Evaluating Minimum Wage Laws


Term Paper, 2020

26 Pages, Grade: 1,7


Excerpt

Table of Contents

List of Figures

List of Abbreviations

1 Introduction
1.1 Problem definition
1.2 Objectives
1.3 Structure of the paper

2 Theoretical background
2.1 Definition of the term minimum wage
2.2 Minimum wage in the neoclassical macroeconomic theory
2.3 Minimum wage in the Keynesian macroeconomic theory
2.4 Summary

3 Minimum wage laws in Germany and the United Kingdom
3.1 Minimum wages in Germany
3.1.1 History
3.1.2 Structure
3.1.3 Coverage
3.2 Minimum wages in the United Kingdom
3.2.1 History
3.2.2 Structure
3.2.3 Coverage

4 Critical discussion

5 Summary and outlook

Literature

List of Figures

Figure 1: Impact of price floors

Figure 2: Keynesian labor market model with minimum wage

Figure 3: Development of the minimum wage in Germany

Figure 4: National minimum wage in the United Kingdom (UK) from 1999 to 2020, by wage category

List of Abbreviations

Abbildung in dieser Leseprobe nicht enthalten

1 Introduction

1.1 Problem definition

Many different countries have introduced minimum wage laws in the past decades. One of the countries that has established minimum wages most recently in 2015 is Germany (International Labour Organization, 2016, p. 25). Thereby, each government implements different concepts and focuses on various objectives. Nevertheless, minimum wage laws mostly aim at ensuring fair remuneration of employees in low-wage jobs as well as protecting workers against the threat of poverty and addressing an inequitable distribution of income and wealth in industrialized countries. However, controversial discussions concerning that topic continue because not everybody supports such statement just mentioned. That is why opponents claim that minimum wages increase the cost of labor input, lower the amount of labor demanded by enterprises and create an unemployment gap. As a matter of fact, a study, which has been published in 2010 by the British market and opinion research institute YouGov, shows the discrepancy between proponents and opponents of introducing minimum wages. Five years before a minimum wage has been established in Germany, a representative part of the German population was asked whether a nationwide minimum wage in Germany would rather increase or decrease the unemployment rate. Only 26.8 percent of those surveyed believe that the introduction of a minimum wage would create jobs, whereas 22.2 percent hold the opposite view. The vast majority thinks that a minimum wage has actually no impact on the labor market (Statista, 2010). This study is only one example of many, but it shows the need for empirical evidence of the actual impact and effectiveness of minimum wages.

1.2 Objectives

The present paper aims at evaluating minimum wage laws. In order to reflect the topic, two countries – Germany and the United Kingdom –, which have already introduced minimum wages, are chosen as examples. Furthermore, the paper examines minimum wages from the perspective of two different economic theories on government intervention by introducing the neoclassical and the Keynesian approach. It investigates the observed actual impact and effectiveness of minimum wage legislation against the presented market theories as well as against the objectives and expectations raised by the legislation. Finally, the student paper gives a recommendation whether the introduction of minimum wages is actually worthwhile or not.

1.3 Structure of the paper

The paper starts with a definition of the problem and introduces objectives as well as current relevance of the topic. Subsequently, the theoretical background is reflected. This includes the definition of the term minimum wage as well as presenting the neoclassical and the Keynesian economic theory. Chapter two finally ends with a short summary. Afterwards, the paper continues with Chapter three, which describes the minimum wage concepts of Germany and the United Kingdom. Therefore, the implementation track records explain the history, structure and the scope of the different minimum wage concepts. The critical discussion in chapter four finally evaluates the observed actual impact and effectiveness of minimum wages against the economic theories. Furthermore, it reflects the expectations and objectives which are raised by the government. The paper concludes with a summary and an outlook.

