It can be inferred from Figure 1 that having a price ceiling in the economy leads to a surplus of labour supply over labour demand as indicated by the distance between Q2 and Q0. This distance can also represent the quantity of involuntary unemployment that arises as a result of the state setting up a national minimum wage (Piesse, 2003, Lecture 14).
Although imposing the minimum wage on the labour market of an economy creates imbalances in the supply and demand of labour (usually supply exceeding demand by huge amount thus causing involuntary unemployment), governments still impose it due to the several advantages it is supposed to bring to the economy and the society both in the short-run and in the long-run.
In the short-run, one advantage that minimum wage can generate is the prevention of employee exploitation. Initially, without the minimum wage, employers were free to pay workers whatever wages they wished to. This encouraged them to fully exploit the worker and in return pay him meagerly making extra profits. With the minimum wage, the employers were legally entitled to pay the workers a set amount of minimum wage. Furthermore, minimum wage urged more people to work than before as they would be earning more per hour as compared to before. This could increase the supply of labour provided there are enough jobs available in the economy. This would also lead on to a reduction in dependency on benefits. Fewer people would be claiming unemployment benefits now as they would see working as more profitable with the higher minimum wage rate.
With the minimum wage, productivity of workers would probably increase. A worker previously earning £3.50 an hour will work harder and be more productive if he is paid £4.50 an hour now for the same task. Hence, with minimum wage legislation, both the quantity and quality of workers in the economy might increase. Workers would also be highly motivated in their workplace as ‘good’ workers stay to enjoy the wage premium whereas there would be incentive for ‘bad’ workers not to slack as they will lose the wage premium if they are sacked. (Piesse, 2003, Lecture 14) This would further induce a relative increase in general earnings as workers who were previously earning more would demand for a further wage rise to maintain the pay differentials.
At the same time, pay differentials between males and females would tend to reduce if it had existed. Women who were previously paid less then men due to the difference in gender would now be paid the same equal amount with the minimum wage legislation provided they are performing the same task. There would be equality amongst workers performing the same task regardless of anything.
More importantly, labour turnover and absenteeism would decrease drastically with the minimum wage legislation as on a whole, more people would be looking forward to work and be committed to it.
In the long-run, inequality between the rich and the poor would tend to reduce as workers that were poorly paid previously would now be paid the higher minimum wage at the least. This extra pay would mainly be coming from the rich businessmen who would be responsible in running the large companies hiring these unskilled poor workers.
With more people working and earning now, the government would also be earning the extra tax revenues, which it could use in the future to aggravate aggregate demand and at the same time develop the country’s infrastructure.
Moreover, with a larger proportion of the society being satisfied with their jobs, there would be fewer crimes and increased social peace. Overall, the general welfare of the society should improve. A higher number of citizens in the country would be earning more than before thus increasing their disposable income and the level of savings.
On the other hand, there are both short-run and long-run drawbacks that might prevail with the minimum wage.
In the short-run, there would be an immediate indirect increase in unemployment as the minimum wage is imposed. For example, more workers would be looking for and wanting to work whereas firms would want to employ fewer workers as explained by the labour demand curve in Figure 1 which slopes downward from left to right. Instead, firms would rather be looking forward to make some workers redundant as to cut down labour costs due to the higher wages. Some small businesses would simply be unable to afford the new minimum wage rate and the only option available to them would be cutting down jobs.
Interestingly, some firms might choose to hire younger people for whom the minimum wage legislation does not apply. For example, in the UK, workers below the age of 18 has to be content with whatever the employer is willing to pay for his services. For this reason, employers will be more willing to hire those between the ages of 16 – 17 instead of hiring people above the age of 18. An alternative way would be to hire illegal workers from abroad or using child labour. However, there are strict penalties for exercising these as it is against the law.
In the long-run, firms might pass on the extra cost of labour incurred onto the consumers. This might result in cost-push inflation whereby there is a general increase in price level. With less profits available, firms might choose to reduce investment in training and education so as to save capital. Furthermore, foreign direct investment from multi-national companies overseas might reduce due to the fall in competitiveness as these companies would have to pay the minimum wage to the workers. Hence, they would rather opt to set up their plant somewhere else where labour is cheap (3rd world countries).
Some firms would also prefer using machinery to workers in order to save the higher labour cost. Switching to machinery would prove to be real cheap and efficient in the long-run as the company would be able to use the saved capital from labour wages for further development and investment.
In conclusion, minimum wage legislation clearly has important impacts both on the society and the economy in the short-run and the long-run. However, in my view, there are several factors that should be taken into account before deciding upon the true nature of the outcome of imposing minimum wage. For example, if the minimum wage is set below the equilibrium level (price floor), a country may benefit enormously from it as it is seen with the UK. Millions of workers have been better off in terms of a general increase in the standard of living and an increase in the quantity and quality of resources (labour) in the UK.
Also, I think the impact of a minimum wage on employment levels depends on the elasticity of demand and elasticity of supply of labour in different industries. If labour demand is relatively inelastic then the contraction in employment is likely to be less severe than if employers' demand for labour is elastic with respect to changes in the wage level. For example, labour-intensive sectors like retail, catering and cleaning would have a deeper impact with minimum wage legislation than others.
Overall, in my opinion, minimum wage legislation has more advantages than drawbacks to it at least in the short-run. In the long-run, provided that minimum wage set is not noticeably higher than the equilibrium level, it would still be advantageous to have it as it can seen from the advantages mentioned before.
BIBLIOGRAPHY
Books
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Fischer, S, Dornbusch, R and Schmalensee, R, Introduction to Microeconomics, 2nd edition (USA: McGraw-Hill, 1988)
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Ison, S, Economics, 2nd edition, (Pitman: 1993)
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Piesse, J, Lecture 14, Factors of Production - Labour, (Lecture Notes: 2003)
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Sloman, J, Economics, 4th edition (Prentice Hall: 2000)
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Stanlake, G, Introductory Economics, 5th edition (Essex: Longman:1989)
