Unemployment amongst the young and unskilled - Essay Example

Economics of minimum wages Outline: In the following essay, we will consider how the labour market operates. In particular, we will focus on the determination of minimum wages rates in different type of markets. We will see that how minimum wage rates are determined by the various factors such as unemployment/employment position, geographical locations, skills of the employees or skills required for a particular job, respective governments level of intervention/ legislations and migration policies/ conditions. In this essay we tried to explain all these conditions with reference to UK labour market. We focused on UK because recent policy and legislation changes regarding minimum wages converted this country into a more flexible and effective labour market. Introduction: Wages are one of the most important aspects of labour economics. Due to wider changes in business environment one thing is for sure that these changes are affecting the wages structure. Nowadays, due to fast technological changes especially in the field of telecommunication and computers geographical boundaries are diminishing and the mobility of labour force has increased manifold. This mobility destabilizes the demand and supply of labour, which ultimately affect the wages. The labour market has undergone great change in recent years. Advance in technology, changes in the pattern of output, a need to be competitive in international markets and various social changes have all contributed to changes in work practices and in the structure and composition of the workforce. Major changes in the UK include the following: 1. A shift from Agriculture and Manufacturing to Service sector employment. The fall in manufacturing employment, however, has been more recent, starting in the 1960's and gathering pace through the 1970's, 1980's and 1990's. By contract, employment in the service industries has grown steadily since 1946. In fact since 1979, it has expanded by over 5 million jobs. 2. A rise in part time employment, and a fall in full time employment. In 1971, a one in six worker was part-time; by 2003 this had risen to one worker in four. The fall in the proportion of full-time employees closely mirrors the decline in manufacturing, where jobs were more likely to be on a full-time basis. At the same time, the growth in part time work reflects the growth in Service sector where many jobs are part time. Since 1979 part time employment has risen by over 2.2 millions. 3. A rise in female participation rates: Women now constitute approximately half of the paid labour force. The rise in participation rates in strongly associated with the growth in the service sector and the creation of part-time position. Nearly half of all female workers, about 6.3 million are the part-time worker. 4. A rise in proportion of workers employment on fixed-term contract or on a temporary or casual basis. Many firms nowadays prefer to employ only their care workers / managers on a permanent (continuing) basis. They feel that it gives them more flexibility to respond to changing market conditions to have the remainder of their workers employment on a short-time basis and perhaps, to make use of agency staff is to contract out work (Employment in different sector of the UK economy, European Historical Statistics by B.R. Mitchell (Macmillan Press); Labour Market Trends, National statistics, various editions). Labour demand and supply in different market: It has become very fashionable in recent years for companies to 'trim' the numbers of their employees in order to reduce costs but, however a growing consensus that the process may have gone too far. When looking at the market for labour, it is useful to make a distinction between perfect and imperfect markets. Although in practice few labour markets are totally perfect, many do at least approximate to it. In the perfect market, everyone is a wage taker. Neither employers nor employees have any economic power to affect wage rates. The other assumptions of a perfect labour market are as: Freedom of entry i.e. there are no restrictions on the movement of labour: Perfect knowledge i.e. workers are fully aware of that jobs are available at what wage rates and with what conditions of employment; Homogeneous labour i.e. It in usually assumed that, in perfect markets, workers of a given category is identical in terms of productivity. Relationship between demand and supply of labour and wages: Wage rates and employment under perfect competition are determined by the intersection of market demand and supply of labour. Generally it would be expected that the supply and demand curves slope the same way as in goods markets. The higher the wage paid for a certain type of job, the more workers will want to do that job. This gives an upward-sloping supply curve of labour. On the other hand, the higher the wages that employer has to pay, the less labour they will want to employ. Individual employer has to accept this wage. The supply of labour to that employer is infinitely elastic. An individual worker also has to accept this wage. In this case it is the demand curve for that worker that is infinitely elastic. Now we can look at supply of labour at three levels, which are the supply of hours by an individual worker, the supply of workers to an individual employer and the total market supply of a given category of labour. Work involves two major costs to the worker: When people work they sacrifice leisure and the work it self may be unpleasant. Each extra hour worked