2 Theoretical background

2.1 Definition of the term minimum wage

Before the different market theories can be presented, it is important to understand what a minimum wage actually is and how it is defined. The Gabler Wirtschaftslexikon provides a first approach of definition. The authors Keller and Henneberger define the term as a legally fixed remuneration that employees receive as a minimum for their work performance. The binding floor of minimum wage is determined by the government or collective bargaining parties (Keller & Henneberger, 2018). It can refer either to the hourly wage or monthly wage for full-time employment. Moreover, a government can differentiate and set minimum wages in a variety of ways, such as by region, industry or occupation. As already mentioned in section 1.1, the aim of minimum wages is to protect workers from exploitation by employers and enable them to live above the poverty line. Furthermore, minimum wages are intended to prevent wage dumping. In the same way they can contribute to the maintenance of social peace (Keller & Henneberger, 2018). The International Labour Organization (ILO) provides another, much more comprehensive definition. This definition has already been developed during the International Labour Conference in 1992. Although the Commission first emphasizes that the term “minimum wage” cannot be defined by any ILO instrument, the participants of the conference finally describe the term in the General Survey as follows (International Labour Organization, 1992, para. 27): “In the light of the foregoing, “minimum wage” may be understood to mean the minimum sum payable to a worker for work performed or services rendered, within a given period, whether calculated on the basis of time or output, which may not be reduced either individual or collective agreement, which is guaranteed by law and which may be fixed in such a way as to cover the minimum needs of the worker and his or her family, in the light of national economic and social conditions” (International Labour Organization, 1992, para. 42). Like the definition of Keller and Henneberger, the ILO definition also refers to the binding nature of minimum wages and to the major social and economic considerations (International Labour Organization, 2014, para. 35). In addition to that, the ILO definition emphasizes that not only the time can be used when calculating the minimum wage, but also the output. Finally, there is to add that this definition should be considered sufficient for the moment. The term will be more detailed in the following sections 2.2 and 2.3 when the different market theories are going to be explained.

2.2 Minimum wage in the neoclassical macroeconomic theory

The neoclassical market theory was developed in the late 19th century and replaced the school of classical economics. Classical economists focus on the price mechanism. As Koch describes, they belief that “the volume of goods produced and goods purchased would always balance out each other” (Koch, 2019, p. 9). This is often described as an “invisible hand”. It also includes the fact that governments should not intervene in the market system through controls on prices or quantities (Koch, 2019, p. 9). Neoclassical economists modernized this model by focusing on all markets in a national economy. Some of the most important representatives of this theory were the economics William Stanley Jevons and Leon Walras (Bundeszentrale für politische Bildung, n.d.). They are convinced that every market in a national economy would reach a state of general equilibrium. Moreover, the neoclassical economy is also called supply-side economics. This is, because it focuses especially on producers, growth and employment (Koch, 2019, p. 9). According to the growth theory of neoclassic, the level of productivity increases with rising the amount of goods and services produced (Koch, 2019, p. 18). Furthermore, the theory concentrates on the individuals and their economic decisions made at the margin. In this context, proponents of the theory try to describe such decision making by mathematical models and statistics (Koch, 2019, p. 9). Therefore, several assumptions have to be made. The most important ones in this case are the belief that individuals always want to maximize their utility and that every human being acts rationally when it comes to making economic decisions. As we will discover later in this paper that are also the two major criticisms of the model. This includes the claim of opponents of neoclassic economy that the concept is too far away from the real world and individuals do not act rationally in every situation. Another important point to mention about the neoclassical market theory is that it excludes social interaction. Thus, it restricts interaction among individuals to market exchange (Schettkat, 2020, pp. 106–109).

