Minimum Wage And Its Implications

Last Updated on April 26, 2022 by Rational thinking

More or less all countries have established minimum wage by law. It serves as a floor for the price of labor. Put simply, minimum wage is the lowest hourly, daily or monthly payments that employers can legally pay to its workers. Even a worker cannot sell his labor at a lower price if he wants to!

In this article, I will try to explain why we have a minimum wage and why it is mostly a bad thing. However, markets are complex and it’s hard to pinpoint exact cause and effect due to the infinite factors in the marketplace.

Why does such a law exist? Why can’t I offer my labor lower than what the government decides? The minimum wage has a strong social appeal. For most people it makes sense: why should someone get very low paid jobs? Make it illegal! Employers are taking advantage of poor people! The reasoning behind it is that workers need to receive a minimum salary to avoid poverty. Otherwise, “smart” businessmen will take advantage of workers and pay them much less.

Now, stop and think for a moment. If this is such an effective tool to avoid poverty and “abuse”, why not increase the minimum wage more? Let’s say someone is making the minimum wage of 5 USD. If the minimum wage is raised to 7 USD, that must be good news for that person? No. Politicians know that increasing the minimum wage too much will create unemployment. Perhaps he will lose his job if the employer needs to pay more.

Let’s look at another commodity: goods. Why is there not a minimum price for which goods can be sold? Labor is also a commodity. Why is there not a minimum price on a lawnmower? After all, some producers are making lawnmowers at a loss and cannot pay their employees properly. A lawnmower maker can go bankrupt and the employees will lose their job and income.

Dealing with economics we often have to use the words “supply and demand”. However, it’s meaningless to talk about the “supply of labor” and “demand of labor” without considering the price, in this case the salary. In a market for goods, it will always be cleared/sold, it is just a question about price. Sometimes producers sell their goods at a loss just to be released from them. Sometimes they even receive zero, and perhaps negative, just to remove the goods. A seller just needs to lower its price and the goods will be sold.

Dealing with labor prices are exactly the same. Whatever supply of labor is brought to the marketplace it can be sold, but only if wages are set at such a price it will be “cleared” in the marketplace.

Thus, in a free market, there will never be unemployment. If someone wants to be employed, there will always be someone hiring if the price is correct or low enough. But no one wants to be employed without getting paid what he considers sufficient. From this, we can conclude there is no employment problem, but rather a subsistence problem. Of course, in a free market, there is no guarantee that a worker will make an above-subsistence salary.

Therefore, minimum wage will always create unemployment. That in turn makes the total production of goods and services in a society smaller, thereby reducing profits and perhaps also wages. Simply put, the cake is smaller than it could have been. In the long term, wages have been fairly constant at around 65-70% of the total GDP in the western world. If the cake gets bigger, more salaries will be paid out.

Wouldn’t it be better to have people work for less than staying unemployed? Staying unemployed for a long time is a personal tragedy and makes it even harder to land a new job. Who wants to hire someone who has not worked for several years? Look at Spain. Close to 25% of those under 30 have no job. What a catastrophe for those individuals. I am quite confident a lot of those would have taken badly paid jobs just to get some experience. Would it not be better to lower wages and let those people work for a lower salary? That may in turn make the economy better. But they cannot find a job. Why? One reason is because of minimum wage (of course other things too).

Minimum wage also creates less social mobility. Those who cannot get a job at minimum wage might end up long term unemployed. They might have been better off working at a low salary to get job-practice and the possibility to land another and better-paid job later.

A very good example of unemployment and wages is the recent years’ development in Germany. Germany’s real wages have fallen from early 2000 up until now. At the same time, the unemployment rate has fallen dramatically. Germany has become more competitive compared to for example Spain and Greece. From 2005 to 2012 the unemployment rate has fallen from about 12% to around 6%. Why? Because the real wage has fallen and more labor has been “cleared” in the marketplace. Yes, a lot of those are struggling to cover living expenses with such a low salary, but I believe Germany has taken the necessary steps to reform the economy. In my opinion, it must be much better to have a low-paying job than no job at all. Simply by being employed the future prospect are much better.

So what is the alternative to minimum wage? There is only one way to increase salaries: That is to increase the total productivity in society. Accumulation of capital, improvements and innovations and efficient management will give rise to productivity gains. I will give you one practical example:

I live in Latvia. Here the price of labor is so cheap that what machines would do in my native Norway is done by manual labor. Yesterday my Italian neighbor made a drainage channel all over his garden. Two young men were digging for three days to put down the drainage pipes. A machine would do this many times faster, but because labor is so cheap and there is a lack of capital, it’s cheaper for my neighbor to use labor instead of machines. Through the accumulation of capital and savings, those two young diggers could have used a machine and dug three gardens instead of one in the same amount of time. Increasing productivity is the only way to increase income and living standards.