The visible hand in economics

$12 minimum wage

Posted on: December 18, 2007

Following on from our post on the minimum wage yesterday, the government decided to announce an increase in the minimum wage to $12, from $11.25.

The money-quote from the stuff story has to be:

“Initially business groups were opposed to lifting the minimum wage, which was set at $7 an hour when Labour took office in 1999.

However, in recent years they became more relaxed as the labour market tightened and hiring staff became more difficult.”

This tells us that the minimum wage increases are unbinding for a lot more groups than they used to be, and as a result the effect of the policy will be minimal.

Lets try to discuss this increase in regards to yesterdays conditions for a minimum wage to ‘increase’ employment.

Ok, so we had the conditions:

  1. Firm has market power in the labour market
  2. Workers have no market power
  3. Everyone must get an increasing wage as employment rises
  4. Firm will not be put out of business by increase in average costs

Now, as far as I can tell there are two main firm types that change their wage rate based on the minimum wage: Small firms that require only a minimal labour input (eg dairies), and large firms that hire relatively ‘low-skilled’ labour (eg my old workplace, the Warehouse – where I got to be a checkout operator).

As well as the firm types we need an idea of location. In an area with a Warehouse and dairies, the Warehouse is often the dominant firm (in both labour and goods markets) while the dairies act as residual claimants in the market. As a result, the Warehouse does act as a ‘monopsony‘ in the labour market, albeit one that is constrained by the size of a bunch of dairies.

As a result of NotSneaky’s idea it is possible that this increase in the minimum wage may lead to further increases in employment by the Warehouse, by reducing the marginal cost of further hiring.

Now what do you think the increase in the minimum wage will do, and why?

6 Responses to "$12 minimum wage"

What you may have overlooked is the flow on effect to other employers. For example my company pays around $6 an hour more than the minimum wage for what is an unskilled job. We do that so we get good employees. Our rates are also above the market average for our industry.

If the minimum wage goes up, that does put some pressure on employers like me to increase wages (which is inflationary as I will put fees up also) so we maintain a good gap.

I 100% agree with the idea that a higher minimum wage is likely to increase wages in other industries, where the minimum wage does not seem to hold. For example, the Warehouse always pays above the minimum wage, but it has to pay that gap in order to get the type of staff it wants. If the minimum wage rises, they have to increase wages in order to retain the staff they want.

I am glad that you brought up the inflation point, as an increase in the minimum wage seems like an it would be rather inflationary in the current environment.

People may ask why it is so inflationary. Well the answer is that people on the minimum wage will spend a greater proportion of this income than other income groups would if given the same increase. This implies that demand will increase for goods in our already capacity constrained economy, forcing prices up – in fact, since business have said they don’t mind a higher minimum wage, they must believe that they can pass the higher labour cost on to consumers anyway.

The counter-argument to this would be to say that a great proportion of the number of people on the minimum wage are secondary earners. However, if this is the case then there is no equity reason to have a minimum wage, making it sort of pointless.

Another counter-argument could be that, if the increase in the minimum wage increases output, as we found it could in the previous post, then this would counter the inflationary impact. This could be a good point, ultimately it would be good if we had some numbers to back it up. My feeling is that the general impact of an increase in the minimum wage would be to further drive inflation.

So as dpfdpf pointed out we have inflation as a potential problem from the minimum wage increase. Any others?

I pointed out to Tane first at Not PC and second at his The Standard the following paper to comment on, such as to refute its findings and he hasn’t. I think that he realised that minimum wage is bad for the employment rate of minors.


“I think that he realised that minimum wage is bad for the employment rate of minors”

In a sense this makes sense. Think of it this way, firms hire labour based on their expectation of the marginal value of that labour. If they believe that youth workers have a lower marginal product, then for the same wage they would rather hire an adult worker.

Now we could have an increase in the minimum wage which increase total employment but decreases youth employment if the higher wage increases the supply of adult workers. In this case we would have changed the firms marginal cost curve in such a way that they will hire more staff in order to profit maximise, but the increase in the supply of adult workers would exceed the increase in equilibrium employment, implying that youth employment is lower.

This could help explain why cross-sectional studies on the minimum wage are usually ambiguous about total employment, but show a decrease in youth unemployment 🙂

I think the data on negative employment effects is a little bit stronger than you imply Matt (if not conclusive). This was the most recent survey of the literature I’ve read, from the conclusion:

In sum, we view the literature – when read broadly and critically –
as largely solidifying the view that minimum wages reduce employment
of low-skilled workers, and as suggesting that the low-wage labor
market can be reasonably approximated by the neoclassical competitive

Interesting, so literature that seperates unskilled and skilled labour is more likely to find a reduction in employment than literature that just looks at the general level of employment (assuming both control for other factors).

Does this imply that skilled and unskilled labour are substitutes? If so an increase in the minimum wage will decrease the relative price of skilled labour, implying that a higher minimum wage makes skilled labour more attractive, which may possibly lead to an increase in skilled labour.

I’m also not too sure about this survey. They seem to just accept that most studies find the impact of the of the minimum wage on employment is not statistically significant, but say that since most of them have a negative sign on a non-significant coefficient it must be negative.

Fundamentally I do believe that the immediate impact of an increase in the minimum wage will be an increase in unemployment for unskilled workers. However, I don’t think I’m convinced that this will always be the case, and the impact of the minimum wage as a policy should involve more factors than its employment impact.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Add to Google
%d bloggers like this: