, there would appear to be zero ability to influence price or productivity, so the ability of the industry to absorb the National Living Wage is nil.”
Say goodbye to paid breaks, free food, Sunday pay, bonus and even the company Christmas dinner - just some of the ways in which employers across the UK have responded in an attempt to recoup the cost of the NLW. And while others respond by passing the increase on to their clients and customers, when it comes to the ability of employers to recoup the cost, there was a general consensus amongst the panel that Northern Ireland’s health and care sector which is almost wholly reliant on government funding, is in real difficulty.
On the residential care side there is limited scope for care providers to levy increased supplementary charges on families, whereas on the care side, there is no scope for any sort of supplementary charge whatsoever. When it comes to outsourcing domiciliary care work, Trusts specify the price per hour, the level of service they require and companies are invited to bid on quality and volume. Consequently there would appear to be zero ability to influence price or productivity, so the ability of the industry to absorb the living wage is nil.
PwC had estimated that, on average, up to 17% of Northern Ireland employees would come under the NLW legislation. However, when it comes to the social care sector that could be as high as one-in-three workers, with virtually no scope to pass cost increases along the supply chain. The panel acknowledged that this was a sector almost wholly dependent on the Executive’s ability – or willingness - to fund the NLW shortfall or to dramatically modernise tendering and commissioning to facilitate productivity gains. Whatever the option, it was beyond the ability of employers to solve.
The hospitality sector, the panel felt, was also facing hard choices and ironically, some employer responses – such as cutting paid breaks, shift bonuses and charging for previously “free food”, were actually detrimental to the workers the NLW was intended to benefit. Hospitality is a sector which is acutely price sensitive, labour intensive and does not lend itself easily to automating. The recession previously has forced the industry to take significant cost out of the sector.
According to the Resolution Foundation, employers in the hospitality industry will be amongst the hardest-hit sectors, with their wage bills increasing by 3%- 4% by 2020 with almost half of employees in the sector receiving a pay rise due to the rollout of the NLW.
A major issue for hospitality is tips, perceived as a ‘bonus’ but not counted as part of the industry pay and reward structure, nor are they counted as part of employees’ “pay” for NLW purposes. One survey of the Northern Ireland hospitality sector suggested that, when average levels of tips were included, the wage of a server was in the order of £12 per hour. However, in an industry that is often seasonal and is generally competitive, the consensus was that the impact of the NLW on Northern Ireland will be pub and restaurant closures and the almost certainty of job-losses.
“The NLW has increased the hourly rate of the least-skilled and lowest-paid, but we have had to increase the pay of every other employee by 50 pence per hour to maintain differentials… the overnight impact in payroll cost can be up to 7% per year.”
One theme the panel agreed upon was the issue of union and workforce pressures to maintain differentials. There were a number of examples across the region where the impact of the NLW was to put groups of workers on a par with team leaders and supervisors.
Several panel members were aware of businesses where, having increased the hourly rate of the least-skilled and lowest-paid, they have had to increase the reward of 100% of other employees by 50 pence per hour to maintain differentials. Where performance bonuses and incentives were linked to base pay, these too had to be automatically uplifted, further adding to payroll costs. Where there were large hourly-paid labour forces, the overnight annual increase in payroll was estimated to be between 2% and 7%.
There were also reports of salaried staff and their representatives seeking hourly-paid differentials to be reflected in uplifts across salaried staff reward.
A number of panel members suggested that the impact of the NLW and associated administration costs would ultimately persuade some organisations to consolidate base reward and motivational bonus/reward into a basic hourly rate or salary. This, some members believed, would simplify the administration of the successive years of NLW increases, but would also reduce the flexibility of companies to create and manage reward schemes.
Exports and international competitiveness
“…while Northern Ireland’s unemployment levels have reduced to pre-recession levels, output remains around 8% below the pre-recession level, with no sign of recovery.”
Manufacturers and business representatives on the panel, warned that the cost of the NLW had to be matched with increased competitiveness, if export markets were to be retained, let alone expanded. There were concerns over UK suppliers already seeking to pass on their NLW costs, especially where the market was not conducive to even marginal increases, so manufacturers’ margins were getting slimmer as they were being forced to absorb increased costs.
This concern was exacerbated by the inability of the local economy to increase productivity, despite substantial increases in employment. It was pointed out that, while Northern Ireland’s employment levels had reduced to pre-recession levels, output remained around 8% below the pre-recession level, with no sign of recovery. There was a recognition that, cutting Corporation Tax would be an incentive to investment, but if labour costs were increasing annually at up to 7%, it could dramatically erode trading profits, negating the intended benefit of lower corporation tax.
The panel say that there are other challenges to make the region internationally competitive for tourism and hospitality. There are some 245 tourism destinations with lower VAT rates – either the headline rate or a special “tourism” VAT rate, with Ireland’s rate at 9%, for example.
Northern Ireland faces 20% VAT and substantially higher staff costs. The panel recognised that the cost of travel has fallen steeply, to the extent that travel and holiday destinations are increasingly chosen based upon the costs of accommodation and entertainment and that the NLW and VAT rate will impact on Northern Ireland’s ability to be competitive on price.
What’s the upside?
“The UK is a better place to be an employer as compared to France and Germany where there is a heavy burden of compliance and restrictions on employment. The burden of administration in the UK is rising and that gap is closing. Productivity levels in the UK do not currently compare well to certain European territories and there is an opportunity for companies who invest in their people to bridge that gap.”
