How to introduce a minimum wage without raising unemployment
A quick summary of what theory says should happen might help. In theory, the market price is the price that ‘clears the market’: everybody who would be willing to sell at that price finds a buyer and everyone who would buy at that price can do so. At a price higher than the market price, more sellers would enter the market, while more buyers would be deterred, so ‘the market would not clear’: there would be an excess of supply relative to demand. In labour market terms, that means that there would be more would be more workers and fewer jobs, which means unemployment.
Looking at it from a different perspective, economic theory tells us that wages should equal the marginal product of the worker. If I can produce £6/hour worth of value to your company, it is worth you paying me £5.95/hour to work for you, but not £6.05/hour. Thus, a minimum wage set higher than my marginal productivity does not increase my wages; it just renders me unemployable.
So how come millions of workers with low productivity did not swell the ranks of the unemployed as a result of introducing the minimum wage? There are three possible reasons that come to mind.
The first is the stickiness of labour markets that results from other government intervention. In the short-term, it may be cheaper to increase a person’s wages to a level that is higher than their productivity than to make them redundant. This is particularly true if they have been in the same job for a long time: redundancy payments would be high, while they may be expected to retire or move on soon. So in the short term the impact may be softened.
Secondly, if the minimum price floor is set below the market price, it will not affect supply or demand (or, for that matter, wages!). If, when it was introduced, very few workers in the UK had a marginal productivity of below £3.52/hour, it would not have had a discernable impact: it would, in fact, have been nothing more than a hollow gesture intended to burnish the socialist credentials of the New Labour government (imagine!).
Thirdly, as welfare economics teaches us, what matters to a person considering changing their employment is the next best alternative. In the case of the UK, the real minimum wage is not necessarily the legal minimum, but the amount that one would receive in benefits if one were not working. Housing Benefit alone can be worth around £5 or £6 an hour. Thus, for the poorest and least-skilled in our society, working only ceases to be the next best alternative once the wage they can command rises above the level of out-of-work benefits.
It is not beyond imagination that the Labour government knew this, and deliberately introduced the minimum wage at a low level as a Trojan horse, enabling them to prove that it caused no harm before ramping it up to levels that would impact upon employment. One needs to bear in mind that the Labour government helped create a spectacular economic bubble during their time in government. With the amount of deficit spending and monetary expansion they indulged in, the real question should be why we didn’t have full employment.
Of course, all booms turn to bust. There are now 2.5 million unemployed in the UK, yet the government still refuses to abolish the minimum wage or even to consider less controversial options such scrapping it for under 25s or freezing the rate. Don’t expect those unemployment figures to fall quickly.