Macroeconomic Effects of the Minimum Wage to the Economy - Coursework Example

Name Class Unit Introduction The chancellor of England decision to increase the minimum wage has been met with criticism and praise from different sources. The chancellor said that the employers were to be forced to increase the minimum wage to £7.20 an hour from 2016. The wages would be raise by 6% annually to an average of £9 by the end of the year 2020 (BBC, 2015). While this announcement has continued to elicit debate on its merits and demerits, it is important to look at the implications of such a policy (Elliott & Wintour, 2015). This includes looking at the impact of raising the living wage to the hiring and employment as well as economy and macroeconomic effects. This report analyse the decision to raise the minimum wage and the implications it has on unemployment rate. The report also looks at the macroeconomic effects of the minimum wage to the economy. Changes in the minimum wage impact on unemployment rate Using the microeconomic theory the minimum wage is the price floor above the equilibrium price which is set by the supply and demand curve (Falk, Fehr & Zehnder, 2006). When the minimum wage is increased, the number of the workforce increases due to a surge of interest in joining the workforce. Also the, the amount of labour demanded reduces since the costs of labour increases with minimum wage. This leads to an increase in the quantity supplied while the quantity demanded decreases. The resultant is surplus labour hence an increase in the levels of unemployment (Dolton, Bondibene & Wadsworth, 2012). Wage D S Wm Wc S D Em Ec Employment Fig.1, supply and demand curve explaining effects of increment in minimum wage Key Em-Employment after minimum wage increment Ec-Current level of employment Wm- Increment in minimum wage Wc-Current wage D-Demand S-Supply As the minimum wage increases beyond the set natural equilibrium in the market, unemployment rate increases (Falk, Fehr & Zehnder, 2006). Firms which highly depend on labour are forced to fire some of the workers with an aim of minimising their costs. The effort for workers in most cases is increased with an aim of ensuring that they earn the minimum wage. Firms whose employees are retiring fail to replace them which reduce the rate of employment growth (Earl &Wakeley, 2005). Wage£/hr. D Q Quantity of labour Fig.2, Reducing demand for labour as minimum wage increases Higher incomes increase the cost of production for goods and services. This makes the producers to pass some of the costs to the consumers through higher prices. The higher prices for goods and services make the consumers to make few purchases for the goods and services (Stewart, 2004). This leads to a situation where the producers makes few foods and services due to low demand hence they hire few workers. This is known as the scale effect and leads to reduction in employment for both low and higher wage workers (Dolton, Bondibene & Wadsworth, 2012). According to Forbes.com (2015), minimum wage increase leads to an increase in the costs of low wage workers. This is in relative to the costs of other inputs used by workers in production of goods and services such as machines and technology. This makes some of the employers to respond through reducing the number of the low wage workers. This substitution effect reduces the number of employees hence increasing the rate of unemployment (Falk, Fehr & Zehnder, 2006). The increase in the minimum wage affects those earning below the minimum wage as well as those earning higher than minimum wage. After there is an increase in the minimum wage, employers tries to come up with ways in which the differential pay that existed can be maintained. This involves raising the wages of people whose earnings were a little higher than the minimum wage. This may lead to employers firing some of the employees who earned slightly higher than the minimum wage instead of increasing their wages (Dolton, Bondibene & Wadsworth, 2012). The level of employment reduces more in firms whose customers are price sensitive. This is due to fact that the demand for their products reduces as the prices rise. This makes these firms to reduce their production hence cutting the number of employees. Employment also reduces most in firms where low costs workers makes up the largest cost of production (Earl &Wakeley, 2005). Firms which have low number of employees earning below the minimum wage may experience an increase in demand as the competitors increases their prices. Over time, most of the firms replace low wage employees through use of inputs and technologies that save costs. This makes the percentage of unemployed employees to be higher in the long term than the short term (Stewart, 2004). Apart form the low wage earners, high wage workers are also affected by the minimum wage increment. Most of the industries that reduce their production due to wage increase tend to reduce both higher wage and low wage employees (Dolton, Bondibene & Wadsworth, 2012). Despite this, a minimum