Discuss arguments for and against the UK's minimum wage policy. Under what conditions is it possible that a minimum wage might actually increase employment?

University Degree Business and Administrative studies

Dorothy Pinkney

Economics 1

Microeconomics and International Trade

Discuss arguments for and against the UK’s minimum wage policy. Under what conditions is it possible that a minimum wage might actually increase employment?

The Labour government in 1999 introduced the minimum wage to provide social protection to low echelon workers from being exploited by firms. The minimum wage makes it illegal to pay an employee less than a specified hourly rate. However, by looking at economic models and imperial evidence, it is evident that restricting the labour market creates some negative effects. It is also possible to see how the minimum wage could be increasing employment with the theory of monopsy power.

The main argument against the minimum wage policy is that it creates a surplus of labour which results in increased unemployment. In the competitive labour market, the policy raises the incomes of workers whose free market equilibrium wage is below the minimum wage. In a competitive labour market, profit-maximising firms are looking to employ cheaper labour to keep costs of production down. The free market equilibrium is where the supply of labour is equal to the demand from the market. The competitive firms want a low price of labour compared to the cost of production but the minimum wage policy increases their price of labour which means that they are less willing to employ individuals, and their demand decreases. However, the supply of labour increases because more individuals are willing to work for a higher wage.

This graph shows that the section of the supply curve below the minimum wage is rendered useless by minimum wage legislation.

The Labour party’s policy does not affect the high decile earners of society but disadvantages the lowest paid workers because it takes away employment opportunities. When the UK’s economy is in a downturn, individuals may be willing to accept low-income jobs because it is better than being unemployed. Companies would not be able to produce at their most efficient rate because they would not be able to afford enough workers as they have to pay the minimum wage and this would have a detrimental effect on the economy. Therefore it could be argued that the minimum wage creates inefficiency. ...

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However it could also be argued that the increase in wages amongst the entry-level earners will have little to no effect on the unemployment rates as far as income and substitution effects are concerned. The income effect says that when individuals earn more, they are better off and so they work fewer hours, which in turn decreases the labour markets. However the substitution effect says that an increase in wages changes the trade-off. That is to say that by working one more hour, the individual has an increased additional amount to spend on goods so they are willing to put in extra hours and the labour market increases. The income and substitution effects counter-balance each other so that the net effect is insignificant. It is generally assumed that the substitution effect dominates amongst the lower income workers whereas as the high end of the income scale on the labour market, individuals are significantly better off so they work less hours with each wage increase and the labour supply decreases. Therefore the substitution effect will increase the labour market as individuals are willing to work longer hours. This will benefit the firms but not the individuals because it will not change the amount of people employed.

The minimum wage will affect the lower end of the labour supply curve so that the labour supply will increase due to the substitution effect.

The relevancy of the minimum wage in the future is questionable because as the UK is becoming an evermore technologically advanced society, the labour demands are leaning towards the most skilled, educated and well-paid workers. Firms find it more financially viable to automate low skilled workers with labour saving technology (e.g. mechanics in automobile factories). In the first half of the 1980s and between 1991-1993, the unemployment rate in Britain had reached between 3 and 3.5 million however the employment rate is on the rise and that may mean that the minimum wage is becoming irrelevant. Imperial evidence from the Low Pay Unit shows that although the minimum wage has given low-income earners a fair wage and does not decrease the employment rate, the increase to labour costs in a firm offsets benefits and job perks like bonuses and overtime.

In theory, the labour supply curve facing a perfectly competitive firm is perfectly horizontal, which means that when the wage increases, the firm has unlimited access to labour. However this is not the case in reality because the labour market is not completely free. Transfer of labour is restricted because workers may not want to change jobs, and with the UK’s highly specified job training, workers may have non-transferable skills and costs of moving home to suit a new job may prevent them changing. In these cases, employers may exploit individuals because they know that their employees cannot easily find a new job. The minimum wage does advantage individuals as it intended by preventing unfair exploitation of employees. At a higher wage, even the low-income earners will work harder for the firm that employs them so the firm will enjoy the benefits of increased productivity. Also, increased unemployment will mean that it is harder to find a new job so employees will be less likely to shirk off because the risk of redundancy is to high.

The argument that the minimum wage will not cost jobs but may even increase employment is based on the idea that firms have monopsony power. A monopsonistic labour market is where there is only one source of employment, for example where there is only one firm in a small village. This means that to hire another person the wage must increase to attract new employees. As a result, the wages of all of the workers must increase so the marginal cost of an employee (i.e. the additional cost of hiring the person) is equal to the difference between the new wage and the original wage multiplied by the quantity of previous employees plus the new wage for the extra employee. To maximise profits, the employer hires workers until the marginal cost of hiring another worker is equal to the marginal revenue produced by hiring them. With a minimum wage, the marginal cost of hiring an extra worker need only be the minimal wage, which would be the same as the other workers. Therefore, in a monpsonistic labour market the marginal cost of employment is less with a minimum wage so the firm can employ more people. It seems unlikely that many firms in the UK have any monopsy power but an analysis of fast-food outlets in the U.S states of New Jersey and Pennsylvania showed that MacDonald’s and Burger King did have some monopsy power. This suggests a reason why the minimum wage may increase employment providing that the minimum wage is set only slightly above the free market wage.

In conclusion, the advantage for the employees is the protection from exploitation and the advantage for the firms is longer working hours and increased productivity. The disadvantages for the individual and society are the higher unemployment rate and the inefficient labour market, particularly amongst the low-income earners. The way in which employment may increase is if firms have some monopsy power which would allow them to employ more individuals whilst still maximising profits. The effect of this policy is more noticeable amongst the entry-level earners but it seems that the overall effect of the minimum wage is insignificant on the economy as a whole.

Bibliography

Economics, Joseph E.Stiglitz and John Driffill, 1993, W.W. Norton & Compnay, Inc.
Low Pay Unit,

Minimum Wage Fact Sheet by the Low Pay Unit.

Martin Wolf, “A Policy with No Point”, Financial Times, 22 April 1997; Alan Manning, “If It’s Good Enough for Everyone Else, Its Good for Us”, The Independent, 11 May 1997.