The National Minimum Wage was introduced on 1 April 1999, with an adult rate of £3.60. Its introduction benefited about one million low-paid workers and had no measurable adverse effects on employment or inflation. This reflected the deliberately cautious policy of the Commission in setting the initial rate.

From 1999-2002 the minimum wage was increased roughly in line with average earnings, reaching £4.20 in October 2002. These increases also had no significant adverse effects and indeed employment continued to grow strongly in the sectors where low pay is most prevalent. By 2002, however, it had also become apparent that somewhat fewer people had benefited from the minimum wage than originally estimated, due to deficiencies in the labour market data originally available but subsequently improved.

It was against that background that the Commission, in its fourth report published in March 2003, concluded that it was appropriate to increase the effective level of the minimum wage, increasing it faster than average earnings for a number of years, and thus benefiting more workers. In line with our recommendations, the adult minimum wage rose to £4.85 in October 2004, an increase of 15.5 per cent over two years in which average earnings increased by nearly 8 per cent. We also indicated in our fourth report that we believed that some further increase above average earnings would likely be required in subsequent years to arrive at an appropriate long-term level.

This report analyses the impact of the significant upratings over the last two years and considers the appropriate path of the minimum wage over the next two. Our analysis suggests that the upratings have largely been absorbed without adverse effects. Employment continues to grow in most low-paying sectors and the impact on wage bills and profitability appears sustainable. We have therefore concluded that it is safe to propose a further two year period of increase above average earnings.

But we are aware that some businesses have found the significant increase of 2004 a challenge, particularly because of the consequences for pay differentials. And the full impact of the 2004 upratings may not yet be clear in the macroeconomic data. We have therefore erred on the side of caution, proposing an increase only slightly above average earnings, and with a smaller increase in the first year to allow business time to adjust. The implication of this caution, however, is that some further increase relative to average earnings is likely to remain appropriate in subsequent years.

In making our recommendations on the adult rate and the youth Development Rate (which currently applies to 18-21 year olds) we have also needed this year to consider the impact of two other pieces of proposed or prospective labour market regulation: the proposed requirement that bank holidays count as paid holidays in addition to the 20 days required by current legislation, and the forthcoming implementation of anti-age discrimination legislation (the Equal Treatment Directive). The bank holiday proposal would not be an impediment to the medium-term uprating of the minimum wage, and if implemented its full impact would be very unlikely to be felt within the next two years. In our next report, and once the details of its implementation are known, we will consider its impact in more detail. Our recommendations are, however, based on the assumption that the implementation of the Equal Treatment Directive will facilitate the continued use of the youth Development Rate, which plays a key role in protecting the employment prospects of some young people. We believe, however, that the youth Development Rate should most appropriately apply to 18-20 year olds, with 21 year olds paid the adult rate.

The National Minimum Wage has been a great success. It has brought higher wages to many low-paid workers. In combination with the tax and benefits system it has significantly improved the incomes of many low income families. As Chapter 4 describes, it has played a major role in reducing the gender pay gap. And it has achieved these benefits without any significant adverse effects on business or employment creation.

This result reflects the careful way in which the wage has been set and the detailed analysis on which the Commission's decisions are based. As will be clear to readers of this report, that analysis depends upon an enormous amount of hard work by the Commission's secretariat. It is therefore appropriate that I end with my thanks for their support over the last year.

February 2005