Unemployment In UK and Effect of a Wage Increase - Essay Example

?Unemployment in UK and effect of a wage increase How do we measure the unemployment rate in the UK? In October the minimum wage in the UK increased from ?5.80 to ?5.93 per hour for workers over 21 (2.24% increase per hour). Use suitable economic analysis to examine the effect of this increase In analysing or anticipating the impact of a wage increase, the standard conventional models in macro and microeconomics are useful. For instance, in analysing the issue of whether an increase in the minimum hourly wage causes unemployment, Baumol and Blinder (2009, p. 115) produced a model that we reflect in this work as Figure 1. Figure 1. Anticipated impact of an increase in hourly minimum wage Source: Baumol and Blinder 2009, p. 115 In general, a minimum wage rate sets the price of hourly labour at a level that defies the ability of the market forces to determine the price of hourly labour. The legislated minimum wage, of course, is not set below the equilibrium wage rate or the wage rate in which the demand for labour is equal to the quantity of labour supplied or the hours of labour supplied. Otherwise, there would not be a need for a legislation of a minimum wage rate. Legislation on the minimum wage rate is usually above the equilibrium wage rate. At that level, however, or at the level in which the legislated minimum wage rate is higher than the equilibrium wage rate, the quantity demanded for labour or the number of hours of labour demanded is lower than the quantity of labour supplied or number of hours of labour supplied. Thus, involuntary unemployment takes place. In Baumol and Blinder (2009, p. 115) discussion, the line segment AB (see Figure 1 of this work) represents the employment gap. The work of Mankiw (2009, p. 212) and Gwartney et al. (2005, p. 85) also supports the perspective articulated in Figure 1. Varian (2005, p. 178) pointed out the wage increases can actually increase or decrease the supply of labour but Varian’s (2005, p. 178) view on the matter may not be relevant because the wage increase that we are discussing pertain to the minimum wage. Baumol and Blinder pointed out, however, that research undertaken by economists David Cards and Alan Krueger in early 1992 for New Jersey and Pennsylvania reportedly did not provide support for the perspective reflected in Figure 1 because the New Jersey stores in which wages were higher produced more net hiring than their Pennsylvania counterparts whose wages are lower. Thus, even if Baumol and Blinder (2009, p. 115) articulated a conventional perspective on the impact of legislated minimum wage, the authors called for more studies. In another section of Baumol and Blinder (2009, p. 201-202), the authors viewed that an increase in the nominal increase in nominal wage at current prices lead to a leftward shift in the aggregate supply curve. This is because the marginal costs for output will increase with an increase in the minimum wage. Baumol and Blinder (2009), however, did not clarify if the economic model represented in Figure 2 will also apply to a vertical aggregate supply curve but it seems appropriate to view that it is probably the case. Thus, it is possible that a net effect of an increase in the minimum hourly wage for labour above 21 years old will be to contract the economy, assuming that increasing the minimum wage for above 21 years old will have a net effect of increasing the overall minimum hourly wage. In addition, if the Baumol and Blinder perspective (2009, p. 201-202) applies, the increase in hourly minimum wage (assuming the increase in minimum wage for labour above 21 years old will have that effect), will also lead to an increase in the price level. Of course, we are assuming here that aggregate demand is unchanged. The current world crisis has probably shifted the aggregate demand to the left and, thus, it is more likely that the contraction will not be associated to a significant increase in prices. Figure 2. Nominal wage and the aggregate supply curve Baumol and Blinder (2009, p. 202) If the overall nominal wage level increased as a result of increasing the legislated minimum hourly wage of labour above 21 years old, the increase can be thought of as a supply shock or disturbance to economy. Following Dornbusch et al. (2011, p. 137-138), the supply shock would shift the aggregate supply curve up. The same is also equivalent to a leftward shift in the aggregate supply. Given an unchanged aggregate demand, a leftward