will involve additional disutility. This marginal disutility of work (MDU) will tend to increase as people work more hours. This increasing margined disutility will tend to give an upward-sloping supply curve of hours by individual workers. The reason is that, in order to persuade people to work more hours, a higher hourly wage must be paid to compensate for the higher margined disutility incurred. Under certain circumstances, however the supply of hours curve might bend backwards. The reason is that, when wage rates go up, there will be two opposing forces operating on the individual's labour supply. On the one hand, with higher wage rates people will tend to work more hours, since leisure would now involve a greater sacrifice of income and hence consumption. On the other hand, people may feel that with higher wage rates they can afford to work less and have more leisure. A rise in wage rates acts as an incentive: it encourages a person to work more hours. Under perfect competition, the supply of labour to a particular firm will be perfectly elastic. The firm is a wage taker and thus has no power to influence wages. The position of market supply curve of labour will depend on the number of people willing and able to do the job at each given wage rate. This depends on the three things i.e. the number of qualified people, the non-wage benefits or costs of the job, such as the pleasantness or other satisfaction working environment status, power, degree of job security, perks and fringe benefit and the wages and non wages benefits of the alternative jobs. A change in the wage rate will cause a movement along the supply curve. Now if we analyze, we find that the market wage rate changes according to the difficulties and costs of changing jobs and the time period. Mobility of labour or we may say supply of labour, whether geographical or occupational mobility have an impact on wages. The second point, immediately comes up that how many workers will a profit maximizing firm / company want to employ In the labour market, the firm will maximize profits where the marginal cost of employing an extra worker equals the marginal revenue that workers output earns for the firm. The reasoning is simple, if an extra worker adds more revenue than to its costs to the firm. But as more workers are employed, diminishing returns to labour will set in. Eventually the marginal revenue from extra workers will fall to the level of their marginal costs. All that points the firm will stop employing extra workers. Under perfect competition between firms will ensure that profits are kept down to normal profits. If the surplus over wages is such that supernormal profits are made, new firms will enter the industry. The price of the good will fall and the wages will be bid up until only normal profits remain. In the real world, many firms have the power to influence wage rates. They are not wage takers. This is one of the major types of labour market imperfection. In the case of monopsony or in oligopsony too, they are wage setters not wage takers. Thus a large employer in a small town may have considerable power to resist wage on increases or even to force wage rates down. If the firm wants to take on more labour, it will have to pay a higher wage rate to attract workers away from other industries. But conversely, by employing less labour it can get away with paying lower wage rate. Minimum wages: The purpose of the minimum wage (MW) is to raise the pay of low-wage workers above what it otherwise would be. Therefore the immediate task is to set out just what the national minimum wage (NMW) has done to pay. If it has had no effect it cannot be held to influence employment. Identifying workers as being low paid clearly involves making certain values judgments about what constitute 'low'. One way is to consider pay relative to living standards but the more rational approach is to define low pay relative to the average wage rate. If the minimum hourly wage were to be based on this then in UK it would be set at just under 8 pound and would raise wages for about 36% of full time workers. The UK defines low pay as being below the minimum wage, which in October 2003 was set at 4.50 pound per hour for those aged 22 and over, 3.80 pound per hour for those aged 18-21. Evidence from various new earning surveys indicates that inequality in pay has evident. Low pay trends to be observable in certain sectors in UK, i.e., eating, retail trade and textile manufacturing, low pay also occurs disproportionately between women and men. A number of factors have contributed to the progressive rise in size of the low paid sector and widening disparity between high and low income earners since 1979. In UK, low wages, many wage rates become common in 80's and 90's due to high rate of unemployment. Again the technology changes led to more and more unemployment. Wages has been increased for skilled workers with newer skills but relative unemployment for unskilled worsen. Changes in the structure of the UK economy-in particular, the growth of the service sector and growing proportion of women seeking work have led to an increase in part time work. Many part-time workers do not receive the same rights, privileges and hourly pay as their full time equivalents. So looking at the labour market in UK, to establish a flexible labour market came with labour market legislation. Before April 1999, there was no statutory minimum wage in the UK. The principle of a minimum or fair wages was based around a voluntary tradition in which, other than in the most poorly paid