Some pointed to higher European productivity as a sign that investing in training was directly related to increased output and greater GVA per capita. There was plenty of evidence that businesses on average in the UK, including Northern Ireland, have not been training enough, or certainly not training as much on the job as their counterparts in many other parts of Europe, or indeed many other parts of the world.
Turning to the Apprenticeship Levy, there is a perception in government that the training market is subject to market failure, where businesses are sometimes reluctant to invest in training because of the fear that a competitor down the road will poach their skilled workforce. Similarly the Chancellor has pointed to statistical evidence that the quantity of training in the UK for so-called intermediate technical/vocational skills, particularly apprenticeships, has fallen short of Germany - the “shining example” of an apprenticeship-training based economy – and other European countries, Switzerland, Denmark and the Netherlands.
One upside, the panel felt, was the pressure to invest in training as a productivity driver would become inevitable. This, as the Office of Budget Responsibility (OBR) and PwC had pointed out would drive up productivity and GVA per capita, thus creating more wealth to underpin more profitable and sustainable employment.
The panel also saw the pressures on profit and liquidity as an opportunity. Looking back to 2007/2008, some organisations prospered because of the downturn. Thanks to the high level of fragmentation within some sectors the slowdown and recession drove a higher level of M&A activity because one of the ways of absorbing increasing costs is a greater economy of scale.
Becoming a larger organisation helps absorb the cost challenge. It drives diversification and companies respond by getting into export markets. All of those things are actually positive things for the local economy.
When it comes to NLW, the winner was supposed to be the people on low pay. However, much of the rationale driving George Osborne’s policy was to explode the perception that the taxpayer was subsidising low pay through tax credits, while improving Treasury’s fiscal situation so that government is the winner. Effectively, the burden is being shifted from the taxpayer to business, but if business takes the NLW and Apprenticeship Levy as a wake-up call to invest in training, upskill the national workforce and that results in improved productivity, the panel took the view that potentially, everyone’s a winner.
The Apprenticeship Levy
“There is no certainty as to how much of the Levy on Northern Ireland companies would actually come back to the region… around £100m or thereabouts would revert to the Executive, but it was also up to the Executive as to how that would be delivered in the region.”
The NLW is not the only employee-related cost that’s hanging over the Northern Ireland business community. The Apprenticeship Levy, which came in as part of George Osborne’s July 2015 Budget is something of a carrot and stick. Hitting businesses with the Levy is the stick - while the carrot is a subsidy to promote and support more training. Underlying the Levy is a belief in government that businesses have not been investing enough in training and a perception that this is partly a factor of fear that, the more companies train and upskill workers, the more likely they are to be poached by competitors.
It comes into force next year as a Levy of 0.5% for all businesses with a wage bill greater than £3m - assuming a £25k annual wage bill per employee and that implies companies with at least 120 staff will be included. A lot of the detail remains unclear, particularly as to how it will work in Northern Ireland, but it does look like it is going to have an element of cross-subsidy for smaller firms which could be beneficial to the Northern Ireland economy.
The panel generally welcomed the incentive to invest in training - underpinning the notion that increased training and greater productivity went hand-in-hand and could therefore serve to offset the cost of NLW – but there was concern as to the cost of administration and possible restrictions on training provision and providers. There was also no certainty as to how much of the Levy on Northern Ireland companies would actually come back to the region. PwC’s discussions with officials suggested that up to £100m or thereabouts would revert to the Executive, as Northern Ireland’s share of the total UK Levy of c £3bn, but it was also up to the Executive as to how that would be delivered in the region.
The panel expressed concern that the process would force the introduction of more apprenticeship schemes even though many production and manufacturing jobs don’t really lend themselves to such a model. That could have a serious impact by creating apprenticeships that are neither necessary nor appropriate and adding a further layer of administration cost.
The panel also expressed concerns at the short-term impact on profitability. As with the NLW, the Apprenticeship Levy, was an up-front cost, while any resulting improvement in productivity would be medium-term with a consequent short-term impact on cash flow and profit. There was a concern that the combination of the NLW and Apprenticeship Levy could potentially turn profit into loss for some already-struggling companies.
“…many companies are totally unaware of the Apprenticeship Levy and many others have not projected the impact of the MLW, Apprenticeship Levy, auto-enrolment and holiday pay on their cash flow and profitability over the years to 2020.”
On top of NLW and the Apprenticeship Levy the panel recognise two other pay issues - auto-enrolment and holiday pay – as potentially impacting on payroll costs but not being recognised by many companies as an issue. Auto-enrolment is not a new topic and has been around for several years now, but in the next few years employers will see a phased increase in the minimum amount of employer contribution - from 2% in 2018 up to 3% in 2019. In addition, holiday pay will have to include in the calculation historically-ignored areas of variable pay such as commission and regular overtime, things like that – yet another area which employers will have to provide for.
Business bodies on the panel also warned that many of their members remained totally unaware of the impending Apprenticeship Levy and that many others admitted to not having projected the impact of the NLW, Apprenticeship Levy, and auto-enrolment and holiday pay on their cash flow and profitability over the years to 2020.
As one panel member said: “…too many companies aren’t looking at the long-term implications of the NLW, Apprenticeship Levy and other payroll costs on their total reward package, business model, supply chain and overall competitiveness. For the unprepared this will become a perfect storm of pay governance.”
Around the panel, most heads were nodding in agreement.