shift in the aggregate supply will cause output to be lower and the price level to be higher. Thus, the increase in the legislated minimum wage rate of labour above 21 years old in so far it increased the overall labour wage rate will cause output to be lower and can possibly also decrease the real wage. If minimum wage was increased only in the labour sector above 21 years old but not in the sector below 21 years old, we can modify the discussion in Hall and Lieberman (2005, p. 370). Following Hall and Lieberman (2005, p. 370), the increase in the minimum wage for labour above 21 years old will increase the demand for labour 21 years old and below. Given that minimum wage rates for labour above 21 years old and higher, some firms will substitute labour 21 years old and below for workers above 21 years old. This will imply that although unemployment among workers above 21 years old will decrease and employment among labour 21 years old and below will increase. Thus, the minimum wage law will likely benefit young people in terms of increasing their level of employment and will be disadvantageous for low-skilled labour above 21 years old in terms of employment prospects. Meanwhile, Figure 3 taken from Miles and Scott (2005, in turn taken from the work of Haldane and Quah, 1999) describes the relationship between wage inflation and unemployment rate. The vertical axis of Figure 3 represents nominal wage inflation in percentage per year between 1856 to 1997 while the horizontal axis represents the percentage change in unemployment. Although there are outliers or data points that do not lie close to the regression line, it is clear from Figure 3 that the higher the nominal wage inflation, the lower the increase in unemployment. Thus, based on historical trends and possibly in a manner that is not so consistent with theory, what is suggested by Figure 3 is that unemployment will be in fact lower with a higher nominal wage increase. Figure 3. Wage inflation and unemployment in figure 7 of Miles and Scott (2005, p. 416) The regression coefficients of Haldane and Quah (1999) and their significance are not immediately available to make a better appraisal of the Haldane and Quah (1999) regression statistics. Nevertheless, it seems valid to say based on the Haldane and Quah (1999) regression as reflected in Miles and Scott (2005, p. 416) that wage rate increases need not lead to a reduction in output and overall employment. The Haldane and Quah (1999) regression is consistent with the findings of Phillips (1958). However, these findings have been considered most applicable for the supply curve of labour rather than as a general truth. Meanwhile, according to the United Kingdom’s Office of National Statistics (2011, p. 7), the UK adopts the definition of the ILO in defining who is employed. The Office of National Statistics (2011, p. 7) said that based on the general parameter, “the main criteria for identifying the person as unemployed are that a) he/she has been actively looking for a job in the past 4 weeks, and b) he/she is available to start work within 2 weeks.” Thus, “the unemployment rate is the number of unemployed over the number unemployed plus employed people, expressed as a percentage” (Office of National Statistics 2011, p. 7). “The unemployment rate therefore excludes people who are active (e.g., those in higher education, looking after a family or are permanently sick/disabled) form the calculation)” (Office of National Statistics 2011, p. 7-8). Reference Baumol, W. and Blinder, A., 2009. Macroeconomics: Principles and policy. 11th ed. South-Western Cengage Learning. Dornbusch, R., Fischer, S., and Startz, R., 2011. Macroeconomics. 11th ed. McGraw Hill Irwin. Gwartney, J., Stroup, R., Sobel, R., and MacPherson, D., 2006. Microeconomics: Private and public choice. Thomson South-Western. Hall, R. and Lieberman, M., 2005. Macroeconomics: Principles and applications. 3rd ed. Thomson South-Western. Mankiw, N. G., 2009. Brief principles of macroeconomics. South-Western CengageLearning. Miles, D. and Scott, A., 2005. Macroeconomics: Understanding the wealth of nations. 2nd ed. John Wiley & Sons, Inc. Office for National Statistics, 2011 (20 July). Unemployment during the economic downturn. London: Office for National Statistics. Phillips, A.W., 1958. Relation between unemployment and the rate of change of money wage rates in the United Kingdom, 1861-1957. Economica, 25 (100), 283-299. Varian, H., 2005. Intermediate microeconomics. 7th ed. Norton Publishers Read More