Minimum wage Totally Explained

Everything about Minimum Wage totally explained

A minimum wage is the lowest hourly, daily or monthly wage that employers may legally pay to employees or workers. First enacted in Australia and New Zealand in the late nineteenth century, minimum wage laws are now enforced in more than 90% of all countries.
   Many supporters of the minimum wage assert that it's a matter of ethics and social justice that helps reduce exploitation and ensures workers can afford what are considered to be basic necessities. The typical minimum wage worker is in a middle-income household.
   In Australia, on 14 December 2005, the Australian Fair Pay Commission was established under the Workplace Relations Amendment (WorkChoices) Act 2005. It is the responsibility of the commission to adjust the standard federal minimum wage, replacing the role of the Australian Industrial Relations Commission that took submissions from a variety of sources to determine appropriate minimum wages. As of 2007, an unskilled labourer earns $13.74 per hour or $522.12 per week. New Zealand In New Zealand the Government has decided to raise the minimum wage and abolish the youth wage (16 - 17 years olds) from April 1 2008. The minimum wage will rise from $11.25 to $12 per hour. That’s $96 for an eight hour day, or $480 for a 40 hour week.
   From 1 April 2008, the training wage will rise to $9.60 an hour before tax. That’s $76.80 for an eight hour day, and $384 for a 40 hour week. The training wage applies to people doing recognised industry training involving at least 60 credits a year.

Economics of the minimum wage

Economic theory analyzes the effects of minimum wages within the context of labor markets (c.f. labor economics). In a labor market, workers supply their labor, which is sold for wages, and employers demand labor.
The neoclassical economic argument views the labor market as perfectly competitive. In perfectly competitive markets, the market price settles to the marginal value of the product. Therefore, under the perfect competition assumption, in the absence of a minimum wage, workers are paid their marginal value. As is the case with all (binding) price floors above the equilibrium, minimum wage laws are predicted to result in more people being willing to offer their labor for hire, but fewer employers wishing to hire labor. The result is a surplus of labor, or, in this case, unemployment.

Supply of labor curve

The amount of labor that workers supply is generally considered to be positively related to the nominal wage. Economists graph this relationship with the wage on the vertical axis and the quantity of labor supplied on the horizontal axis. The supply of labor curve then is upward sloping, and is shown as a line moving up and to the right.
The upward sloping labor supply curve results from the fact that, as wages rise, people in the labor force are incented to spend less time in leisure and more time working while people outside the labor force are incented to join the labor force. As wages rise, the cost of spending time in leisure and the cost of not being a labor force participant rises.

Demand for labor curve

The amount of labor demanded by firms is generally assumed to be negatively related to the nominal wage; as wages increase, firms demand less labor. As with the supply of labor curve, this relationship is often depicted on a graph with wages represented on the vertical axis, and the quantity of labor demanded on the horizontal axis. The demand for labor curve is downward sloping, and is depicted as a line moving down and to the right on a graph.
A firm's cost is a function of the wage rate. As the wage rate rises, it becomes more expensive for firms to hire workers and so firms hire fewer workers.

Supply and demand for labour

Combining the demand and supply curves for labor allows us to examine the effect of a minimum wage. We will start by assuming that the supply and demand curves for labor won't change as a result of raising the minimum wage. This may be an incorrect assumption since jobs this low on the demand curve may be so integral to a business' function that they won't simply disappear because the business has to pay more to hire people for those positions.
The point at which the demand for labor curve and the supply of labor curve intersect is the labor market equilibrium. At the equilibrium, the number of people seeking jobs (the quantity supplied of labor) equals the number of jobs available (the quantity demanded of labor). If the wage rate rises above the equilibrium wage as shown in this chart, then the number of people seeking jobs would seem to exceed the number of jobs available. If the number of jobs is thus negatively affected, there would be fewer jobs available, and would theoretically lead to unemployment. Hence, in the absence of government intervention, competition among workers for the limited number of jobs would cause wages to fall until the wage rate reached the equilibrium. A minimum wage prevents wages from falling.