wage increase may make the high wage workers less expensive. This lead to the firm increasing high wage workers while reducing low wage workers who are less productive. High wage workers number increases slightly with minimum wage increment while low wage workers decrease in large numbers (Stewart, 2004). To sum up, employers cannot afford to pay employees more than the employees can produce. In most cases, employees who earn minimum wage earn it due to their level of productivity. Those increasing minimum wage claims that the business are capable of paying higher wages but are unwilling. This is based on hope that businesses will be ready to reduce their profits without affecting employment (Gilman, Edwards, Ram & Arrowsmith, 2002). Also, most of the workers earning minimum wages are in small companies which are in very competitive markets. Small businesses in most cases operate low profits in order to stay running. Also, large corporations’ faces a lot of pressure from the shareholders to keep their costs at minimum. This implies that chancellor decision to increase the minimum wage will lead to high levels of unemployment both in long and short term (Machin, Manning & Rahman, 2003). Macroeconomic effects of minimum wage change in the economy From macroeconomic theory, an increase in minimum wage leads to an increase in the real wage in an economy. The major macroeconomic indicators affected by the increase in minimum wage are employment, poverty and inequality. UK employment laws require the government to raise wages for their employees who are affected by the raise which increases the budget. The budget is also affected by the rise of products and services that are required by the government (Dolton, Bondibene & Wadsworth, 2012). Consumers face higher prices for goods and services as the minimum wage increases. Workers whose earnings are increased pays higher taxes which helps to reduce the government budget deficit. Despite this, workers, consumers and businesses whose income is reduced are forced to pay less tax and receive higher benefits. This has an effect on increasing the budget deficit. After the minimum wage increment, increases in income become higher than the decrease in the short run and reduces in the long run. This implies that the budget deficit decreases in the first few years but faces slight increases in the long run (Harvey & Jowsey, 2007). According to a report by KPMG, increase in the minimum wages can take 1.3% of the UK national wage bill. This would life about 6 million people out of poverty. The report also claims that the businesses which are early adopters have more benefits. The net benefit to the government according to the report is just over £1.5 billion (Livingwage.org, 2015). Despite this, it is important to look at the minimum wage as a tool that can lead to high cost of labour with no corresponding increase in productivity. An example is Singapore where in 1979 announced a wage increases by nearly 20%. The aim was to improve the economy and make the country highly developed. The result of this decision was similar to an increase in the minimum wage. The cost of labour in Singapore increased and reduced the country competitiveness compared to other Asian neighbours. This led to recession in 1985 and a reduction in employment and exports produced (Falk, Fehr & Zehnder, 2006). Higher wages leads to an increase in the family income. The additional incomes are mostly enjoyed by the families who have low incomes. The increase in the incomes leads to decrease in income on other sources such as business who suffers loss, workers who becomes jobless and rise of prices for goods and services. While it is advocated that increase in the minimum wages reduces poverty, this does not happen in most cases. In some cases, the wage gains do not belong to the families who have very low incomes (Neumark, Mark & William, 2005). The wage gains that are enjoyed by some of the workers are offset by loss of jobs and a reduction in the working hours. This implies that while increase in the minimum wages may help the families living near the poverty lines, it does not help the families who live below it. Increase in the minimum wages does not help the poorest families (Toikka, Aaron & Andre, 2005). These families are less likely to have workers and in cases where they do have, they may lose job due to increase in minimum wage. Also, if an increase in the minimum wages leads to a reduction of the social programs and welfares for the poor, they have little impact in reducing poverty in an economy. This implies that inequality in UK may not be addressed through increase in minimum wage (Dickens & Manning, 2004). Increase in the minimum wages has great impact on the countries which have low productivity as compared to rich countries. The increase in the minimum wages reduces the development in the poor countries (Stewart, 2004). Despite this, the increase of minimum wages by chancellor is huge which makes it to have a great impact on economy. For England to increase the minimum