At the beginning of this section it is mentioned that free economic markets reach a general equilibrium. As neoclassical economists include all markets, this statement is also valid for the labor market. Therefore, labor supply and labor demand will balance out each other as well, assuming that the labor market of a national economy is fully flexible. As a consequence, the price mechanism, already mentioned at the beginning of this section, will lead to an adaption of wages until demand and supply reach an equilibrium. The demand of labor continues “until the value of the marginal product equals the wage rate” (Koch, 2018, p. 101). Following Koch’s argumentation, this is the case when the wage “equals the contribution of one additional worker deployed to the firm’s revenue” (Koch, 2018, p. 101). If a government now decides to intervene by introducing minimum wages, this will lead to inflexibility and imbalances in the labor market. Assuming that the minimum wage is set above the market-clearing level, supply of labor will increase. This is, because individuals see an opportunity in maximizing their utility. Thus, more individuals want to work under the increased wage rate. On the opposite site, demand of labor is getting less attractive for companies, because they have to pay more money per working hour to the employee. As a consequence, demand of labor will decline, because wage costs are rising. This finally results in an unemployment gap which is shown in Figure 1 on the next page, whereas the blue line represents the labor demanded by companies and the red line shows the labor supply (Koch, 2018, pp. 74–75). The decline in labor demand finally results in employees being laid off. As a consequence, unemployment increases. It may even get bigger because of greater incentives for employees to enter the labor market and supply their work force. This finally may result in additional workers entering the labor market (Koch, 2018, p. 75). If the minimum wage is set below the market-clearing level, demand and supply of labor will have the opposite effects compared to setting the minimum wage above the market-clearing level. Thus, labor supply will decline, because workers have less motivation to work for less money, especially when a government provides financial assistance for unemployed people. If such unemployment benefits are high, people may decide to remain unemployed, because the public aid may be more attractive then working for a lower minimum wage. Koch calls this voluntary unemployment (Koch, 2019, pp. 21–24). On the other hand, labor demand grows, because companies hope to hire cheaper employees. As companies will not be successful with this method, they finally will have to adapt their wages until the equilibrium wage is reached again. Under these circumstances, workers will be ready again to supply their workforce at the labor market. That is, why a minimum wage, which is set below the market-clearing level, will actually have no effects concerning the labor market and unemployment.

Abbildung in dieser Leseprobe nicht enthalten

Figure 1: Impact of price floors

(Source: Koch, 2018, p. 75)

To sum up, government intervention by setting a price floor in form of a minimum wage above the market-clearing level leads to less available jobs, according to neoclassical theory. Brožová comes to the same conclusions when evaluating minimum wages and comparing it with the neoclassical market theory. The author emphasizes the fact that introducing a minimum wage finally limits the “invisible hand”. Thus, minimum wages reduce the efficiency of its operation (Brožová, 2018, pp. 35–37). Finally, Mankiw and Taylor quote that, according to neoclassic, minimum wage mostly affect low-skilled and teenage workers. They argue that wages of high-skilled and experienced employees are usually above minimum wage. Therefore, the unemployment gap already mentioned mostly concerns teenage and low-skilled workers. Nevertheless, the authors emphasize that proponents see these effects as relatively small, because supply of work also grows. In conclusion, benefits of minimum wages outweigh the negative points like rising costs of the government or increase of unemployment for example (Mankiw & Taylor, 2014, p. 371).