sector of economy, earnings and wages were determined through the process of collective bargaining. The supporters of a national minimum wage, including Labour Govt. argued that its introduction would not only help to reduce poverty among the low paid but would also have little or no adverse effects on unemployment. British workers were covered for the first time ever by a national minimum wage (NMW) for the last nine months of the twentieth century. In order to recommend the rate of NMW the Low Pay Commission (LPC) was established in 1997. The LPC is a form of social partnership with three employer representatives, three worker representatives and three independent members (Brown 2002, 2006). Its recommendations have always been unanimous and the government has always implemented the proposed NMW. Since its introduction in April 1999 the NMW has been revised upwardly on seven occasions. If we focus on a particularly low paid sector, care homes, between one third and two fifths of workers were previously paid below the NMW with a wage gap of 4% (the wage gap is the pay increase required to bring all employees up to the NMW as a percentage of the relevant wage bill). This suggests an average wage increase of over 10% for such workers consequent on the introduction of the NMW (see Dickens and Manning 2003, Machin and Wilson 2004). It is clear from both aggregate labour market data and from information for specific low paying sectors that the introduction of the NMW had a substantial impact on the earnings of those towards the bottom of the pay distribution in both absolute and relative terms. Dickens and Manning (2006) show, using both LFS and NES data, that wage inequality, measured by D50/D10, has fallen since 1998. They state (2004a, b) that the introduction and early up ratings of the NMW had a modest effect on wage inequality, but after 2002 the effect became more pronounced. Wage inequality rose relentlessly from 1978 to 1996. The diminution in this inequality from 1997 to 2005 caused the 50/10 wage ratio in 2005 to be the same as it was in 1989, reversing around half the growth of the inequality which occurred between 1978 and 1996. And this occurred in the face of a huge, rapid alteration in the labour market working in the opposite direction (Dustmann et al. 2007). Immigrant workers as a percentage of native workers rose from 8.7% in 1999 to 11.5% in 2005. Thus the NMW "performs an important role to secure wages of those workers who otherwise would lose out from immigration" (p.45). Minimum wages in a competitive labour market: In a competitive labour market, workers will be hired up to the point where the marginal revenue product, i.e. the demand of labour is equal to the marginal cost of labour. The level of unemployment created, as a result of the national minimum wage will be determined not only by the level of minimum wage but also by the elasticity of labour demand and supply (ILO. 1998). The more elastic the demand and supply of labour, the bigger the unemployment effect will be. In the standard model the unemployment effect of a minimum wage is larger than the employment effect because (i) some previously employed workers lose their jobs (the employment effect); (ii) some workers who did not find it worthwhile to work at the competitive wage now wish to work at the minimum wage but cannot find a job. The unemployment effect - (i) plus (ii) - is larger the higher the minimum wage and the more elastic the labour supply and demand curves. Evidence suggests that the demand for low-skilled workers is likely to be wage sensitive. The standard economic model relates to the demand side of the labour market (see e.g. Stigler 1946, Hamermesh 1993). If the minimum wage is set above the competitive wage employment falls back. The extent of this reduction depends on (i) by how much the minimum wage exceeds the competitive wage; and (ii) the elasticity of demand for labour. Marshall's (1901 pp.361, 362) famous rules of derived demand describe the factors that influence labour demand in a particular industry. The negative impact of minimum wages on employment result from substitution effect i.e., when the labour becomes more expansive, decreases in firms demand for low skilled labour and the scale effect i.e. due to increase in cost of labour, prices increase and reduction in low-skilled labour. In implementing minimum wages, competitive model presupposes certain things such as: the labour force might be substitutable; minimum wages legislation covers the whole economy. All the employers comply with the minimum wage legislation and employers have little or no influence in wage settings. In actual situation, conditions of labour market become different than expected. The motion of equilibrium in the above model does not seem to reflect the dynamic and complex nature of labour market. So several new modified versions have been formulated, among them is two sector model formalized by Welch (1974) cited by Brown, Gilsoy, Kohen (1982). In this model, it has been assumed that economy has two sectors one with minimum wage Legislation and other without minimum wage legislation. The effect of minimum wage legislation on total employment depends on the elasticity of labour supply to wages and demand for labour. Another model, called Two- sector model with queuing for covered- sector job in the extension of the preceding one. Mincer (1976) formalized it. He explained that if minimum wages are higher than the equilibrium rate then workers are encouraged to wait for jobs, which created more unemployment. The