The Government set the terms of reference for this report in August 2004. We were asked to monitor the impact and review the levels of the minimum wage and to make any consequent recommendations for change. Subsequently, in October, the Government enlarged the remit, asking us to consider a number of other issues including the incidence of the youth Development Rate and the likely cost to employers of the intention to ensure that bank holidays were not treated as counting towards workers' statutory leave entitlement. We were asked to report by the end of February 2005.

As with previous reports, we have based our recommendations on evidence gathered from a number of sources and by a variety of means. We commissioned thirteen research projects and we carried out a survey of mainly small firms in low-paying sectors. We analysed relevant data provided by the Office for National Statistics. We consulted workers and their representatives and we consulted employers and their representative bodies. We visited different parts of the UK to listen face-to-face to some of the employers and workers most affected by the minimum wage. Finally, in the Autumn of 2004 we undertook a formal process of consultation taking written and oral evidence from a wide range of organisations.

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Background

1.1 Four years ago we recommended that the minimum wage should be reviewed every two years and that a report should be issued in February so that recommendations could be implemented the following October. This report follows that cycle. It builds on previous reports, reflects on the impact of the minimum wage since its introduction, but particularly over the past two years, and looks forward over the next two.

1.2 The National Minimum Wage was introduced nearly six years ago on 1 April 1999. Since its introduction amid controversy, it has become an accepted part of the UK labour market scene. For many, it has proved an unadulterated success story. However, as our consultation and our visits reminded us, aspects of the minimum wage still cause some people concern. Some of the employers we met were concerned at the pace of recent increases to the minimum wage and many raised concerns about the difficulty of maintaining differentials. And there was no shortage of union voices calling for a more substantial rate of increase and for the adult rate to apply to all workers regardless of age.

1.3 This introductory Chapter explains how we have gone about our task. It sets out how we collected the information which has informed our debates and discussions, and the evidence which underpins our conclusions and recommendations. We have aimed to combine an understanding of high level economic issues with an appreciation of specific implementation problems. We have relied on academic research and analysis of statistical data, but not exclusively. We have also taken account of discussion, debate and personal testimony.

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Terms of Reference

1.4 In August 2004, the Government set out the terms of reference for our 2005 report. We were asked to:

• continue to monitor and evaluate the impact of the National Minimum Wage, with particular reference to the effect on pay, employment and competitiveness in low-paying sectors and small firms; and the effect on pay structures; and
• review the levels of each of the different minimum wage rates and make recommendations, if appropriate, for change.

1.5 In making any recommendations for future rate changes, we were asked to have regard to the wider social and economic implications; the likely effect on employment levels; the impact on the costs and competitiveness of business; and the potential costs to industry and the Exchequer. We were also asked to report on the effect that the minimum wage has had on the gender pay gap and the pay of ethnic minority and disabled workers since its introduction.

1.6 In October 2004, the Government wrote to us again enlarging our remit. The Commission was asked to:

• consider whether there was evidence of any significant increase in the number of employers paying 18-21 year old workers lower rates than adults and to advise on the reasons for any such increase;
• factor into our deliberations the increased cost to employers of the Government's intention to make bank holidays additional to the existing annual leave entitlement of twenty days;
• continue to cooperate with the new Women and Work Commission;
• consider whether salary sacrifice schemes involving childcare vouchers should be allowed to count towards minimum wage pay.

1.7 The Commission considered the last point carefully and came to the conclusion that the issue of childcare vouchers could not be properly considered in isolation from the wider issue of non-pay benefits as a whole. This meant that we were not in a position to produce the advice required within the timescale requested. We explained this to the Government in late October. We return to the subject of salary sacrifice in Chapter 3 when we consider the retail sector in more detail and suggest that the Government invite us to give the matter detailed consideration for inclusion in our next report.

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Research

1.8 Academic research into the effects of the minimum wage provides us with an important source of insight. After a tendering exercise, we commissioned twelve research projects designed to help us arrive at our recommendations for this report. We were looking for answers to questions such as: what has been the impact of the minimum wage over time on the hours people work and the number of second jobs? What is the extent of non-compliance? What are the effects of the minimum wage at the level of the individual business in those sectors most affected? Has it harmed employment prospects in any of the most affected sectors for any of the groups most likely to be at risk? Who benefits most from the minimum wage? What has been the impact on productivity?

1.9 In September 2004 we organised a one day workshop to enable researchers to share their emerging findings with each other and the Commission. A fuller list of the research projects and a summary of findings is set out in Appendix 2. We will publish the research reports on our website (www.lowpay.gov.uk) and make them available for study in certain libraries.

1.10 In addition to the research projects mentioned above, in October 2004 we commissioned additional research from Incomes Data Services (IDS) to help us address the part of the remit relating to the extent of the use of the youth Development Rate by employers. We draw on that research when we address this subject in Chapter 5.

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Low Pay Statistics

1.11 In previous reports we have drawn attention to problems with the official data on low pay and acknowledged the work that the Office for National Statistics (ONS) has done to improve the accuracy of data relating to low-paid workers.

