Minimum wage

The minimum wage is the minimum rate a worker can legally be paid (usually per hour) as set by statute. It is different from the lowest wage determined by the forces of supply and demand in a free market. In most cases, the minimum wage acts as a price floor. Each country sets its own minimum wage laws and regulations, and many countries have no minimum wage.

Consequences of minimum wage laws

If the law is successfully enforced, and if they are high enough in real terms (or relative to the average wage), minimum wage laws are alleged to have various benefits and costs.

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Hypothetical costs and benefits

Minimum wages may have the positive effect of:

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• Reducing low-paid work, which may be unfair and exploitative.
• Reducing the dependency of the low-paid on welfare-state benefits, which may in turn reduce taxes or allow increases of other government outlays.
• Stimulating economic growth by increasing the purchasing power of workers.
• Stimulating economic growth by discouraging labor-intensive industries, thereby encouraging more investment in capital and training.
• Encouraging many of those who would normally take low-wage jobs to stay in (or return to) school and thus to accumulate human capital.
• Decreasing crime by proportionately reducing the attraction of receiving income through the black market.

On the other hand, deadweight loss caused by minimum wages may have the negative effect of:

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• Limiting employment of low-wage earners, increasing employment at sub-minimum levels and generally increasing unemployment.
• Raising employment barriers for people with little or no work experience or formal education: if a worker's labor is not worth the minimum, he may not find employment at all.
• Curbing economic growth by increasing the cost of labor.
• Curbing economic growth by lowering the supply of labor.
• Increasing the price of goods and services, since employers pass on employment costs in the form of higher prices. (Opponents of minimum wage often see a negative income tax, e.g., as a way to support the lower-waged jobs, with the money coming from those who pay taxes, not those who pay for the products including the unemployed)
• Decreasing incentive for some low-skilled workers to gain skills.
• Where implemented locally, making labor more expensive than in other areas, which may discourage inward investment and encourage local businesses to relocate their operations elsewhere.

The effects of minimum wage laws, both positive and negative, may be increased by 'knock-on effects', with increased wages for workers already earning above the minimum wage. For example, some labor union contracts are based on a fixed percentage or dollar amount above the minimum wage. Certain public grants or taxes are based on a multiple of the minimum wage. (For example, a worker may have an exemption if his earnings are below 2.5 minimum wages.)

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Debate

The costs and benefits arising from minimum wages are subject to considerable disagreement among economists, though the consensus among economics textbooks is that minimum wage laws should be avoided whenever possible as the costs exceed the benefits. Indeed, a survey in the Winter 2005 issue of the Journal of Economic Perspectives reports that exactly two-thirds of academic economists at top universities agree with the statement, "a minimum wage increases unemployment among young and unskilled."

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This unified view was challenged by empirical research done by David Card and Alan Krueger. In their 1997 book Myth and Measurement: The New Economics of the Minimum Wage (ISBN 0-691-04823-1), they argued the negative employment effects of minimum-wage laws to be minimal if not non-existent (at least for the United States). For example, they look at the 1992 increase in New Jersey's minimum wage, the 1988 rise in California's minimum wage, and the 1990-91 increases in the federal minimum wage. In each case, Card and Kreuger present evidence ostensibly showing that increases in the minimum wage led to increases in pay, but no loss in jobs. That is, it appears that the demand for low-wage workers is inelastic. Also, these authors reexamine the existing literature on the minimum wage and argue that it, too, lacks support for the claim that a higher minimum wage cuts the availability of jobs.

Related Topics:
David Card - Inelastic

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Critics of this research, however, argue that their research was flawed.http://www.fee.org/vnews.php?nid=3896,http://www.cato.org/pubs/journal/cj15n1-8.html For example, Card and Krueger gathered their data by telephoning employers in Pennsylvania and New Jersey, asking them whether they intended to increase, decrease, or or make no change in their employment. Subsequent attempts to verify the claims requested payroll cards from employers to verify employment, and ostensibly found that the minimum wage increases were followed by decreases in employment. On the other hand, data analysis by David Neumark and William Wascher, economists who are usually critical of minimum-wage increases, supported the Card/Krueger results.http://www.epinet.org/briefingpapers/minimumw_bp_1996.pdf

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Some idea of the empirical problems of this debate can be seen by looking at recent trends in the United States. The minimum wage fell about 29% in real terms between 1979 and 2003. Yet real wages have risen in the free market anyway, with real hourly earnings up by 7 percent since 1997 (the last time the minimum wage was increased). Some argue that a declining minimum wage might reduce youth unemployment (since these workers are likely to have fewer skills than older workers).

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Theoretical arguments

As is usual in serious social science, any empirical conclusion is subject to doubt and is simply the basis for further questions and research. One key question is the possible theoretical explanation of the different results.