length of queue (unemployment level) would depend on the type of frontier separating the format from informal sector. Apart from competitive model, some alternative models are the monopsony, the theory of wage efficiency and the model of minimum wage, unemployment and growth. In the monopsony model, Labour supply is a positive function of the wages paid but it is based on one employer and in present condition it is more theoretical them true. In present condition, minimum wages might be associated positively with employment increase but beyond a certain limits, it might lead to decrease of jobs prospects. Brown (1999, p.2108) states, "Although they are not, in the end, intended to believe it, undergraduate students are exposed to the possibility that a "skillfully set" minimum wage increases employment under monopsony". Stigler (1946) first noted this possibility. The key point is that the monopsonist faces an upward sloping labour supply curve. The profit maximising equilibrium is where the marginal cost of labour equals the marginal revenue product (demand for labour curve). This yields wage and employment levels below their competitive counterparts. As long as the minimum wage is set between the monopsonistic and competitive wage both employment and pay will increase. The minimum wage acts as a floor and prevents a profit-maximizing monopsonist reducing the quantity of labour employed and cutting the wage as much as it would like to. In an oligopsonistic labour market minimum wage set moderately above the market wage will cause establishment-level employment to increase because, if all employers offer higher pay (to comply with the minimum wage), the labour market participation rate also rises: "Intuitively, by setting the minimum wage above the market wage employers find it easier to fill their vacancies" (Bhaskar et al. 2002, p.168). Second, a binding minimum wage decreases employers' profits, and with free entry into and exit from the labour market some employers will be forced to go out of business and exit. The jobs in such firms are lost. Thus, minimum wages have two opposing effects: "the employment-increasing "oligopsony" effect and the employment reducing "exit" effect. The overall effect of a minimum wage depends on which effect dominates" (Bhaskar et al. 2002 p.169). The general conclusion is that a minimum wage set moderately above the market wage "may have a positive effect or negative effect on employment, but the size of this effect will generally be small because of the two countervailing forces" (p.169). The efficiency of wages theory propounds that higher real wages can, through various mechanism results in higher labour productivity. As a result, employers are frequently prepared to offer wage rates above the market clearing level attempting to balance increased wage costs against gain in productivity. The paying of efficiency wages above the market-clearing wage will depend upon the type of work involved. Workers who occupy skilled positions where the business has invested time and money and replacing it becomes costly, workers are likely to receive higher wages. Basically the efficiency wage theory relates to several dimensions such as nutritional, job shrinking, turnover and sociological factors (Riveros and Bouton, 1994). Akerlof (1984) argued that labour productivity might rise as a result of additional efforts made by workers if they regard their wages as a 'fair wage'. Brown (1999 p.2110) suggests that if employers respond to the minimum wage "by raising the effort standard they require on the job, employment effects may be magnified rather than mitigated". Another theory propounded by Pierre Cahue & Philippe Michel (1993), which is called minimum wage, unemployment and growth it is very close to human capital theory. It says that high minimum wages can have positive effects on growth rate and welfare by increasing the proportion of skilled workers. Fitzner (2006), a government economist, also confirms that "the minimum wage has not only significantly reduced the incidence of low pay, it has also helped contain wage inequality" (p.14). Likewise Lam et al. (2006), who work for ONS, write, "The NMW does appear to be reducing inequality at the bottom of the wage distribution". In the UK the previous system of minimum wage protection (abolished in 1993) via the Wages Councils (see Metcalf 1981) did not cover all workers or even many low paid sectors like care homes and business services such as cleaning and security. But the NMW, introduced in 1999, provides near universal coverage. As Brown (1999) puts it: "the uncovered sector may dilute but not eliminate the negative effects of the minimum wage on employment" (p.2104). There is considerable variation in pay across geographic areas in the UK. Therefore the introduction of the national MW affected the wage distribution much more in some areas than in others. Card (1992) notes that: "from an evaluation perspective, a uniform minimum wage is an under appreciated asset". Stewart (2002, p.584) has exploited this uniform MW coupled with geographic wage variation: "On the basis of the standard textbook model of the labour market, we would expect to see a relative decline in employment in low-wage areas where the minimum bit more deeply compared to higher wage areas where relatively few employees' wages were affected". Employment effects on minimum wages studied by Stewart's (2004a) and in his summary he states clearly that: "The estimated impact of the introduction of the minimum wage on the probability of remaining in employment