Opportunistic employers tend to fix low wages in order to maximize their profit margin. One main advantage of minimum wage is that it protects workers from employer-manipulation. The minimum wage legislation ensures that workers are paid equitably. In the long term, it ensures that they can afford better basic, medical and educational facilities. This has an effect on the productivity of the nation’s labor force. Not only does the minimum wage ensure that workers are paid enough to afford facilities to sustain better standards of living but it also acts as an incentive to workers to work harder.
On a macroeconomic level, minimum wages will ensure that spending will increase. When spending increases, aggregate demand increases and creates a Keynesian multiplier effect on the economy. If there is an additional expenditure, the initial increase in expenditure will be multiplied by a multiplication factor so that the overall expenditure increase is a multiple of the initial expenditure increase. The multiplication factor, Mf, is determined by the marginal propensity to save, tax and import.
Mf = , where s, t and m are the marginal propensities to save, tax and import respectively.
For example, if a government increases its minimum wage such that its expenditure increases by $8 billion, a cumulative effect is seen. If the Keynesian multiplier is 5, then the aggregate demand is increased by $40 billion (assuming there are no other leakages other than the ones in the formula above).
Furthermore, when minimum wages are increased within productivity levels, demand for goods and services go up because aggregate demand is increased, as explained above. Investors will be encouraged to invest in the tertiary industries, such as IT, education, hospitality and transport. Increased foreign direct investment, FDI, will boost growth and expansion of the economy.
Good X
Good Y
There are, however, many disadvantages of minimum wages. One main disadvantage of minimum wage is that when it is implemented, labor costs will increase enormously, causing a major burden for firms. For example, in the year 2000, when Bill Clinton increased the minimum wage from $5.15 to $6.50, employers in Washington Sate alone saw that labor costs increased by a total of $204 million per year. As a result, employers preferred to substitute labor with capital. They also preferred to hire short-term casuals and lay off their permanent workers, who were expensive to maintain. Some even preferred to get the regular paper-work done abroad at cheaper cost. This resulted into massive unemployment. As a result, 7,431 workers lost jobs in Washington State alone. When workers were laid off, ethnicity and age happened to be one of the factors. Most of the people that they laid off were workers who were young (between the ages of 19 and 23) and ethnic minorities. Therefore, a 2.8% increase in family income caused 7,431 people to lose their jobs, social problems to spark up, and company expenditure to rise sky-high. On a long-term basis, minimum wage can be a major disadvantage for the economy.
It should be noted that the worker unions do not consider extensively the unemployment that will be caused by their demands for higher minimum wages, if not accompanied by an increase in labor productivity. If a minimum wage is increased, the employer will feel obligated to lay off workers unless workers are prepared to increase their productivity, denoted by the value of the marginal physical productivity of labor. If, however, the employer observes that an increase in minimum wage has not increased the marginal physical productivity of labor, then the employer will lay off excess workers in order to regulate expenditure. This is a trade-off, quid pro quo.
Wage MPPL2
MPPL1
k3
Wm k2
W1 k1
L2 L1 Quantity of Labor
This diagram shows that when wage is increased from W1 to Wm (minimum wage), labor force has to be decreased from L1 to L2, causing unemployment. However, to maintain the same labor force (at L1), the marginal physical productivity of labor has to shift from MPPL1 to MPPL2. If the marginal physical productivity of labor increases to MPPL2, then the new equilibrium is at k3, ensuring that the same workforce as before is maintained.
This shifts the spotlight onto the economy as a whole. The government will have to increase its spending to pay the unemployment benefits. Its own policy has caused it to face increased spending. This will eventually cause a crowding out effect, where the government will be forced to borrow money from the private sector to finance the budget deficit, thus, making less money available for potential domestic entrepreneurs in the private sector.
A high minimum wage also means that companies will have to sell at higher prices. This results into inflation. Inflation has very severe long-term effects within the nation and abroad in the international markets. The major internal effects are a lessening in internal investment, hence, causing economic growth to slow down. The nation experiences negative external effects whereby the foreign direct investment decreases as investors are discouraged by increasing rate of inflation. Exports become uncompetitive in the international markets as high costs of domestic production affect their global competitiveness. Therefore, the nation’s balance of trade will face a deficit as quantity of exports dwindles drastically.
Increase in minimum wage is not a long-term solution to satisfy workers. According to Adam Smith, workers suffer from money-illusion, as it is the real value of money, not the nominal value that matters to them. Therefore, a large quantity of money with no real value will not satisfy the workers. The minimum wage will keep them happy only for a while. When their standards of living are not met by the wages due to increased expenditure, they will eventually start asking for a revision of their wages. It leads to a wage-price inflationary spiral in an unending battle between employers and workers through holding collective bargains. In Zambia, there have been many strikes for an increase in wages. The higher salaries which were granted because of the strikes soon lost their purchasing power due to a high inflation of 27.1% per year. Hence, workers are found in a vicious circle of collective bargaining rounds.
In Zambia, the IMF put pressure on the Zambian government to reduce the bloated civil service to make it lean, mean and efficient by retrenching its identified redundant labor. This was part of the recommended Structural Adjustment Program meant to reduce labor costs and to bring about a sustainable, motivated and efficient labor force in the civil service. Following IMF’s recommendations, the government initiated the Public Sector Reform Program (PSRP) which was meant to reduce the wage bill by cutting down workers and not granting minimum-wage increases. Therefore, any minimum-wage increases asked for by worker unions have been declined by the government in accordance with the policies of the Public Sector Reform Program (PSRP) and the regulations set by the Highly Indebted Poor Countries (HIPC) initiative. Ironically, it has been observed that new posts have been created in the government. When the government did not have money to increase minimum-wage, how did it have enough money to create many new posts, like that of the District Administrator (DA)? The practical reality of minimum-wage increases lies beyond economically-defined advantages and disadvantages that this essay has covered. On a global level, minimum-wage increases are determined more on the basis of politics than economics.
Acknowledgements
The following sources of information have been consulted:
Modern Economics 7th Edition, Jack Harvey, Palgrave Publishers, 1998; New York, USA
Economics 2nd Edition, Alain Anderton, Causeway Press, 1995, United Kingdom
Economics for GCSE, Alain Anderton, Collins Educational, 1986, United Kingdom
GCSE Economics Revision Guide; Barry Harrison, Longman; 1989; Singapore
The following sources have been used for statistical information:
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