wages, the country must look at the impacts that it has on the economy. The country may face an increase in unemployment and negative impacts on the economy (Forbes.com, 2015). Despite the good intentions of increasing the minimum wages, the real economy impacts are worse if not checked. This implies that the minimum wage must be set in a way that they do not have a negative impact on the economy. The government must set the minimum wage at a reasonable amount which does not hurt the economy. This is in accordance with UK minimum wage laws (Dolton, Bondibene & Wadsworth, 2012). Wage MC w’’ MC’’ A B S MRP w’ L L’ Labour Fig.3, curves showing effects of excessive minimum wage An excessive minimum wage as suggested by the chancellor will raise unemployment since the price will be fixed above the demand for labour. Also, a reasonable increment in minimum wage will lead to economic growth since workers bargaining power will be reduced and the labour market become monopsonitic (Harvey & Jowsey, 2007). Conclusion To sum up, the discussion shows that an increase in minimum wages as proposed by the chancellor will have a devastating impact in the job market and economy in general. There is enough evidence that the level of unemployment will increase and the rate of job creation reduce. The quantity of workers will increase in the economy due to surge of interest to join the workforce. Despite increase in workers, the quantity of labour needed by the companies decreases due to high labour costs. It is also evident that increasing minimum wage may not always reduce the level of poverty. The increase in minimum wages has several unintended consequences which are in most cases ignored. While some workers benefit from an increase in wages, those who lose jobs suffers. Employers reduce working hours and eliminate some of the employees. Higher costs of labour are passed to consumers by businesses. The benefit to the government budget is also minimal. It is therefore advisable that despite the good intention of raising minimum wage by the chancellor, there is need to ensure that the increment does not hurt the labour market and economy. References BBC, 2015, Budget 2015: Osborne unveils National Living Wage, BBC.com, 8 July 2015, Retrieved 14th November 2015, http://www.bbc.com/news/uk-politics-33437115 Dickens, R., & Manning, A. 2004. “Has the national minimum wage reduced UK wage inequality?.” Journal of the Royal Statistical Society: Series A (Statistics in Society), Vol.167, no.4, p.613-626. Dolton, P., Bondibene, C. R., & Wadsworth, J. 2012. “Employment, Inequality and the UK National Minimum Wage over the Medium‐Term”. Oxford Bulletin of Economics and Statistics, Vol.74, no.1, p.78-106. Earl, P. & Wakeley, T. 2005. Business Economics: A Contemporary Approach, London, McGraw-Hill. Harvey, J. & Jowsey, E. 2007. Modern Economics: An Introduction, 8th Ed., Palgrave McMillan. Elliott, L. & Wintour, P. 2015, Budget 2015: Osborne hopes minimum wage increase will soften welfare cuts Thursday 9 July 2015, Retrieved 14th November 2015 from, http://www.theguardian.com/uk-news/2015/jul/08/george-osborne-budget-minimum- wage-rise-12bn-welfare-cuts Falk, A., Fehr, E., & Zehnder, C. 2006. “Fairness perceptions and reservation wages: The behavioral effects of minimum wage laws.” The Quarterly Journal of Economics, Vol.3, no.2.p.1347-1381. Forbes.com, 2015, The $15 Minimum Wage Would Cause At Least 300,000 Job Losses, Forbes.com, 9th July 2015, Retrieved 14th November 2015, http://www.forbes.com/sites/timworstall/2015/07/09/the-15-minimum-wage-would- cause-at-least-300000-job-losses/ Gilman, M., Edwards, P., Ram, M., & Arrowsmith, J. 2002. “Pay determination in small firms in the UK: the case of the response to the National Minimum Wage.” Industrial relations journal, Vol.33, no.1, p.52-67. Livingwage.org, 2015, KPMG economic analysis: Raising the minimum wage to the Living Wage would benefit staff and businesses 7th July 2015, Retrieved 14th November 2015 from, http://www.livingwage.org.uk/news/kpmg-economic-analysis-raising-minimum- wage-living-wage-would-benefit-staff-and-businesses Machin, S., Manning, A., & Rahman, L. 2003. “Where the minimum wage bites hard: Introduction of minimum wages to a low wage sector.” Journal of the European Economic Association, Vol.1, no.1, p.154-180. Neumark, D. Matthew T. & Leslie K. 2012. “The Effects of Living Wage Laws on Low-Wage Workers and Low-Income Families: What Do We Know Now?” IZA Journal of Labor Policy, Vol.1, no.11, p.1-34. Neumark, David, Mark Schweitzer, and William Wascher. 2005. “The Effects of Minimum Wages on the Distribution of Family Incomes: A Nonparametric Analysis.” Journal of Human Resources, Vol.40, no.4, p.867-894. Stewart, M. B. 2004. “The impact of the introduction of the UK minimum wage on the employment probabilities of low-wage workers.” Journal of the European Economic Association, Vol.2, no.1.p.67-97. Toikka, R. S., Aaron Y., and Andre N. 2005. “The “Poverty Trap” and Living Wage Laws.” Economic Development Quarterly, Vol.19, no.1, p.62-79. Read More