Academic journal article The Economic and Labour Relations Review : ELRR

The Minimum Wage Debate: Politically Correct Economics?

Academic journal article The Economic and Labour Relations Review : ELRR

The Minimum Wage Debate: Politically Correct Economics?

Article excerpt


Most economists believe that, other things equal, an increase in the minimum wage rate leads to a fall in employment. Those who supported this type of regulation usually did so on social grounds (eg. arguing that minimum wage rates provide protection for lower income families) rather than on the basis of economic analysis. Since it was believed that the unintended consequence of this form of government regulation was to create unemployment, with all its related social and economic costs, the social justification for minimum wage legislation always seemed somewhat tenuous.

Now, however, the debate has been reawakened by a series of studies arguing that an increase in the minimum wage rate has a zero or even a positive effect on employment. The best known example is Card and Krueger (1994) which looks at the employment effects on fast food outlets in New Jersey of an increase in the minimum wage rate. The study uses similar outlets in Pennsylvania, where there was no increase in the minimum wage, as a 'control'.

Before examining the Card-Krueger study it would be useful to review the various ways in which an increase in the minimum wage rate affects employment. The discussion will be divided into two subsections, one covering the microeconomic and the other dealing with the macroeconomic effects of an increase in minimum wages. The first subsection will be further split into discussions of the impact of the increase in minimum wage rates on the demand for labour and an analysis of its impact on the supply of labour.

Traversing these preliminaries will allow us to consider how the conclusions obtained by Card and Krueger (1994) differ from those suggested by economic theory and many earlier studies and to subject their techniques and conclusions to a critical scrutiny. A final section is necessary to consider the implications of this discussion for Australia because we do not have simple minimum wage legislation.

Minimum Wage Rates--Microeconomic Effects (1)

We will assume that a firm is producing its output with a number of factor inputs. Some of these are different classes of labour and one of these classes ('unskilled labour') is priced at the minimum wage. We will assume that the minimum wage rate is effective ie. the market clearing wage rate for this class of labour is not above the minimum wage rate. If it is above the minimum wage rate, an increase in the latter will not change employment. In such circumstances, there is no need for minimum wage requirements and it is unlikely that this case has any empirical relevance.

An increase in the cost of one class of labour will reduce the firm's demand for it in two ways. First, the substitution effect leads the firm to substitute other factors of production for the class of labour in question. Secondly, the scale effect leads the firm to reduce its level of production, thereby reducing its factor demands. The elasticity of the demand for unskilled labour is greater the lower the share of that form of labour in total cost and the higher the elasticity of demand for the final product

The size of the substitution effect will depend on the substitutability in the production process of other factors for the one in question. If, for example, skilled labour can be easily substituted for unskilled, the skilled labour being more productive and now not as relatively costly, substitution will occur. In some cases, minimum wage legislation appears to have the objective of protecting the jobs of other workers by ensuring that they are not replaced by slightly less skilled but cheaper workers. For example, in Australia this objective appears to play a role in union support for minimum youth wage rates. However, it seems more likely that capital will be substituted for unskilled labour.

It is not impossible that the demand for some of the other factors will actually be increased by the increase in the minimum wage rate although the negative scale effect will often outweigh positive substitution effects (Hamermesh 1986, p. …

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