The Effect of the Minimum Wage Has on Unemployment

David Metcalf has concluded that the implementation of the minimum wage appears to have had no negative impact upon Employment. Critically examine the possible explanations for this outcome.

The minimum wage was implemented and became law on the 1st April 1999 this helped prevent unfair low pay and “levelled the playing field” (http://www.businesslink.gov.uk/bdotg/action/layer?topicId=1074402393) for employers as companies could compete on quality of goods rather than setting a reduced price based on low pay. It applies to most workers and sets hourly rates below where pay is not allowed to decrease; these rates are recommended by the Low Pay Commission (LPC). At first the adult rate was set at Ð'Ј3.60 per hour for adults in the first 6 months of their job with sufficient training, there was also a lower youth rate of Ð'Ј3.00 per hour for those aged 18 вЂ" 21.(Stuart p5) Presently the minimum wage stands at Ð'Ј5.52 per hour for ages 22 and over and Ð'Ј4.60 aged 18-21. (http://www.is4profit.com/business-advice/employment/minimum-wage-and-statutory-pay-obligations_2.html). Neo-classical economic analysis suggests that an individuals wage should equal their marginal product of labour, “as wages constitute the individuals reward for their personal contribution to output of a firm” which resembles that of perfect competition. ( Forth & O’Mahoney p4) The implementation of a minimum wage leads to a rise in wage rates for those that were previously paid unfairly which theoretically has a positive impact on employment. Therefore workers that previously got paid below the minimum wage will likely surpass their marginal product.

Figure 1 illustrates the impact of the implementation of a minimum wage, the model assumes a competitive market where homogenous workers earn W0 and then earn Wm after the minimum wage is introduced. If demand and supply measures were used to determine employment then the initial equilibrium would be at point E0 and after the implantation of the minimum wage it will be at point Em. It is clear from figure 1 that this would cause an excess supply of labour as shown by point Sm. Economically this could be caused by the substitution effect where a wage increase will decrease the hours worked due to an individuals specific level of utility or satisfaction. Therefore it is apparent that their will be an increase in unemployment as shown by Em to Sm. In theory a profit maximising firm would be likely to decrease the quantity of labour demanded especially those “whose marginal product is lower than the statutory minimum” (Forth & O’Mahoney p5). This is shown by Figure 2 where demand (D) is based on the Value of marginal product of labour (MVP).

The market determined wage rate (Wo) is replaced by the minimum wage(Wm) causing a decrease in demand of quantity of labour (Lm-Lo) resulting in firms employing fewer workers.

The perfectively competitive model of labour assumes that each firm in the industry faces the same competitive price regardless of quantity of output sold and also that each firm pays all its workers an equal wage. However by using alternative market structures such as monopsonistic competition it is apparent that a fixed wage could increase both employment and wage itself. Monopsony is a firm that faces an upward sloping supply curve of labour and in order to hire workers it must pay higher wage to provide incentive. In figure 3 assuming perfect competition, equilibrium is shown by Wpc and Lpc where demand meets supply. However in a monopsonistic market if a minimum wage was proposed the employer must raise the wage rate from Wm in order to hire more workers. If a monopsonist charged a wage rate below Wpc workers would be more inclined to work at the rate of the minimum wage as it is higher. The monopsonist, therefore, must then raise its wage rate to Wm2 in order to provide the required amount of incentive for workers. As the monopsonist must increase the wage rate the marginal cost of labour curve would also be upward sloping and lie above the supply curve (MCe). The profit maximising monopsonist would be likely to hire up to the point where the marginal cost of labour is equal to the marginal cost of marginal productivity so would set a wage at point X. This could result in an increase in wages and employment as well as providing incentive for workers.

Neo- classical theory seems to suggest that an implementation of the national minimum wage is likely to create a rise in unemployment however evidence disproves this theory. Figure 4 illustrates the unemployment rate from 1992-2005 as the National minimum wage was implemented in 1999 unemployment will only be analysed within this time period. As the graph shows, the introduction of the minimum wage did not have any significant negative effect on the rate of employment. The graph shows that since 1999 the level of unemployment has decreased proving that the Neo-classical theory of the minimum wage could be faltered. However as the national minimum wage is more likely to affect firms in the long run, as can be seen by the diagram the ages 18-24, 25-49 and 50+ seem to be at a steady constant rate of employment. Another worrying factor is the employment of teenagers aged 16 to 17, the figure shows that the unemployment rate has increased showing that the imposition of the minimum wage could have a negative effect supporting neo classical theory. An explanation of this could a rise of participants in higher education

Examination of the growth of the overall employment rate would also be useful to see whether employment has increased since the administration of the minimum wage. An example of the hotel and construction industry will be used to identify any trends in the rate of employment as shown in Figure 5. Geoff Riley mentions that general workers unions most affected by the minimum wage have claimed that employment has “continued to rise… and that a series of increase in value has little or no negative effect on employment” (Riley p1). The higher rate of pay was expected to impact lower level jobs such as those in construction, catering and in hotels where employers would have to employ fewer workers to cut costs. However as the graph shows that there is a notable, steady rise in employment of these industries since 1999 instead of a downturn which classic economic theory suggests.

David Metcalf suggests a critique that is derived from the lack of compliance of the minimum wage, it is clear to see from evidence that not everyone is protected by the minimum wage in the UK. This can be seen as important as any affects of unemployment in terms of the minimum wage are likely to be not measured properly and results would not be completely valid