Raising the Minimum Wage

A minimum wage is a measure with the stated aim of raising living standards for the poor. Who could object to that?! ME.

One of the most fundamental aspects of economic theory, is that policy has consequences - usually unintended.  If firms are currently paying people £4 per hour, there's probably a good reason - that the worker is "worth" £4ph to the firm. If not, then there is a market force that raising the wage and so govt. action is unnecessary. This shows how a minimum wage will affect the profitability of a firm, and when a company goes out of business a state law over "fair pay" is irrelevent.

For some firms, at the margin, the increase in wage rates will make them switch from labour to capital (i.e. mechanization). Unemployment is the consequence of a minimum wage. But it might not be that stark. Legislation usually means that firing people becomes more costly. So some firms might keep on the same staff but reduce their hours, or they might not be able to expand. Unfortunately ministers are more concerned with protecting today's jobs, then increasing the jobs of tomorrow.

Now, let's look at the Public Choice argument. Might the legislation be driven by self-interest, rather than benevolence? A minimum wage will benefit those who previously worked in low-paying jobs, who now retain their jobs. These tend to be people with bargaining/political power i.e. trade unions. It's no surprise that miniumum wages are driven by the unions, and implemented by the parties that rely on them. Public Choice shows the harmful consequences of interest groups: they can concentrate benefits on their members, and disperse the costs amongst society at large.

I've had two jobs where the pay was below the minimum wage. The first, I found another one and quit. The second, I was not being "exploited" because I was more aware of the complex mix of non-pecuniary pay (in the form of training) than a government official could ever ascertain. Indeed there were several other workers, more than happy with the situation. If the tax man had found out we'd have all been out of a job. If you fear for the world being run by massive corporations, you should be worried by this - minimum wages and other such labour regulations make starting a new small business harder.

With this in mind, I was reading the BBC article: Minimum wage increased to £5.05

The minimum wage will rise in October, benefiting more than 1m people, the government has announced...
Businesses wanted it frozen, warning more rises could damage competitiveness but the unions want a £6 rate...
The Trade Unions Congress welcomed the increase, but has called for a £6 minimum wage by next year.

So far, so expected: firms are unhappy, the unions want more. For me, this is reason enough to oppose the rise. A business should have the right to offer whatever contract it deems feasable, and the only right an employee should have over a job is that their contract is adhered to. But I imagine other Filter^ readers are unswayed by this "property right" argument, so I'll proceed.

The recommendations came from the Low Pay Commission which said the number of jobs had continued to grow since the minimum wage was introduced in 1999

Ah - the evidence conflicts with my predictions, and so my surprise will cause a rethink. My first thought was that the economy is growing so strongly, firms have a little room to "absorb" the costs. Indeed:

"We have therefore recommended only a slight increase above average earnings, and concentrated it in the second year to allow business more time to absorb the impact," said chairman Adair Turner."

Implication being that a minimum wage doesn't really cause harm, as long as it's done slowly. Maybe that will convince Filter^ readers that this measure to get the young out of poverty is working... but i'll proceed.

The government says most of those on the minimum wage are women - with many working in cleaning, catering, shops and hairdressing.

I thought I'd look at the figures. At the Low Pay Commission website I looked through a research paper called Impact of the National Minimum Wage on the Hairdressing Sector.pdf and noticed the second headline, from the executive summary:

The most common response of salon owners to the  increased costs generated by the NMW in hairdressing took the form of price rises  for customers.   

So unemployment doesn't rise, but the costs are passed on via price rises. Two problems. Firstly, inflation is a massively harmful phenomena. But secondly no one should care what their nominal wage is, because money is only useful in that you can buy things with it. Your "real wage" is the relationship between your "nominal wage" (what's on your paystub) and the price level. If the minimum wage goes up by 50p, but prices rise as well, you're not any better off. Indeed your worse off, since now you're living in inflation.

That, is some preliminary discussion of minimum wages. Far from complete, I hope i've exposed the myth that it is come charitable act that makes people better off. It is a means for those with political power to make short term benefits, at the ultimate cost to everyone.

Update: Thanks to Quinn for pointing out some more (and better) economic reasoning at Stumbling and Mumbling

Comments

[Quinn]

I have read a few interesting discussions on the minimum wage today, at Stumbling and Mumbling, Tim Worstall and Blimpish.

The problem I often have when discussing various economic theories is the assumption of ceterus parabus that is made; that all other things remain equal; but in the real world all other things don't remain equal, and everything impacts on everything else. I soon get lost wondering what effect an individual economic decision will actually have in practice.

[AJE]

Good point - in fact that is precisely the reason why "unintended consequences" are such an important issue to discuss. Political rulers, in conjunction with economists, construct these almighty models to trace through the effects of policy.

It is the distinctly Austrian view that blows open the problems of applying "ceterus parabus" to the real world: the world is far more complex than policy assumes. We don't know the effects of policy, and that should be a reason to refrain.

The policy maker is like Homer Simpson when he goes back in time: chaos theory applies to the economy as well.

[Matthew Whitfield]

I see that you've conceded the point that unemployment hasn't risen during the period of the minimum wage being introduced, despite many predictions of it's cataclysmic effect. However, drawing evidence of price rises/inflation from one document about hairdressers fails to take account of the record low levels of inflation the UK has enjoyed over the past 7 or so years. I completely see your arguments about wage regulation having the potential to effect both these things (unemployment and inflation), but doesn't the fact that neither have actually been affected much tell you that the current level of the minimum wage has been pitched low enough to avoid these negative consequenses? I mean, it's really, really low. Even at £5.05 an hour somebody working in a full time job would earn £1000 less a year than I do as a research student on a pretty miserly bursary. All I have to do is read and write about things that interest me, not pack chickens in a industrial estate somewhere.

[AJE]

Careful though: unemployment hasn't increased but hours worked have fallen, and overtime has fallen. (According to the Stumbling and Mumbling). Both are a "negative employment effect", since less hours are being worked, albeit the mixture is such that the macro statistics look better.