1.12 There have been noticeable improvements in the quality of low pay statistics. We note that the ONS has responded positively to many of our earlier comments and we have been able to place greater confidence in official data this time round. We are confident that the improvements in train - for example the introduction of the Annual Survey of Hours and Earnings (ASHE) in place of the New Earnings Survey (NES) - will provide even more reliable data in the longer term. Appendix 7 sets out the changes made so far and those planned. We would like to record our thanks to the ONS for the significant work it has done to improve the data on low pay.

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Visits

1.13 We regard visits as an essential part of our programme. During 2004 Low Pay Commissioners undertook eight visits to different urban and rural areas of the UK: the West Midlands, Edinburgh, Belfast, the North East of England, Kent, Cardiff, Leeds and Cambridgeshire. In the course of these visits we spoke to a wide variety of people affected by the minimum wage. We met homeworkers, representatives of major supermarket chains, cleaners, owners of hairdressing salons, staff from Citizens Advice Bureaux and employment agencies, farmers and shelf stackers - among others. As in previous years, we found that talking to people directly often added a dimension of understanding that could not be arrived at by any other means.

1.14 In addition to the visits we undertook as Commissioners, the LPC secretariat arranged many more meetings and visits with interested parties. During 2004 members of the secretariat met a wide range of officials from different Government Departments, dozens of businesses and firms, and unions and employer representatives from all sectors of the economy most affected by the minimum wage.

1.15 A list of the organisations we visited is provided in Appendix 1. We are grateful to everyone we saw and also to the many people who helped us to arrange the visits.

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Postal Survey

1.16 In the Summer of 2004 we conducted a survey of employers in low-paying sectors to find out what they thought about the minimum wage in general and about the impact of the October 2003 upratings in particular. In designing the survey, we followed the broad outline of previous LPC surveys so as to facilitate comparison. We employed NOP World to administer the survey.

1.17 Questionnaires were sent to over 32,000 employers in low-paying sectors with a deliberate bias toward smaller firms. We received 3,130 completed questionnaires - a response rate of about 10 per cent. As expected, those who completed the survey tended to be companies with concerns about the National Minimum Wage. Many of the concerns expressed, for example about the rate of increase and difficulty of maintaining differentials, were consistent with much of our other evidence.

1.18 We are grateful to those businesses that took the time to complete the questionnaires. Further information about the survey and details of the results are set out in Appendix 3.

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Consultation

1.19 In addition to our programme of visits, we launched a formal consultation process in August 2004. We wrote to hundreds of bodies inviting them to submit written evidence on the impact of the minimum wage and related issues.

1.20 More than eighty organisations sent in written evidence. Some submissions took the form of detailed reports with attached survey findings, others responded in letters of various length and detail. The Government delivered cross-Departmental evidence co-ordinated by the Department of Trade and Industry (DTI). As with previous Low Pay Commission consultation exercises, much of the material we received was impressive. Appendix 1 lists the written submissions. All of the written evidence received will be made available in selected university libraries, except in cases where the respondent has requested that it be treated in confidence.

1.21 In our attempt to understand as fully as possible the practical impact of the minimum wage on firms, we also approached trade associations to invite firms in low-paying sectors to produce case studies detailing the actions they took to respond to the minimum wage. Twelve firms sent us such studies. As might be expected, we said that we would treat this information as confidential, but we would like to place on record our thanks and appreciation of those companies that took the trouble to prepare and send in case studies.

1.22 In addition to the formal written consultation process, the Commission spent three days taking oral evidence. During that time we heard from the TUC, the CBI and many other key organisations representing employers and workers in low-paying sectors. These discussions were valuable in that they often provided an opportunity to seek clarification, exchange views or debate an issue in a way not possible in written consultation.

1.23 A list of the organisations which gave oral evidence is provided at Appendix 1.

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Conclusion

1.24 In February 2003 we recommended two consecutive increases above predicted average earnings, bringing the adult rate of the minimum wage to £4.85 by October 2004. We said at the time that we thought there was a case for increasing the effective level of the minimum wage, implying a series of increases for a number of years above average earnings.

1.25 Our task this time was to review, in the light of available evidence, the impact of our last decision to recommend two significant upratings. We also needed to revisit the commitment to increase the effective level of the wage and consider if it still held good. We had to do both before we could make a decision as to our recommendations for 2005 and 2006. The Chapters that follow provide the evidence for our conclusions and lead to our recommendations concerning future rates in Chapter 7.

1.26 This report also looks at ways of improving the operation of the National Minimum Wage including compliance and enforcement. We have discussed operational aspects of the policy with officials in the Inland Revenue, HM Treasury and the DTI and we have had similar discussion with other interested groups. Our recommendations have been shaped by such discussions.

1.27 The next Chapter assesses the overall impact of the minimum wage so far, looking in particular at the effect of the October 2003 upratings. The impact of the October 2004 upratings is more difficult to assess since earnings data for October 2004 are not yet available, but some of its impact is likely to be reflected in an analysis of earnings and employment earlier than October 2004, given that some employers appeared to anticipate the October increases at least six months in advance. In Chapters 3-5 we look in more detail at the impact on particular sectors and groups of workers. Chapter 6 addresses awareness and the important issue of compliance and enforcement of the minimum wage. Chapter 7 sets out our recommendations.