Standard theory criticism

Gary Fields, Professor of Labor Economics and Economics at Cornell University, argues that the standard "textbook model" for the minimum wage is "ambiguous", and that the standard theoretical arguments incorrectly measure only a one-sector market. Fields says a two-sector market, where "the self-employed, service workers, and farm workers are typically excluded from minimum-wage coverage… [andwith] one sector with minimum-wage coverage and the other without it [andpossible mobility between the two]," is the basis for better analysis. Through this model, Fields shows the typical theoretical argument to be ambiguous and says "the predictions derived from the textbook model definitely don't carry over to the two-sector case. Therefore, since a non-covered sector exists nearly everywhere, the predictions of the textbook model simply can't be relied on."
An alternate view of the labor market has low-wage labor markets characterized as monopsonistic competition wherein buyers (employers) have significantly more market power than do sellers (workers). Such a case is a type of market failure and results in workers being paid less than their marginal value. Under the monopsonistic assumption, an appropriately set minimum wage could increase both wages and employment, with the optimal level being equal to the marginal productivity of labor. This view emphasizes the role of minimum wages as a market regulation policy akin to antitrust policies, as opposed to an illusory "free lunch" for low-wage workers. Detractors point out that no collusion between employers to keep wages low has ever been demonstrated, asserting that in most labor markets, demand meets supply, and it's only minimum wage laws and other market interference which cause the imbalance. However collusion isn't a pre-requisite for market power; segmented markets, information costs, imperfect mobility and the 'personal' element of labor markets all represent movements away from the idealized perfectly competitive labor market.

Debate

Support Supporters of the minimum wage claim it has these effects:

Helps small businesses as well as big businesses.
Increases the standard of living for the poorest and most vulnerable class in society and raises average.
Motivates and encourages employee to work harder. (Contrast with welfare transfer payments.)
Does not have budget consequence on government. "Neither taxes nor public sector borrowing requirements rise." (Contrast with negative income taxes such as the EITC.), and so doesn't put any extra pressure on welfare systems.
Businesses' annual and average payrolls grow faster.
Employment grows more quickly when minimum wage is increased.

Opposition Opponents of the minimum wage claim it has these effects:

Hurts small business more than large business.

Lowers competitiveness

Reduces quantity demanded of workers. This may manifest itself through a reduction in the number of hours worked by individuals, or through a reduction in the number of jobs.

Reduces profit margins of business owners employing minimum wage workers, thus encouraging a move to businesses that don't employ low-skill workers.

Businesses try to compensate for the decrease in profit by simply raising the prices of the goods being sold thus causing inflation and increasing the costs of goods and services produced.

Increases prices for customers of employers of minimum wage workers, which would pass through to the general price level, which disproportionately affects the prices that poor people pay for goods and services.

Does not improve the situation of those in poverty. "Will have only negative effects on the distribution of economic justice. Minimum-wage legislation, by its very nature, benefits some at the expense of the least experienced, least productive, and poorest workers."

Is a limit on the freedom of both employers and employees. Minimum wage laws make it illegal for employers to pay workers less than the minimum wage. This also prevents workers from being made to provide labor or services for less than the minimum. For example, during the apartheid era in South Africa, white trade unions lobbied for the introduction of minimum wage laws so as to exclude black workers from the labor market. By preventing black workers from selling their labor for less than white workers, the black workers were prevented from competing for jobs held by whites.

Businesses spend less on training their employees.

Increase in unemployment.

Decreases human capital by encouraging people to enter the job market instead of pursuing further education.

Excludes low cost competitors from labour markets, hampers firms in reducing wage costs during trade downturns (etc.), generates various industrial-economic inefficiencies as well as unemployment, poverty, and price rises, and generally dysfunctions as basically a special form of political-economic protectionism – the equivalent or analogue of such things as tariff barriers to low cost imports.

Debate over consequences

Equivalence to a tax and subsidy

As argued by former Council of Economic Advisors Chairman Gregory Mankiw, a minimum wage is equivalent to:

A wage subsidy for unskilled workers, paid for by

A tax on employers who hire unskilled workers. The first part of the policy provides some benefit to low wage workers while the second part creates more unemployment among low wage workers. This is why the minimum wage is often criticized as a self-contradictory policy. Others argue the small decrease in employment is offset by the increased benefit to workers.

