Should We Abolish the Minimum Wage

The minimum wage is a one-size-fits-all redistributive policy that seeks to target the worst-off in society by ensuring that they have a basic standard of living. It is a reaction to the exploitation of firms under the free-market mechanism, whereby the ‘invisible hand’ fails to reach an equilibrium wage rate that ensures a reasonable standard of living. Yet, the minimum wage’s ability to meet its purpose is increasingly under scrutiny, as many see it as a tokenistic gesture, a cause of job loss, as well as pointing to viable alternatives. In what follows, it will be argued that the minimum wage should not be abolished for it is a good redistributive policy, though not perfect. Furthermore, this redistribution will not come at the cost of significantly higher employment or inflation, because the conventionally assumed trade-offs with employment and inflation exist only to a very small degree. This essay will primarily focus on developed countries, where the informal sector, in which it is difficult to implement a fixed minimum wage, is smaller than developing countries.

It has been traditionally argued that the national minimum wage (NMW) has a trade-off effect with employment [figure 1]. Classical economics suggests that the NMW tends to increase the cost of production for firms. Since the wage paid by firms is higher than what they would otherwise pay, given their labour demand schedule, firms would reduce the number of workers hired and hence decrease overall employment. In the long term, higher wage bills may cause firms to either automate existing production or outsource these jobs abroad to low-wage countries, both of which would reduce employment further. Therefore, some oppose the NMW on grounds of threats to employment, such that attempts to help the underprivileged is counter-productive when they lose a job. Instead of receiving low pay without NMW, some workers would lose their job under NMW and receive no pay.

[Figure 1]

However, it is important to note that the classical model and its predictions are underpinned by the assumption of a perfectly competitive market. In the last few decades, a growing number of industries have become dominated by a decreasing number of firms. Evidently, in 2017, the number of publicly traded companies in the US was half that of 1997 (Bloomberg - Are you a robot?, 2018). Yet with fewer firms in 2017, the US GDP is now triple that of 1997, reflecting higher concentration in the market. Manning (2020), in a review of literature on monopsony power, found significant evidence of rising levels of monopsony power in multiple labour markets. This phenomenon has given large firms monopsonist powers, which is further amplified by workers’ loss of the power to effectively collective bargain, as many trade unions have been dismantled and trade union membership has been falling. Evidently, union membership in the UK decreased dramatically from 55.4% in 1980 to less than 30% in 2004 (Phelan, 2007). A monopsony, or a “buyer's monopoly”, is when one buyer dominates the market, forcing down prices as they are the sole buyer of goods, services and labour. A good example of this would be an industrial town, where one big company acts as a main hirer of labour. The market power of monopsonist firms give them wage-setting capabilities, such that wages are set below the rate under perfect competition. Even if fully monopsonist firms do not exist, and the market is shared by a few dominating industries, there may be collusion, such that firms attain monopsonist powers in practice. As Mike Konczal of the Roosevelt Institute has pointed out, Silicon Valley tech firms are able to get away with paying less by agreeing not to poach one another’s employees (Konczal, 2021).

To illustrate the implications of monopsony in the labour market for the minimum wage, we can use the following model. Monopsony firms with wage setting capabilities maximize profits by picking the level of wage and employment that gives them maximum profits. Referring to figure 2, rather than picking the equilibrium output under perfect competition (e*), they maximize profit by picking a level of employment (em) where the Marginal Return of Production (MRP) = Marginal Cost of Labour (MCL), such that marginal revenue equals marginal cost. At this point, marginal revenue is greater than average costs (ACL), allowing more profits to be made. In a monopsony, the introduction of the minimum wage forces the firm to at least pay NMW. Given that they need to pay at least NMW, the profit maximizing level of employment is now eNMW, which is higher than before. The monopsony argument is contrary to what classical economics would suggest, in that an increase in the minimum wage does not necessarily lead to a decrease in employment. This explains the empirical observations of the relationship between wage and employment in practice. A meta-analysis of 1451 studies, conducted by the UK government, calculated an average wage-employment elasticity of -0.013 (UK Low Pay Commission, 2016). A percentage increase in the minimum wage hence decreases employment by a very small amount, which the authors considered negligible. Another research conducted by the Institute of Fiscal Studies in the UK, showed that a 10% increase in wages results in a 0.05%-0.1% decrease in employment (Institute for Fiscal Studies, 2019). This reflects a very weak relationship between minimum wage rate and employment, suggesting that the monopsony model is a better characterisation of labour markets than the conventional one posited by classical economics. Therefore, the NMW should not be abolished, as the perceived tradeoff between wages and employment is small such that it is negligible, meaning that it is not counter-productive.

