I’ve been thinking and reading recently about the value of minimum wages. From what I’ve read most economic theory is against minimum wages on the ground that it increases unemployment. There is a fairly obvious argument with regard the fact that a minimum wage will price out people who would otherwise be able to get a job at a lower wage because, while their labour still has value to an employer, its less than the minimum allowable by law and they are thus shut out of the market.
Under this rationale a minimum wage may mean that some workers may get paid more, but they do so at the expense of those who would otherwise work. The minimum wage therefore creates unemployment and makes poorer those who would otherwise work.
I’ve no doubt that there is truth in this. Certainly if you raised the minimum high enough then it would undoubtedly cause unemployment.
On the other hand even if you could pay people 1 cent per hour the real effective minimum wage is considerably higher than that due to the training/management/hiring costs in your own time not to mention getting a decent return on any capital you may have invested for the employee to use and this is even if there was no other regulations on employment. A minimum wage below a certain point is going to have minimal impact on unemployment.
This is not even to mention that in systems where there is welfare available in the form of unemployment benefits, if the minimum is too low there will be little incentive to move off welfare and into work as the welfare is withdrawn and the tax rates kick in.
Because of the relatively discrete nature of employment, its also possible to think of scenarios where at least for small changes in the minimum wage the effect on employment will be essentially zero. ie. the demand is relatively inelastic. A raise in the minimum won’t be enough for any factory/shop etc to sack their least productive worker, nor will a small decrease make hiring any more likely because of natural boundaries (factory or shop physical size).
Empirically it appears to be somewhat of an open question, studies have found zero effect although historically most have found negative effects. The UK Low Pay commission report found no increase in unemployment but an increase in productivity in some effected service companies.
While there is no doubt if minimums are too high unemployment will ensue, I would tend to support the idea that situations can exist in reality where the minimum wage can be used to increase wages without increasing unemployment.
So if this can occur, what would be the likely effect under the scenario I’ve just outlined? It seems to me that the most likely outcome would be, where possible, for the extra increase to be passed on in higher prices. While an employer could potentially absorb an increase, nothing would change in the return the employer would want on his capital so likely he would try to pass on a marginal increase in prices.
The risk therefore is that even if you don’t cut employment, higher prices for basic services will effected the poorest group, the unemployed, the most harshly. This is essentially the converse of what is claimed for Wal-mart where their low wages and low prices results in lower general prices in a region, benefiting everyone (except the low paid workers), but particularly the poor.
The solution to this then appears to be income support either in the form of negative income tax, or a modified version of this that exists in the US, the Earned Income Tax credit (EITC).
The object of these structures is to provide income support to low income workers and ensure that the effective marginal tax rate as welfare is withdrawn is not so high so as to discourage additional work.
These have the advantage of being specifically targeted at low income households. Many minimum wage workers come from high income households being a second often part time income which won’t receive the EITC. Additionally by operating through the tax system they don’t distort either labour market, or the eventual prices but rather it is paid through the tax system and therefore progressively.
It seems to me that I can accept that minimum wages can be set and raised at least at fairly moderate levels, without meaningfully effecting unemployment rate. However, this does may reflect potential secondary effects such as rising prices which can have a negative effect on the poor. On the other hand we have other policy instruments which can potentially more effectively target the working poor and that these may provide better tools to effect the people who can find employment without putting the cost of it onto those least able to afford it.
My main concern about such schemes is that with no minimum wage, employers will pay proportionally lower wages, effectively splitting the payment with the employee. This would seem to be somewhere that minimums, even if relatively low, could effectively ensure that this does not occur to any great extent.
Rather than raising minimums the government should look to freeze it and reduce the taper rates for welfare, and raise minimum tax rate brackets as a way of more effectively assisting the welfare of poor workers while simultaneously encouraging people with greater incentives to work. As a further step a scheme such as the EITC could be implemented to increase this effect.