In our 2005 Report, which made recommendations for October 2005 and October 2006, we said that we believed it was appropriate to increase the minimum wage slightly faster than average earnings over that two-year period. We also recommended that we should review the October 2006 rate in January 2006 to check whether economic conditions had changed in any way that made the proposed increase inappropriate.

Our review of economic conditions revealed some factors which could argue for a slight reduction in the October 2006 increase: economic growth in 2005 was less dynamic than we anticipated in January 2005, and forecast growth for 2006 has also been shaded down. Consumption spending was relatively subdued, with negative implications for low-paying sectors, in particular retail. Average earnings increased somewhat less than we anticipated over the last year (by 4.1 per cent not 4.5 per cent) and forecasts for 2006 suggest a similar shortfall. And the slowdown in average earnings growth appeared greater if we focused on the private sector alone, and particularly on some of the most affected sectors.

Conversely, we noted that employment continued to grow, both in the overall economy and in the low-paying sectors, and that corporate profitability continued its cyclical improvement. The latest data showed that, although total employment fell by 22,000 in the quarter to November 2005, it increased by 221,000 over the year to November. While some groups, such as young people, did less well, the employment rates of others, older workers for example, rose. Between September 2004 and September 2005, 38,000 net new jobs were created in the low-paying sectors, including 22,500 net new jobs in the retail sector. In 2005, private sector employment grew at its fastest rate since 2000.

By our latest calculations, 0.9 million jobs benefited from the 2005 upratings, and 1.3 million jobs are scheduled to benefit from the 2006 upratings. The percentage of jobs benefiting is 3.6 per cent in 2005 and slightly greater than 5 per cent in 2006. These numbers are similar to those of previous upratings.

Pending employment legislation will have implications for subsequent reviews of the minimum wage. The Government intends to extend statutory holiday entitlement to include bank holidays, giving a typical full-time worker 28 days annual leave. The timing of the introduction of this entitlement and, in particular, whether it is phased over a number of years or introduced in one, may have implications for the appropriate level of increase in the minimum wage rates over subsequent years. The nature of UK implementation of the Equal Treatment Directive is also relevant to the setting of the minimum wage rates, but the Commission is satisfied that the Government intends to introduce the legislation in such a way that the rates for young people retain their viability.

In response to our consultation exercise, employer groups tended to emphasise the downturn in the economy and the adverse impact this was having on businesses. They stressed both the impact of energy price hikes and likely forthcoming changes in employment legislation on employers' costs, and argued that the proposed increase in the minimum wage should be reduced or delayed. In contrast, union groups tended to focus on the strength of the labour market and employment creation. They pointed out that, while the economy was growing more slowly than in recent years, it continued to expand. Evidence from the Government highlighted the success of the minimum wage, and noted no untoward effects arising from the ongoing increases.

Given the above, we acknowledge that a case could be made to shave the 2006 increase by a small amount. In particular, we noted that, since average earnings growth had been slightly less than anticipated, the 2005 and 2006 increases would (if followed through) result in slightly faster progress towards raising the minimum wage relative to average earnings than had been anticipated at the time of the 2005 Report recommendation.

Although some Commissioners believed that this overshoot was sufficient to justify a reduction in the 2006 rate to, for instance, £5.30 or £5.25, we concluded that the divergence of economic outcomes from those anticipated was not a sufficient basis on which to agree a reduction in the 2006 increase. We therefore confirm our original recommendations. However, we do now consider that the phase in which the Low Pay Commission is committed to increases in the minimum wage above average earnings is over. Looking forward, we have no presumption that further increases above average earnings are required. In addition, we note that it will be particularly important over the next year to look in detail at trends in average earnings by sector, analysing, for instance, whether private sector average earnings growth continues to lag behind that in the public sector and reviewing, in the light of that analysis, the appropriate average against which to consider increases in the minimum wage which primarily affects private sector employees.

Introduction

2.1 Following increases significantly above average earnings growth in 2003 and 2004, we recommended in our 2005 Report that the adult minimum wage should increase by more than the predicted increase in average earnings over the next two year period (2005 and 2006). However, our recommendations were designed to keep the adjustment above average earnings small and to concentrate the increase in the second year so that businesses would have time to absorb the impact of previous increases. We said that we thought further increases above the growth in average earnings would be required in subsequent years before the adult minimum wage had been brought to an appropriate long-term level. We recommended that the adult rate and youth Development Rate be increased in October 2005 and again in October 2006. However, our recommendations for October 2006 were conditional on a review of the prevailing economic conditions in early 2006.

2.2 We based our recommendations for 2005 and 2006, made in our 2005 Report, on our assessment of the impact of the minimum wage to that point and an assessment of the future prospects for the economy as a whole. We also took account of the views expressed by interested parties. This Chapter reviews the upratings recommended for October 2006 in the light of the economic circumstances prevailing at the beginning of 2006.

2.3 First, we look at the performance of the macroeconomy and the labour market since the 2005 Report before reviewing trends in inflation and pay settlements. We then assess the impact of the 2004 minimum wage upratings on earnings. We also note any differences in earnings and employment growth between the public and private sectors. We then summarise the views of interested parties who responded to our consultation exercise in the Autumn of 2005. We revisit our estimates of the number of beneficiaries of the 2005 minimum wage upratings in light of the economic outcomes in 2005, before reviewing the economic prospects for 2006 and beyond. The prospects for growth in average earnings and price inflation, which constitute important benchmarks against which to assess proposed upratings to the minimum wage, are then used to revisit our estimates of the likely number of beneficiaries of the proposed 2006 upratings. Finally, we set out our recommendations, taking into account the likely impact of the planned new legislation on age discrimination and the extension of statutory annual leave entitlement to include bank holidays.