[Figure 2]

Even if there is no trade-off between a higher minimum wage and unemployment, the NMW might still have negative consequences for society and the poor because of the trade-off between wages and inflation. An increase in the minimum wage is expected to increase costs for firms, shifting the AS curve to the left. To offset this increase in cost and maintain profit margins, firms would increase prices. This would result in wage-push inflation, which has a negative impact on all consumers because it erodes their purchasing power. In fact, the poor might also bear the brunt of the inflation because they spend much of their income on consumption goods. Hence, the inflationary consequences of the NMW could leave everyone in society worse-off and also negatively affect the poor.

Whilst it is appealing to argue for wage-push inflation and in turn against the NMW, the empirical evidence in support of this phenomenon is weak. In fact, the minimum wage has minimal association with inflation historically. In a survey conducted in the US from 1978 to 2015, Macdonald & Nilsson (2016) found that a 10% increase in the minimum wage is only associated with a price increase of 0.36% (Upjohn Institute, 2016). Similarly, another meta-analysis of over 30 reports in the US demonstrated that a 10% increase in wages was only associated with a 4% increase in food prices and an overall price level increase of 0.4% (Lemos, 2008). Once again, the evidence argues against there being a significant trade-off between wages and the price level. This could be explained by the fact that in the UK, only 7% of workers are paid the minimum wage, limiting the impact raising the minimum wage would have on prices. Even if there is slight inflation as a result of the minimum wage, this would be more than offset for lower workers by the rise in purchasing power caused by higher wages. Overall, the minimum wage should not be abolished on the assumption of a trade-off with inflation, which is proven to be very minimal.

It is worth evaluating if the minimum wage achieves its goal of successfully redistributing income to those at the bottom of the income ladder, in order to understand if it should be abolished. One major concern with the minimum wage is that it may be a tokenistic gesture that is inefficient at tackling the problem of low standards of living because it is stagnant. Once implemented, it does not increase over time or keep up with inflation, meaning that the purchasing power of low-income workers would still fall. In particular, the minimum wage has not increased in the US for over 11 years. There are two reasons why this may be so: complacency and weak trade unions. Firstly, the introduction of a national/comprehensive minimum wage increases the sense of complacency and pacifies the public. Since many people would believe that something has already been done for the poor and further action is unnecessary, there might be increased resistance to proposals to adjust the minimum wage. Secondly, the demise of trade unions in the 1980s during the Regan-Thatcher era meant that workers lost a large source of power both in the workforce and in the political arena to demand for higher minimum wages. If the minimum wage is stagnant, it could also hurt the poor even further as this would create an unemployment trap and cycle of dependency. The minimum wage would simply not be high enough to incentivise people to come off welfare allowances and join the workforce.