Empirical studies

A classical economics analysis of supply and demand implies that by mandating a price floor above the equilibrium wage, minimum wage laws should cause unemployment. This is because a greater number of workers are willing to work at the higher wage while a smaller numbers of jobs will be available at the higher wage. Companies can be more selective in those whom they employ thus the least skilled and inexperienced will typically be excluded.
   However, there are many other variables that can complicate the issue such as monopsony in the labour market, whereby the individual employer has some market power in determining wages paid. Thus it's at least theoretically possible that the minimum wage may boost employment. Though single employer market power is unlikely to exist in most labour markets in the sense of the traditional 'company town,' asymmetric information, imperfect mobility, and the 'personal' element of the labour transaction give some degree of wage-setting power to most firms.
   Economists disagree as to the measurable impact of minimum wages in the 'real world'. This disagreement usually takes the form of competing empirical tests of the elasticities of demand and supply in labor markets and the degree to which markets differ from the efficiency that models of perfect competition predict.
   A 2000 survey by Dan Fuller and Doris Geide-Stevenson reports that of a sample of 308 American Economic Association economists, 45.6% fully agreed with the statement, "a minimum wage increases unemployment among young and unskilled workers", 27.9% agreed with provisos, and 26.5% disagreed. The authors of this study also reweighted data from a 1990 sample to show that at that time 62.4% of academic economists agreed with the statement above, while 19.5% agreed with provisos and 17.5% disagreed.
   A similar survey in 2006 by Robert Whaples polled PhD members of the American Economic Association. Whaples found that 37.7% of respondants supported an increase in the minimum wage while 46.8% wanted it completely eliminated.
   In the debate about minimum wage it's rarely mentioned by how much the quantity of labor demanded may fall if the minimum wage is raised. Research papers by the Employment Policies Institute and by the National Center for Policy Analysis claim that increases of 10% in the minimum wage may reduce demand hours worked at the minimum wage by around 1% or 2% depending on circumstances.
   Some research suggests that the unemployment effects of small minimum wage increases are dominated by other factors. (External Link

) In Florida, where voters approved an increase in 2004, a follow-up comprehensive study confirms a strong economy with increased employment above previous years in Florida and better than in the U.S. as a whole. : “The Florida Minimum Wage After One Year.” http://www.risep-fiu.org/reports/Florida_Minimum_Wage_Report.pdf
According to a claim by the Mackinac Center for Public Policy, the passage of the first Federal mandated minimum wage in the United States in 1938 led to an estimated 500,000 blacks losing their jobs via replacement by higher skilled and more educated white laborers. Milton Friedman, 1976 Nobel Prize winner in Economics, called the minimum wage one of the most "anti-negro laws" for what he saw as its adverse effect on black employment.
Today, the International Labour Organization (ILO) don't consider that the minimum wage can be directly linked to unemployment in countries which have suffered job losses. Although strongly opposed by both the business community and the Conservative Party when introduced in 1999, the minimum wage introduced in the UK is no longer controversial and the Conservatives reversed their opposition in 2000. A review of its effects found no discernible impact on pay levels.

Analysis	Source	Comparison	Prop. Effects on Wage	Prop Effects on Employment
New Jersey vs. Pennsylvania	New Jersey MW Increased to $5.05 April 1992	Fast Food Joints Across States	0.11*	0.04
Texas Fast Food Joints	FED MW increased to $4.25 April 1991	High- and Low-Wage Restaurants	0.08*	0.2*
California Teenagers	California MW increase to $4.25 July 1988	Teenagers in California	0.1*	0.12
Teenagers Across States	Fed MW increase to $4.25 1989 - 92	Cross States	0.08*	0.00
Low Wage Workers Across States	FED MW increase to $4.25	Across States	0.07*	0.02