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The traditional view that minimum wages have significant negative effects on employment is straightforward if one assumes that labor markets for low-skill workers can be characterized as fitting the model of a perfectly competitive market, where the only role of wages is as a cost. On the other hand, if Card and Krueger's empirical research is valid, it may be explained by the efficiency wage hypothesis which states that higher wages may "pay for themselves" by increasing worker efficiency (i.e., labor productivity). Higher wages encourage a higher willingness of low-skill workers to stay with their current employers and to gain experience and skill, while the employers are more willing to train them. Alternatively, if monopsony exists, then an increase in the minimum wage can raise employment. Alan Manning's 2003 book, Monopsony in Motion: Imperfect Competition in Labor Markets (ISBN 0691113122) suggests that this kind of market is common if not ubiquitous in labor markets.

Related Topics:
Perfectly competitive - Efficiency wage hypothesis - Monopsony

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Even if Card and Krueger's results are accurate, there may be a "tipping point" above which their conclusions do not apply and the standard economic consensus does apply. The possible validity of their research may be the result of political forces: in the United States, business political pressure on legislatures and Congress may have kept the minimum wage so low that it has little negative employment effect. Further, the Federal minimum wage has moved away from the presumed tipping point, becoming less relevant. It has fallen from about 50 percent of the average hourly wage in manufacturing during the late 1960s to less than 40 percent.

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Some argue that minimum wage laws "lock-out" the poorest individuals from obtaining employment by legally forbidding them to compete for jobs by offering to work for lower wages. This argument of course does not apply to the black economy. The idea that a lack of a minimum wage naturally directs employment opportunities to the most needy is viewed by some as a moral justification for the elimination of minimum wage laws. On the other hand, the fact that the working poor often struggle to support themselves without government support (eg food stamps), under the assumption that the minimum wage is a net benefit to these people, is a moral argument in favour of it.

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Some say that if developing countries had minimum wages, or minimum wages commensurate of those of developed countries, that jobs would not be exported to these poor individuals and their opportunity for economic advancement would be impeded. Others say that this overlooks the fact that movement of jobs applies above all to industries which require large quantities of unskilled or low-skilled labour, and that relative prices for such labour are very different.

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Wage subsidies

If they exist, it is clear that some of the adverse effects can only occur when minimum wages are implemented and successfully enforced by government fiat: either these effects are a consequence of the cost of wage regulation or they do not exist. If, however, a floor on wages is implemented indirectly by providing wage subsidies, there would not be decreased employment. However, since this program is not a "free lunch", some other economic damage may be created instead, as with an externality. On the other hand, it is possible that there are already externalities contributing to unemployment, and that subsidies at the right level would merely be Pigovian solutions to these and would not actually cause any further harm after all. Research would need to be done to determine this.

Related Topics:
Wage regulation - Externality - Pigovian

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While straightforward Pigovian subsidies would have funding problems, particularly when introducing them for the first time, there are other approaches. One was examined by Professor Kim Swales of the University of Strathclyde (See http://www.faxfn.org/03_jobs.htm). This avoids funding problems by not having an actual subsidy but a virtual one — the funds flow is always from employers to the government, being netted off by the virtual subsidy before funds ever change hands. This may also be analysed by means of game theory (e.g "the prisoner's dilemma" or "the tragedy of the commons").

Related Topics:
Pigovian - Kim Swales - University of Strathclyde - Game theory - Prisoner's dilemma - Tragedy of the commons

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Alternatively, in the United States, many economists see the "earned income tax credit" (EITC, a wage subsidy) in the Federal income tax as providing the poverty-fighting benefits of the minimum wage without the non-budgetary costs, while being superior to most welfare state anti-poverty programs. One problem has been that many of the working poor (the target of this program) have a hard time with the tax forms needed to receive the EITC payment. There may also be long delays between when the money is needed and when the EITC payments are received. That is, a person might become eligible for the EITC in April but then get laid off for the rest of the year. But this person would not get help from the credit until nearly a year later (since Americans pay their taxes in April). Further, like with the minimum wage, those people working at home taking care of children and other loved ones do not receive any benefits; only those doing paid labor are rewarded.

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Finally, if these kinds of "complications" do not exist, it is possible that the benefit of the tax credit is received by the employer: assume that for low-skill workers the equilibrium market wage equals "X." Before the EITC is introduced, all of this wage is paid by their employers. After the EITC is instituted, the workers receive Y + Z, where Y is the new wage paid by employers and Z is the tax credit. If the labor market returns to the same equilibrium, then X = Y + Z. This means that the low-skill workers receive exactly the same amount as before the EITC was introduced and that the employer is paying less to the employees. This issue needs to be examined further.

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