However, the minimum wage being stagnant in the US does not represent an inherent flaw in the minimum wage itself, but simply in the specific character of the legislation that formulated it. The minimum wage can be made flexible if there is a mechanism that allows it to be automatically adjusted with inflation on an annual basis, such that each increase would not have to go through a legislative body and risk being politicised. Moreover, complacency and resistance to minimum wage adjustments differs from country to country, and should not be the basis for the abolishment of the minimum wage. Evidently, in the UK, where attitudes towards the welfare state is much more accepting than the US, the minimum wage rose by 4 times the rate of inflation in 2019 (Partington, 2019). Even the Conservative party, that was originally hostile towards the minimum wage, has grown to embrace it as they seek to present themselves as the party of the working class. Hence, stagnant minimum wages have little to do with the inherent nature of the policy itself, but its practical implementation designed by legislators and social attitudes. Thus, minimum wages can be successfully designed in a way to achieve its goal of redistribution, meaning that the above factor should not be a reason to abolish the minimum wage.

Lastly, it can be argued that the minimum wage incentivises the relocation of firms since the minimum wage acts as another layer of government regulation. Evidently, the US lost 3.7 million jobs to China, accounting for ¾ of manufacturing job losses (Autor, Dorn and Hanson, 2016). This is because of lower wages in China, as well as looser regulations. Minimum wage and regulations tend to undermine states that impose them, as under international anarchy, there is no supranational authority to impose said policies worldwide. When implemented in isolation, minimum wage policies would appear to simply benefit other countries at one’s own expense.

However, it is important to note that this criticism does not apply to the minimum wages, because the minimum wage tends to affect those in service industries. By nature, such industries are non-tradable and these jobs are unlikely to be able to be transferred or outsourced abroad. Industrial or manufacturing jobs in the US, which can and have been easily outsourced, are generally paid above the minimum wage, meaning that they would be unaffected by the policy. Hence, the loss of jobs from the US to China cannot be blamed on the minimum wage, but instead factors such as globalisation and technological advances. Thus, the minimum wage should not be abolished on such grounds.

At the inception of the minimum wage, it was highly controversial, dividing politicians and economists. However, it has dispelled the concerns over trade-offs with employment and inflation and has since become a widely accepted means to improve the standard of living for the lower classes. It is clear that the minimum wage, whilst not being the perfect solution, is a tool the welfare state cannot spare.

References

• Autor, D., Dorn, D. and Hanson, G., 2016. The China Shock: Learning from Labor-Market Adjustment to Large Changes in Trade. Annual Review of Economics, [online] 8(1), pp.205-240. Available at: <https://www.annualreviews.org/doi/full/10.1146/annurev-economics-080315-015041>.

• Bloomberg.com. 2018. Bloomberg - Are you a robot?. [online] Available at: <https://www.bloomberg.com/opinion/articles/2018-04-09/where-have-all-the-u-s-public-companies-gone>.

• Institute for Fiscal Studies, 2019. What do we really know about the employment effects of the UK’s National Minimum Wage?. Economic and Social Research Council, p.21.

• Konczal, M., 2021. The Silicon Valley Labor Scandals Prove Minimum Wage Hikes Don't Cost Jobs. [online] The New Republic. Available at: <https://newrepublic.com/article/116608/silicon-valley-labor-scandals-prove-minimum-wage-hikes-dont-cost-jobs>.

• Lemos, S., 2008. A Survey of the Effects of the Minimum Wage on Prices.. University of Leicester.

• Manning, A., 2020. Monopsony in labor markets: a review. Industrial and Labor Relations Review. The London School of Economics and Political Science.

• Partington, R., 2019. UK minimum wage to rise by four times rate of inflation. [online] the Guardian. Available at: <https://www.theguardian.com/society/2019/dec/31/boris-johnson-to-raise-minimum-wages-by-four-times-inflation>.

• Phelan, C., 2007. Trade Union Revitalisation : Trends and Prospects in 34 Countries. Peter Lang, p.147.

• UK Low Pay Commission, 2016. The impact of the National Minimum Wage on employment: a meta-analysis. RAND Europe.

• Upjohn Institute, 2016. The Effects of Increasing the Minimum Wage on Prices: Analyzing the Incidence of Policy Design and Context. California State University, pp.5,20.