MW - Minimum Wage FED - Federal

indicates significance at 5%

Card and Krueger

The laws of demand and supply predict that an increase in the minimum wage will reduce employment.
   In 1992, the Minimum wage in New Jersey increased by 18% while the adjacent state of Pennsylvania remained at $4.25. Card & Krueger gathered information on fast food restaurants that lay very close to the borders of Pennsylvania and New Jersey in an attempt to see what this effect had on employment within New Jersey. Classical economic would have concluded that relative employment should have decreased in New Jersey. Card and Krueger asked employers whether they intended to lay off workers in response to the increased minimum wage. Based on the employers' responses, the authors concluded that the increase in the minimum wage had no significant impact on employers' intentions to lay off employees.
   The more common debate is on changes to minimum wages. This unified view was challenged by 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. They assume that the demand for low-wage workers is inelastic. Noteworthy is that these results don't refute the theory underlying the prediction that a minimum wage reduces employment. Rather, the results suggest that the effect predicted by the theory may, in some instances, be small enough as to be statistically zero.
   Critics, however, argue that their research was flawed. 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 make no change in their employment. Subsequent attempts to verify the claims requested payroll cards from employers to verify employment, and found that the minimum wage increases were followed by decreases in employment. On the other hand, an assessment of data collected and analyzed by David Neumark and William Wascher didn't initially contradict the Card/Krueger results, but in a later edited version they found that the same general sample set did increase unemployment. The 18.8% wage hike resulted in "[statistically] insignificant—although almost always negative" employment effects.
   Another possible explanation for why the current minimum wage laws may not affect unemployment in the United States is that the minimum wage is set close to the equilibrium point for low and unskilled workers. Thus absent the minimum wage law unskilled workers would be paid approximately the same amount. However, an increase above this equilibrium point could likely bring about increased unemployment for the low and unskilled workers.

Reaction to Card and Krueger

Since the introduction of a national minimum wage in the UK in 1999, its effects on employment were subject to extensive research and observation by the Low Pay Commission. The Low Pay Commission found that, rather than make employees redundant, employers have reduced their rate of hiring, reduced staff hours, increased prices, and have found ways to cause current workers to be more productive (especially service companies). Neither trade unions nor employer organizations contest the minimum wage, although the latter had especially done so heavily until 1999.
   Some leading economists such as Greg Mankiw and Paul Krugman, don't accept the Card/Krueger results, while many leading economists accept the Card/Krueger results, The Joint Economic Committee of the United States Congress has been critical of Card and Krueger's work. They note that it conflicts with other studies done on minimum wage laws within the United States over the past 50 years. According to the JEC, minimum wage laws have been shown to cause large amounts of unemployment, especially among low-income, unskilled, black, and teenaged populations, as well as cause a host of other mal-effects, such as higher turnover, less training, and fewer fringe benefits.
   According to economists Donald Deere (Texas A&M), Kevin Murphy (University of Chicago), and Finis Weltch (Texas A&M), Card and Krueger's conclusions are contradicted by "common sense and past research".
   They conclude that:

Minimum wage alternatives

Some critics of the minimum wage argue that a negative income tax or earned income tax credit benefits a broader population of low wage earners, and society as a whole bears the cost. In this view, this is more economically efficient because a low tax rate on the broader economy causes less deadweight loss than a high tax rate on a small section of the economy. The ability of the earned income tax credit to deliver a larger monetary benefit to poor workers at a lower cost to society was recently documented in a report by the Congressional Budget Office.(External Link

) Lewis F. Abbott argues that employing companies are economic organizations not charities or welfare agencies and that national minimum wage fixing is a comparatively inefficient, costly, and dysfunctional method of raising the living standards of poorer households. It is much more practical and cost-effective for governments to seek to:

maximize opportunities for work at whatever the going market rate for jobs (although virtually all full-time jobs pay more than the dole-money alternative, and even comparatively low-grade jobs offer valuable work experience and opportunities for advancement, etc.).

top-up low wages with earned income tax credit or other direct cash subsidies if necessary; and

save money in other areas -- for example, cut purely social status-based welfare benefit payments to persons who don't require them, reduce monetary inflation, and remove various artificial political additions to basic living costs which necessitate income subsidies in the first place (for example regressive indirect taxes, tariffs on cheap food and clothing imports, and dear housing policies).Further Information

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