is insignificantly different from zero for all four demographic groups (male, female adults and youths) and all three datasets" (p.96). The implied elasticities of employment with respect to the wage are tiny, all non-significant, and mostly positive. Stewart concludes that the evidence indicates: "no significant adverse employment effects of the introduction of the UK minimum wage in any of the four demographic groups considered or in any of the three datasets examined"(p.96). Since the introduction of the minimum wages in UK in 1999, there is little evidence to suggest that employees have responded by employing fewer workers. In fact unemployment rates have fallen. Stewart and Swaffield (2002) analyzed the hours of over 4500 workers aged 18-60/65 from the 1999 BHPS. The authors conclude "employees who had their pay increased due to the NMW have a higher probability [than workers whose pay was unaffected] of having reductions in their basic hours as a direct result of the introduction of the NMW". Connolly and Gregory (2002) in contrast to Stewart and Swaffield (2004) they: "find no evidence that hours worked amongst sub-minimum wage workers have changed significantly differently from those in the comparator group whose pay was unaffected; even where the change appears negatively signed it is not significant" (p.629). Some 1.3 million workers benefit from the minimum wages and there have been virtually no adverse effects on unemployment. Women, especially those working part-time, and many of who are lone parents and people from ethnic minority were the main beneficiaries of the NMW (LPC 1999, 2001). There would continue to be little effect if the minimum wages were rise substantially (e.g., from 4.50 pound to the council of Europe decency threshold of around 8 pound) (Sloman & Sutcliffe, 2004). Galindo-Rueda and Pereira (2004) analyzed minimum wages for eight separate low paying sectors: cleaning, hairdressing, hospitality, retail, leisure, security, social services, and textiles over years 1997-2001. Their two employment indicators were net creation of establishments and aggregate employment. Both these measures of employment increased in all sectors except textiles. Robinson and Wadsworth (2005) analyze whether the introduction of the NMW affected this incidence of second jobs and argue that the supply of jobs was not affected by the introduction of the NMW and, therefore, any change in the probability of second job holding represents a labour supply effect. Case studies of one or a few firms exist for most of the low paid sectors. Examples include hospitality (Adam-Smith et al. 2003), textiles (Heyes and Gray 2001a), hairdressing (Drucker et al. 2005), apparel (Undy et al. 2001) and Asian home workers in the clothing industry (Heyes and Gray 2001b). A survey of the findings concerning jobs from such case studies (Mason et al. 2006) "found no evidence of systematic adverse effects" (p.103). Conclusion: Now after discussing the various facets of minimum wages, we can conclude that minimum wages has affected various areas of demand-supply of labour and decision of wages, discussed above but several other factors also have the potential, which could be taken care of before deciding the minimum wages. The overall business environments, perceptions about a particular organization or geographical location or particular industry also have to be considered before deciding the minimum wages in the labour market. In general, Wage determination is one of the complex issues for the organizations because it ultimately decides the prices of the product/services but also minimum wage determination in one of the most complex issue, which has the potential to affect the whole labour market dynamics. Minimum wages could be attracting or distracting factor for choosing particular industry, of particular labour-force age group employment behaviour, particular job location. Concluding the evidence from various industries and firms across the whole economy and for the care home sector suggests a positive association between the NMW and productivity, but typically not statistically significant. Unfortunately it is impossible to generalize whether or not this apparent weak advance in labour productivity triggered by the NMW was the result of employment-reducing capital deepening or employment-stabilising work intensification and better work organisation. So different countries are adopting different practices for minimum wage determination. For example, we can observe that the new flexible working is becoming more prevalent in business in the UK. Flexibility is the way of prudent business all over the world, which is based around Total quality management that involves all employees, Eliminating waste through" Just in time' principle, Superiority of team work belief and collective efforts and finally functional and numerical flexibility to maintain high levels of productivity. These factors have been widely accepted as being important in creating and maintaining a competitive business in a competitive market place, within the European union, UK has been one of the most successful in cutting unemployment and creating jobs. Much has been attributed to increased labour market flexibility. **************************************************************** References: 1. Mittchell, B.R. Employment in different sectors of the UK economy, European historical statistics, Macmillan and Labour market trends, National statistics, various editions. 2. Dickens, R. and Manning, A. 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