2.3 Minimum wage in the Keynesian macroeconomic theory

The economist John Maynard Keynes developed the Keynesian macroeconomic theory. Some major characteristics of the theory are derived from Keynes’s investigation of the great depression of the 1930s. Contrary to the neoclassical macroeconomic theory, Keynes argues that the government must intervene anti-cyclically. In this context, the economist supports the view to spend and invest more money on government side in times of depression in order to stimulate the economy and recover the market. Although this will first lead to increased indebtedness of the government, public spending and deficits can be cut and reduced later when the market has recovered (Koch, 2019, p. 10). The theory can be seen as the opposite of the neoclassical theory. Thus, it considers not the supply, but the demand of markets. Moreover, it covers not only the labor market, but also includes fiscal and monetary policies as well as goods markets (Herr et al., 2017, p. 10). In this context, it has to be mentioned that the student paper focuses on the labor market. Nevertheless, fiscal and monetary policies are a very important part of Keynesian economics. One key point of Keynesianism is that demand drives supply. According to this, an economy will balance out when aggregate demand equals total supply. However, actual demand probably deviates from the equilibrium level when looking at the short-term. In this context, Koch also argues that the actual demand will increase with rising income (Koch, 2019, p. 57). This finally leads to the conclusion that circulatory relationships have a big impact on the development of an economy and are fundamental for the labor market. It actually means that a company, for example, can only earn money if others, e.g. individuals, spend it. This expenditure, in turn, can result from income, funded loans or even reduction of assets (Herr et al., 2017, p. 11). Another important point, proponents of Keynesianism are convinced of, concerns the labor market. As just mentioned, Keynes’s theory also takes goods market into account. In this context, Keynesian economists point out that the labor market does not regulate the demand of labor. This contradicts the neoclassical model. Representatives of Keynesianism support rather the view that the expected demand of goods and the correspondingly planned production of goods determine labor demand. Therefore, demand of labor is driven by the production volume. Another counterargument to the neoclassical school is the assumption that companies have market power. Thus, they are able to set prices. This leads to the fact that a fully competitive market cannot be assumed. The same applies to the labor market and wage setting. In this case, it has to be taken into account that wages are usually negotiated because individuals and especially labor unions often have bargaining power on the labor market (Herr et al., 2017, pp. 10–11). It can also not be neglected that imperfect information and aspects of efficiency and fairness influence the labor market. As a consequence, fully flexible nominal wages are not suitable for balancing out demand and supply but risk a destabilization of cost- and price level. In this context, someone has to remember that nominal wages do not consider changes in prices. In contrast, real wages do (Herr et al., 2017, pp. 10–11). Based on the characteristics just mentioned, the Keynesian approach takes both attributes of wages into account. This includes the fact that, on the one hand, wages are part of production costs. On the other hand, they affect also the aggregate demand of goods. Considering now the introduction of minimum wages, the following effects will appear: As demand of labor depends on the demand of goods, companies demand only as many employees as they need in order to produce their goods, which they can currently sell. By introducing a minimum wage above the market-clearing level, employees receiving minimum wage will discover a higher income. This finally leads to an increase of real wages which, in turn, will influence the purchasing power effect. As a consequence, demand of goods will rise, because workers have more money to spend (Klaus Bartsch Econometrics, 2009, pp. 23–25). That results in an increase of production. As it has already been mentioned, demand of goods drives demand of labor. In order to be able to produce more goods, a company now has to hire more workers. That is why the demand of labor increases, too, which finally leads to a decline in unemployment. Sticking to Mankiw and Taylor, Keynesian economists call this the multiplier effect (Mankiw & Taylor, 2014, pp. 655–664). The correlation between the rising income and employment when introducing a minimum wage is also illustrated in Figure 2. The demand line in Figure 2 is positioned vertically, because it is inelastic to real wages. The reason for that lies in dependence of labor demand and demand of goods, as already mentioned (Klaus Bartsch Econometrics, 2009, pp. 24–25).

Abbildung in dieser Leseprobe nicht enthalten

Figure 2: Keynesian labor market model with minimum wage

(Source: author, after Klaus Bartsch Econometrics, 2009, p. 25)

2.4 Summary

In summary, someone has to say that an official definition of the term minimum wage does not exist. Nevertheless, several attempts have been made to find a definition. In general, minimum wages can be seen as the lowest wage a company is legally allowed to pay its employees. The wage is usually set by the government or collective bargaining parties. A government has several options to set and define a minimum wage, e.g. setting a minimum wage only in specific regions or differ between various industries. Considering the introduction of minimum wages, neoclassical economists argue that this will lead to a higher unemployment rate. That is, because proponents of the neoclassical approach are convinced that a market reaches a general equilibrium by itself. Therefore, they do not support government intervention. Another approach that contradicts the neoclassical market theory is Keynesianism. Representatives of this model argue that demand drives supply. Thus, they think that government intervention is necessary to regulate the market. One possible way to do so, is introducing a minimum wage. This will increase demand which, in turn, will lead to higher real wages and higher employment. Finally, it should be noted that Keynesianism, in contrast to neoclassic, defines its model from the demand, and not the supply side.

