Why a minimum wage rise could be good for all

So Obama’s recent state address on the minimum wage has caused a lot of controversy with business and economics commentators. The president suggested that the minimum wage be increased from $7.25 to $9 an hour however as usual this has been met by the inevitable cries of fore coming unemployment and despair. Free market supporters have argued that such an increases could lead to large increases in low skilled worker unemployment. This argument however relies heavily on contested economic models such as the competitive labour model.


The model as shown above suggests that if a minimum wage (Wm) is set above the market clearing level (We) there will be an excess supply of labour over demand, more commonly known as unemployment. This is shown in the reduction of employment from Ne to Nm. In simpler terms this means that employers will face higher costs and will respond by either hiring less labor or making cutbacks. However such a model does not take into account market imperfections such as search costs, information costs and worker immobility which may lead to segmented and monopsonistic markets.

John Schmitt of the Center for Economic and Policy Research has argued that employers will not always respond to minimum wage hikes by reducing employment. His paper argues that employers may, among others, respond by cutting wages for higher paid workers, raising their prices or by becoming more efficient. For instance the  efficiency wages theory argues that higher wages will promote greater worker productivity as the potential cost of shirking on the job increases.

So what does the empirical evidence say? It again is largely contested but as pointed out by the World Bank (2003, pp.11) “There seems to be an agreement that the overall employment effects of minimum wages – positive or negative – tend to be small”. For instance an OECD (1998) paper found across the richest nations that the minimum wage rises had an close to insignificant impact on young adults (aged 20-24) and no employment impact on prime age adults (25-54). However it must be noted that most studies are looking at moderate increases in minimum wage and teenagers are commonly found to be adversely effected by any increase.

If rises in the minimum wage do indeed have small negative or insignificant effects upon employment, a rise could be good for all. Firstly it could boost consumer demand by putting money into the pockets of the poorest members of society, in the case of America this amounts to 15 million people. Secondly it could reduce inequality which in turn promotes positive economic outcomes such as greater social cohesion. Thirdly it could promote labour force participation by making ‘work pay’; in effect encouraging those who are unemployed to actively search for work. This could reduce government expenditure as those on benefits find it more economically rewarding to move into work. Similarly those already in minimum wage jobs would become less dependent on government transfers.

Overall these effects could strengthen the economy and the recovery whilst simultaneous promoting greater equality within society. The conflicting empirical evidence shows that economic theory should not be accepted unquestionably and a stronger emphasis on such evidence is needed in policy decisions.

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4 thoughts on “Why a minimum wage rise could be good for all

  1. Omar L. Sherif says:

    This is capitalist versus Welfare economics. Using economics to solve social problems including inequality.The Minimum wage board in Liberia for instance has found it difficult to come up with a proposed $5.00 over the past three years.With a GNI per capita of less than $300.00, one would imagine where did the thought come from in the first place. Unlike the US, Liberia’s economy cannot cope with such welfare policy in the midst of 85 percent unemployment. For America, the new minimum wage could find itself out of the skeptics imagination as employers may opt to cut from higher wage employees to compensate for the cost associated. For a poor country, minimum wage is not sustainable at all.

  2. why the minimum wage is not sustainable at poor countries?

  3. In HK, after there was a minimum wages set, some media interviews show that there is a chain effect of increase in wage of different level of workers at some sectors where differences of different range of low-skilled workers are small, e.g. in restaurants, the rate between cleaning worker, waitress, manager, the cook, therefore minimum wage drive the employers to increase the wage of different rank of workers.

  4. Thanks for the comments guys!

    Omar, I agree it is probably not sustainable in poor countries, this is mainly because many developing countries have a large informal sector and regulation of a policy would therefore be near impossible. However for those in the lowest paid formal jobs such legislation could still offer a possible route from poverty. It should be noted though that if the minimum wage is set too high it could lead to unemployment in the formal sector, this many potentially force workers from the formal to the informal sector lowering thus lowering the wages of those in the informal sector. This could make matters worse, all this ultimately depends on the correct setting of the minimum wage.

    Charlotte, yes I agree I have read about this effect in some other articles. This again could be another beneficial spillover effect of minimum wage increases that many have not considered. It could be quite a good argument for a minimum wage increase because this would lead to increased spending power for not only those on the minimum wage but those just above it too. This could have a large knock on effect for consumer spending in the whole economy.

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