Governments+and+Minimum+Wage+legislation



Minimum wage theory
The minimum wage is a pay floor. Employers are not allowed to pay their employees a rate below the minimum wage. This only causes problems if the minimum wage set is above the equilibrium wage rate that would otherwise exist in the labour market.



The diagram above is the classic minimum wage set up. You see the 'normal' supply and demand curves. The equilibrium wage and employment levels are £2.50 and L1 respectively. The government then imposes the National Minimum Wage at the rate £3.60. As with the situation when the union forces the wage up, the new supply curve is the solid green line SMW. So the new equilibrium is at point A, giving a wage (obviously) of £3.60 and a reduced level of employment L2. Of course, the fall in employment (L1 - L2) is significant, but the effect on unemployment is even worse. The unemployment figures have to include those who will now offer their labour services at the higher wage rate but cannot actually get a job (L3 - L1). This gives a total level of unemployment in this labour market of L3 - L2, which is larger than the loss in employment. Of course, most industries in the UK were broadly unaffected by the National Minimum Wage (NMW). Any industry whose wage rate was already above £3.60 an hour had an equilibrium wage rate above the price floor imposed.  In the diagram above, you can see that the wage floor is below the equilibrium wage rate. In this example, the NMW has absolutely no effect on that equilibrium. The industries that do tend to be affected in the UK are hospitality (a third of the workforce affected); security and cleaning (30% affected) and agriculture, retailing and social care (all 20%, figures from the Labour Force Survey).

The case for the National Minimum Wage

 * 1) Reducing poverty: Unsurprisingly, households whose earners were paid less than the NMW also tended to be those who were officially defined as 'in poverty' (income of less than half median earnings). It was felt that the NMW would lift households out of poverty. Of course, this leads to another advantage of the NMW; it should, therefore, lead to a fairer distribution of income.
 * 2) The effect on productivity: Some economists believe that the increased wage might improve labour productivity. Workers may respond to their higher wage rate by working harder, possibly as a result of worrying about losing their job now that the increased wage rate has made it a more 'sought after' job. Employers may force through productivity improvements. They may feel that the increased wage rate needs to be earned through increased efforts! If the workers are producing more unemployment may not need to increase due to minimum wage legislation

The case against the National Minimum Wage

 * 1) Unemployment: We have already seen how a NMW can cause unemployment. Pessimists did not accept that huge productivity improvements were feasible. This is the main disadvantage, but we shall see in the last section whether this problem proved to be as widespread as the pessimists believed it would.
 * 2) Are those in poverty wage earners? One of the main advantages of the NMW was its success in reducing poverty by increasing the wage of low-income families. But many households in poverty are struggling precisely because no one in the household has a job. The NMW is useless to the unemployed.
 * 3) <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 18px;">High cost to employers: The bureaucracy involved in complying with the new law, plus the actual cost of the higher wage (assuming productivity improvements are not significant) may force firms to increase the price of their products, which is detrimental to consumers.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 18px;">Student task: Research the National Minimum wage in Indonesia and minimum wages in Jakarta. How do these differ from your home country?