Evaluating the Minimum wage

In 1998, the Labour government introduced the minimum wage in the UK, one year following their election victory. Since then, the minimum wage has been used as a bargaining tool by parties across the political spectrum to gain votes. In 2015, the Conservatives introduced the National Living wage, thereby enacting the largest percentage increase to the minimum wage in British history. This raises the question of whether the minimum wage has a positive effect on the economy. Proponents argue that the minimum wage curbs the monopsonistic power of large firms, alongside reducing government top-up benefits. Whilst the latter may hold, the minimum wage has a significant effect on youth workers, price levels and is detrimental for small businesses. As with all economic policies, there are many trade-offs to a minimum wage, with its negative effects depending on the state of the market and the level of the minimum wage itself.

Those in favour of the minimum wage claim that the policy reduces the monopsony power of large companies. This is because large firms can pay wages below the market equilibrium, as in many cases they are one of the only employers of labour. Just as is the case with monopolies who can drive their prices far higher than the market equilibrium, monopsonies can set the price of labour below the equilibrium salary. In this way, the minimum wages should redistribute money from the buyers of labour to the employees. With this said, this is far from the case for low-skilled workers. The abilities of low-skilled workers are transferrable between many professions, thousands of jobs and employers. Entry roles at firms from a range of industries such as Amazon and Unilever demand little experience from their employees. Therefore, the argument that the minimum wage curbs monopsony power is a stretch at best, with the effect of the minimum wage likely to only exacerbate this problem at worst.

Furthermore, proponents of the minimum wage argue that the minimum wage can reduce government benefits. As tax credits are used to top-up the salaries of those living below a certain threshold, a minimum wage is said to reduce the need for these transfer payments, as those earning the minimum wage would no longer need to claim benefits as they would be earning more money. However, this fails to reconcile that a minimum wage at a level too high would result in high levels of unemployment, especially in regions of a country with already low wages and high unemployment levels. This could drive up unemployment levels, thereby increasing government benefits. Therefore, minimum wages do not necessarily reduce welfare payments, as the effects of the minimum wage depend on the needs of a region.

Contrarily, the minimum wage hurts youth workers. For the former, minimum wages prevent youth workers from gaining a job. This is because firms become increasingly reluctant to hire workers with little/no experience, as they can hire a worker with large amounts of experience for the same cost. This was witnessed in the US during the 1960s, as the minimum wage increased by 30% over two years. Whilst youth unemployment was at a constant rate during the previous decade, this higher minimum wage led to youth unemployment increasing from 8% to 12% – an increase of 50%. The minimum wage has had an even worse effect on the young generation of ethnic minorities, as following a 100% increase in the minimum wage from $0.75 to $1.50 in 1956, the unemployment rate amongst African Americans skyrocketed from 10% to 24%. As a result, minimum wages make it harder for the younger generation to find work and gain experience, as it becomes more expensive to hire them.

At the same time, increases to the minimum wage have been linked to higher rates of inflation. This is as firms need to offset their higher labour costs by cutting into company profits and raising prices on consumers. In 2013, a study on the 25% minimum wage increase in California found that almost all of the higher labour costs were passed onto consumers in the form of higher prices; the latter of which ironically hurt low-income workers the most. Another recent study showed that McDonald’s passed on almost 100% of higher minimum wages through higher food prices, thereby reducing the workers ‘real’ wage gains once the higher cost of living is taken into account. Therefore, the minimum wage can lead to higher prices, thereby hurting those who the policy intends to help the most.

Finally, minimum wages increase the extent of monopoly power within a market by reducing the number of small businesses. This is because small firms are priced out of the market, as they are unable to pay higher salaries demanded by minimum wages. Small businesses already struggle much more than bigger firms, as most fail to benefit from economies of scale, whilst struggling more in recessions due to lower bank credit. As a result, consumers may suffer from higher prices due to a lack of competition. This explains why many large firms such as Amazon, are in favour of raising the minimum wage, as they directly benefit from less competition. Thus, minimum wages can be detrimental for small businesses as they price them out of the market due to it becoming more expensive to retain workers, thereby increasing the monopoly power of larger firms.

Ultimately, minimum wages can have beneficial and adverse effects on an economy. Whilst they may reduce monopsony power for large firms and curb government transfer payments, minimum wages make it harder for youth workers to find employment and can lead to higher inflation, through passed-on costs and reduced competition within a market. It would be more effective to focus on measures that reduce the cost of living, thereby focusing on reforms that have a reduced risk of unintended consequences.