Excerpt
TABLE OF CONTENTS
1. Introduction
1.1. The concept of minimum wage and living wage
1.2. Research question
2. Theoretical background of minimum wage
2.1. Labor demand and supply model
2.2. Elasticity and inelasticity of labor demand and labor supply
3. Empirical analysis
3.1. Introduction of a minimum wage in Germany
3.2. Introduction of a minimum wage in the UK
4. Policy implications
5. Summary
Bibliography
1. Introduction
Since the concept of minimum wages dates back several hundred years, to the year 1389 to be exact, it seems crucial to enlighten the modern concept by briefly discussing the history of its origin.
When the black plague, caused by a bacterium named “Yersinia pestis”, which was most likely dispersed by flees that where carried by rats, in 1348 rolled over England, between 30 and 40 percent of the total population were annihilated (Thorpe, 2014) (Cartwright, 1991). Thus, King Edward III was confronted with a demanding situation not unknown to contemporary macroeconomists. Since there was a lot of work to do, but only limited labor force available, the prices for work where getting higher, the land owners had to compete for workers, the prices for agricultural products grew and all together it led to growing inflation (Hatcher, 1994). Thus, King Edward III, who like other rich land owners was dependent on a cheap labor force to ensure his wealth, established a maximum wage. The resolution was called the “Ordinance of Labourers” (Sources of british history, 2002). Three years later it got worse for the working force; in 1351 penalties for paying more than the set rates was established in the so called “Statute of Labourers”. In 1389, this very statute was adapted and the wages were linked to the prices of food. This development led to a yet formal setting of minimum wages.
In 1604 the practice of at least paying enough that workers could afford their daily nutrition was formalized by King James I; in the beginning for workers of the textile industry. During the following centuries several approaches of minimum wages were introduced and dismissed again. The first real minimum wage, however was established in Australia in 1894: ”…the workers should have a rate of payment which would enable them to maintain themselves and their families in decent comfort ” (Macarthy , 1970).
In the same year, the first nation-wide minimum wage was established in New Zealand (Macarthy , 1970). Ever since, the debate of whether or not to establish a minimum wage is going on in many countries.
So much for the history of minimum wages. To establish the same vocabulary, we will now define “minimum wage”, and will make a clear separation to “living wage”, since these two terms are often confused. After this we will proceed with the description of our research question what will lead us to the theoretical background and our empirical analysis.
1.1. The concept of minimum wage and living wage
Minimum wage is defined as a sum of money, which is the legally smallest payment an employer has to pay a worker for his/her work; it is also defined as the smallest amount of money a worker is willing to sell his/her workforce for (Neumark & Wascher, 2014)(Oxford Reference, 2017). Supporters of the minimum wage argue that it would diminish poverty and boost moral; whereas opponents argue that it would increase poverty and unemployment. Hence these are interesting points that will be discussed in this paper.
In contrast to the minimum wage, the living wage is not a legally defined wage standard, but the minimum income needed for a worker to meet his/her needs (Alderman & Greenhouse, 2014).
1.2. Research question
Based on the topic for our group project, our research question is: Is there a need for establishing a minimum wage? Is it always true that such development often hurts the group of workers who are supposed to be benefiting from establishment of such wage standards?
Derived from these questions, our hypothesis that we want to analyze in this paper is as follows: The establishment of a minimum wage has a negative economic impact on the workers, and the country as a whole.
2. Theoretical background of minimum wage
2.1. Labor demand and supply model
Under the theoretical conditions of a perfect market, the equilibrium pay without considering minimum wage would be the result of the intersection of labor supply and demand – thus resulting in an equilibrium pay and equilibrium employment. In this intersection, the marginal return for a company to hire an additional employee will equal the marginal costs for his/her pay, which can be seen in the following figure (Mankiw, 2004):
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Figure 1: Equilibrium in labor supply and demand (Mankiw, 2004)
An increase in the demand of labor supply would shift the labor demand curve to the right, which would result in higher pay. On the opposite, like happened due to the Black Death in the UK in the fourteenth century, the labor supply was sharply reduced, and thus the wages increased, which lead King Edward III to implement a maximum wage in the UK.
If a government decides to implement a minimum wage, the resulting effects depend on the level of this minimum wage compared to the current equilibrium pay. If the new minimum wage is equal to or below the current equilibrium pay, there is no employment impact at all. In this paper, we consider the minimum wage as flooring and define the minimum wage to be above the current equilibrium pay. Thus, the resulting effects are shown in figure 2 (Mankiw, 2004):
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Figure 2: Shifted worker demand and supply after implementation of a minimum wage (Mankiw, 2004)
What happens is that the labor demand goes down to the intersection of the horizontal minimum wage line with the labor demand line (point D1). The labor supply on the other hand would increase due to the higher paid wage and is represented by the intersection between the labor supply curve and the minimum pay line (point S1). The resulting triangle which is highlighted in green between D1, S1, and the former equilibrium point of the labor demand and labor supply curves represents the additional unemployment, which is caused by the implementation of the minimum wage.
To sum up the described implications, according to the presented model above, the introduction of a minimum wage that is higher than the current equilibrium wage is expected to reduce overall employment.
2.2. Elasticity and inelasticity of labor demand and labor supply
To be more specific than in the general explanation in the previous chapter, the extent of the impact of introducing a minimum wage (big or small changes in employment or unemployment) depends on the wage elasticity of labor demand and labor supply (Nicholson & Snyder, 2009).
As can be seen in figure 3, if labor demand is relatively inelastic, a change in the minimum wage has a small impact on total employment, which is represented by the shift from D1 to D2. If on the other hand the labor demand is relatively elastic, the same change in minimum wage has a much bigger effect on total employment.
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Figure 3: Elasticity of labor demand; based on (Nicholson & Snyder, 2009).
Assuming a completely inelastic labor demand, the labor demand curve becomes vertical and the introduction of a minimum wage wouldn’t have any employment effect.
In regards to the elasticity of labor supply, figure 4 shows the relatively elastic and relatively inelastic labor supply. In case of a relatively inelastic labor supply, a change in the minimum wage has a rather small effect on total employment. If the labor supply is relatively elastic, the same change in the minimum wage causes a much bigger impact on total employment.
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Figure 4: Elasticity of labor supply; based on (Nicholson & Snyder, 2009).
To sum up, the theoretical impacts of the introduction of a minimum wage considering the elasticity of both labor supply and demand are (Nicholson & Snyder, 2009):
- The introduction of a minimum wage is expected to reduce overall employment.
- The extent of the change in employment when the minimum wage is raised is determined by the elasticity of the labor demand curve.
- The extent of the change in unemployment when the minimum wage is raised is determined by the elasticities of both the labor demand and labor supply curves.
3. Empirical analysis
The following chart gives an overview of the level of the monthly minimum wages for full-time employment across different European countries. In this chapter, we will focus on Germany and the UK, where the monthly minimum wage is around 1.500 EUR per month, and which are a good benchmark for Austria as well.
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Figure 5: Monthly minimum wage for full-time employment across Europe (Eurostat, 2017)
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