3 Minimum wage laws in Germany and the United Kingdom

After explaining the theoretical background of minimum wages by introducing two different concepts, minimum wage laws of two different countries will now be presented. Therefore, Germany and the United Kingdom have been chosen as examples. First of all, the implementation track record of Germany will be described which covers the history, structure and coverage of the German minimum wage. Secondly, the same logical structure will be applied to the minimum wage of the United Kingdom.

3.1 Minimum wages in Germany

3.1.1 History

First discussions about the introduction of a minimum wage in Germany started in the early 2000s. The positions about this topic and the discussion itself were quite controversial. At the beginning, the vast majority of collective bargaining parties rejected the introduction of a minimum wage, because they feared negative effects on employment. This sticks to the neoclassical concept explained in section 2.2. On the other side, several bargaining parties of the private service sector supported a minimum wage in Germany. They justified the necessity of minimum wage by pointing out the growing number of workers in the low-pay sector, an increase in social injustice and the increase in atypical employment relationships (Keller & Henneberger, 2018). This development, especially the growth of the low-pay sector, dated back to the 1990s. The reasons for such an increase were the deregulation of the labor market and several political decisions that had been taken during that time. Additionally, the number of employers in certain industries, who did not want to conclude bargaining agreements anymore, raised at the same time. These developments finally led two member unions of the German Trade Union Confederation (DGB) demand introducing a minimum wage at the beginning of the 2000s (German Trade Union Confederation [DGB], n.d.). As already mentioned in this section, many other union members of the DGB were careful at first, and thus did not support minimum wages. However, this view changed over the years, so that a campaign of the DGB started in 2006 (DGB, n.d.). One reason for that was also the growing number of bargaining parties especially affected by the explained effects (e.g. hairdressers, construction industry, cleaning industry). Nevertheless, introducing a legal, general minimum wage is also a political issue. Therefore, a majority is needed in order to pass a law for defining a nationwide minimum wage. This majority could not be achieved in the first decade of the 2000s because of various positions of the several political parties and different government formations (Keller & Henneberger, 2018). So, Germany remained one of the few countries in the European Union (EU) that did not have a nationwide minimum wage. In the meantime, however, several industries defined minimum wages for their branches (e.g. meat industry, hairdresser). The difference concerning that type of minimum wage is that it is not generally binding. Furthermore, those wages are negotiated in collective bargaining agreements between employer associations and trade unions (DGB, n.d.; Keller & Henneberger, 2018). Coming back to politics, the situation finally changed in 2013 with the election of CDU / CSU and SPD which formatted the “Grand Coalition” (“Große Koalition”). Thus, the government passed a law concerning a legal minimum wage in 2014. This law finally came into force on 1st January in 2015 (DGB, n.d.). Since then, employees of only a few branches were paid below the minimum wage for a transitional period. This was the case when corresponding tariff wage was already valid between the unions and employer association which had been negotiated before (Bossler & Möller, 2018).

[...]

Excerpt out of 26 pages

Details

Title
Evaluating Minimum Wage Laws
College
SRH - Mobile University
Grade
1,7
Author
Year
2020
Pages
26
Catalog Number
V903343
ISBN (eBook)
9783346222770
Language
English
Tags
Economics, Minimum wage, neoclassic, keynesianism
Quote paper
André Müller (Author), 2020, Evaluating Minimum Wage Laws, Munich, GRIN Verlag, https://www.grin.com/document/903343

Comments

  • No comments yet.
Read the ebook
Title: Evaluating Minimum Wage Laws



Upload papers

Your term paper / thesis:

- Publication as eBook and book
- High royalties for the sales
- Completely free - with ISBN
- It only takes five minutes
- Every paper finds readers

Publish now - it's free