The True Costs of Minimum wage

We all know the theory of minimum wages. The market reaches equilibrium wage naturally, if a firm can receive £4 in benefit from a job it will offer a wage of anything below £3.99 and be better off. If a worker accepts a wage of £3.50 it means that not only does that job give him positive benefits, but gives him the most possible benefit out of all possible jobs he could take. Everyone wins.

When I have talked about this with people, I have come across emotive words such as ‘exploited’ being thrown around. What people seem to fail to realise is that employment is an agreement, if you are forced into a job you are exploited, but if you chose to take a job you are not exploited, indeed you benefit. People take actions such as accepting a job if it increases their utility. If you accept a job, you are increasing your utility.

Then the Government decides to impose a minimum wage above the market clearing wage, say at £5, so all jobs that provide benefit to the firm of £4.99 or below will be scrapped as paying £5 for £4 of benefit makes no sense. The supply of jobs will therefore fall; the demand for jobs will at the very least will stay constant, and due to an increase in the wage probably increase. The consequence is a lack of equality between supply and demand, there is excess supply – unemployment.

 

For a further insight into minimum wage this helpful and amusing video highlights the issues [youtube id=”IFbYM2EDz40)” width=”600″ height=”350″]

So did this happen in Britain when the minimum wage happened? According to a paper here, I had this discussion on twitter and the answer came out as No: http://cep.lse.ac.uk/pubs/download/dp0781.pdf

With the conditions in the UK, things like employment laws prevented employers from reducing labour as they would have liked to. Further suggestions are the, high sunk costs that require the labour meaning in the short run demand for labour did not fall, however, before the left start crowing, there are numerous other effects as this research paper shows which show the true damage the minimum wage cause, something I don’t think the person I was arguing with had read before he linked me to this article.

Firstly while pay per hour may have gone up, total pay stayed constant or fell. Employers who couldn’t reduce job numbers instead reduced hours worked. Those who are meant to benefit from minimum wage find the level of work they do being reduced; they are in no better position than before.

Secondly, again as the paper admits, short run changes take time to adjust, in the long run there is an effect, while Labour laws may mean employee numbers may not  have been reduced, over the long run, less jobs are created and less new employees are taken on board

A third reason was non compliance, as the paper states, the number of workers in the non compliance sector has been growing since the introduction of the minimum wage. Employers understated the hours worked by employees. In a paper quoted in the research I was shown ‘Ram et al. clearly believe that full compliance would force many small businesses in the clothing and catering sector to close’.

Fourthly we have offsets. Examples given include not hiring temporary workers to cover for employees on mandatory training systems ‘Either the existing colleagues had to work a bit harder or service to the customer worsened.’ But the biggest offset was a further area of non compliance. Government uses tax credits to incentivise work, the lower the family pay the higher the tax credit. Therefore some employers would ‘understates the pay of the worker, but understates the hours by even more to demonstrate compliance with the NMW. This permits the worker to get a larger amount of tax credit and the employer to pay a correspondingly lower hourly wage. The employer, for consistency, understates his own turnover which lowers his VAT and income tax burden’

Fifthly we have prices, according to this paper, a study done by Wadsworth in 2007 show that industries relying on minimum wage workers saw their prices rise by 1.8% more than RPI every year, as the paper says ‘It is clear that the price of consumer services provided by NMW workers has risen, since the NMW, relative to the RPI.’

So what results do we have, while minimum wage may not have initially seen job losses it has almost certainly caused a reduction in the number of small businesses starting up, and a fall in jobs being created? Employment effects are seen in the medium to long run as the economy adjusts, seeing as we are in a financial crisis it would be unfair to present employment figures from the present, however the figures after the crisis will be interesting, and not just the unemployment rate, but the hourly work level, as employers have cut hours leaving workers no better off

Furthermore we have non compliance, government tax revenues falling and government welfare payments increasing, hardly something to be mooted as a success.

The question that remains is who gains and loses from National Minimum Wage? As we can see if your hours have been cut and you retain employment, you will be very little better off, so of those who have their wages raised not all will feel the benefits. Government and the public purse as we see lose out, Consumers who face higher prices lose out, but worst of all, those who really lose out are the unemployed, and the unskilled. With falling job creation those who NMW is meant to help are hit the hardest, those with physical or mental disabilities, or who have low skills face increased job competition due to a shortening of work places, and find themselves losing out. There are a plethora of jobs that would benefit companies at amounts below the minimum wage, but cannot be accessed as the amount that would have to be paid would be above the benefits

Minimum wage is nice if you get it and can keep your hours, but for the many others out of a job it is not so fun at all, and at the end of the day, everyone loses. It may sound like a nice idea, and may score political brownie points with the left wing metropolitan elite who will never have to take a minimum wage job, or be kept out of employment due to the minimum wage, but Government, Consumers, Employers and Workers all are hit and all face the huge costs of Minimum wage

2 COMMENTS

  1. Cracking article.
    Once you look past the lofty ideals of behind the minimum wage, you see that it’s actually a rather negative entity.

    Cold hard numbers don’t lie, they don’t have an ideology, and don’t have an agenda.

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