Category Archives: Minimum wage

Whoever won the debate, economics lost


You lose


Hillary Clinton

Investment vs spending






Tax the rich




Figure 1


Source: World Bank and the Tax Foundation



Figure 2


Source: World Bank and the Tax Foundation






Nouriel Roubini wrote


Thomas E Woods writes


The gender wage gap and the minimum wage 






Donald Trump

Corporate Tax






Monetary policy




This echoes something I wrote three years ago





Shortly afterwards I wrote



International trade


I recently wrote







The verdict



The economics of the minimum wage

Minimum wages are a popular topic. Barack Obama proposes a nearly 40% increase from $7.25 per hour to $10.10 and David Cameron has faced calls from some of his own backbenchers to raise Britain’s minimum wage of £6.31 per hour for over 21s. What are the economics?

A wage is the price of labour. At a given price/wage (W1) a certain amount of labour will be purchased (L1). We can show that with the following chart

Many argue that we can make people better off by either setting minimum wages or raising those that there already are. But what are the effects of this? Put another way, what is the effect of raising the price of labour? We can show that with the following chart

As with anything, if you raise its price the quantity of it demanded falls (caveats discussed below); there is less employment, in other words. As economists Paul Krugman and Robin Wells put it, “when the minimum wage is above the equilibrium wage rate, some people who are willing to work  that is, sell labor  cannot find buyers – that is, employers willing to give them jobs.” (Krugman and Wells 2008) Indeed, most supporters of higher minimum wages tacitly accept this. When you ask them “If raising minimum wages makes people better off, why not raise them to £/$50 per hour?” they generally reply “Don’t be so silly”. Well, indeed. A minimum wage that high would be unaffordable for many employers and unemployment would increase.

But by acknowledging that at a higher price a lower quantity of labour will be demanded they are acknowledging that the demand curve for labour slopes downwards as shown in the following chart

But if the labour demand curve slopes downwards between £/$50 per hour and the current minimum wage why would anyone assume that it doesn’t continue to slope downwards below the minimum wage? In other words, might we not see an increase in employment if we reduced the minimum wage (in real or nominal terms) or eliminated it? At that point the conversation often moves to whether people should be able to hire/work at those lower wages, a question outside the scope of economics.

Now for those caveats. I recently asked some friends whether they would continue to buy the same amount of something if its price went up 25%. One answered “Well, cigarettes pretty much have (over a comparatively short time), and I pretty much have continued to buy them. But I admit that my sickness at having to pay that much for my brand has now driven me to tobacco during the week and the odd cigar at the weekend now (rather than the fiver per day for a pack of Embassy)”

What my friend Miguel has identified here is the notion of elasticity, the change in the quantity of something demanded resulting from a change in its price. If the quantity of something demanded varies greatly with changes in price then demand is ‘elastic’, if the quantity demanded changes very little (or not at all) with changes in price it is, like Miguel’s cigarettes, ‘inelastic’. We can show an inelastic demand for labour with the following chart

Here, with the steep curve given by the inelastic demand for labour, a large rise in the wage from W1 to W2 gives a comparatively small drop in employment, from L1 to L2.

But is labour demand inelastic? One of the factors determining elasticity is the availability of substitutes. If nothing else can fulfil the role of the good which is rising in price you will have to pay more (up to a point) but if something else will do well enough you will switch to buying that instead. And there is a substitute for labour; capital, the price of which is falling thanks to technological innovations just as people campaign to raise the price of labour. In a supermarket lately you might have used a machine to scan your own shopping. Those machines are direct substitutes for the labour of checkout staff. Or, as a meme humorously put it recently,

Another friend replied “Depends on the price to start with, the income of the person and their lifestyle. If Nigella Lawson was on a fixed rate water bill and it went up 25% then I think we can be pretty certain she would buy and consume the same amount.”

Indeed, as Tom says, rises in prices are felt differently by different people – and companies. Raising the price of labour by 40% might not have much of an effect on a big business operating on wide profit margins but it would be crippling for a smaller business with its much thinner margins. It’s curious that many supporters of ‘Buy Local’ also support minimum wage policies which give big businesses a crushing competitive advantage over smaller businesses.

So much for the theory, what about the practice? An extensive review of studies into the effects of minimum wages carried out in 2006 by economists David Neumark and William Wascher (Neumark and Wascher 2006) found that


Neumark and Wascher updated and expanded this study in their 2009 book Minimum Wages (Neumark and Wascher 2009), concluding that


A fitting conclusion here also.


This article originally appeared at The Cobden Centre

The real Iron Law of Wages

Lots of labour, little output

One of the oldest fallacies in economics is that the amount of work done should be reflected in the amount of pecuniary reward received for doing it. How can it be fair that someone who slaves away for hours slicing kebab meat in a kitchen on a sweltering day earns £6.19 per hour while someone who kicks a football around for a few hours a week gets £2,040 per hour?

In fact, the amount of work we do is not commensurate with how much we are paid. Nor should it be. In the late 18th century for every bit of effort the average Indian textile worker put in he or she was paid just one sixth of what a British textile worker was paid for the same amount of effort because the British worker, with their greater capital stock, produced six times as much with that given amount of effort. Whatever our gut reactions, what wages reflect is not the ‘effort’ of the worker but their output and the market’s and the employers subjective valuation of that output.

When deciding whether or not to hire, and at what wage, an employer will only employ that person if  they think doing so will add more to turnover than to costs and they will not pay that person more than he or she is expected to add to turnover. To pay more would mean that that the employer is paying to employ that worker. This is the real Iron Law of Wages.

If a landlady has to pay £100 per week to hire a barman she will hire him if she expects doing so to add more than £100 per week in revenue. If hiring that first barman adds £150 per week to turnover, and a second barman (because of diminishing returns to labour) adds £140 both will be hired. If hiring a sixth barman adds £100 in revenue and hiring a seventh barman adds £90, then the landlady will hire six barmen at £100 per week.

If, however, a minimum wage is introduced which raises the cost of hiring a worker to £115 per week the fifth and sixth barman are now being paid more than they generate in revenue, their marginal product, so they will be laid off. The first four barmen are £15 a week better off, five and six are looking at their P45s.

The lesson is that raising minimum wages, as the Conservatives are now rumoured to be considering, makes some people better off but they also make some people worse off.

Some will deny this and say that the mass job losses predicted when the minimum wage was introduced never materialised. But what about the jobs never created? Number seven in our example who was never employed lost a job just as surely as did barmen five and six when the minimum wage was raised. Indeed, many advocates of higher minimum wages implicitly admit this by not pushing for a much higher minimum. Doing so, they admit, would lead to unemployment. But they can never explain why, if the demand curve for labour is downward sloping at one point, it is not so at another.

The only way to raise wages is to raise the marginal productivity of labour. To make labour more productive we either need to train it better (sending one of our barmen on a cocktail course so he can entice a lager drinker to splash out on a Pina Colada) or give it more capital to work with as in the textile example (optics on spirits bottles as opposed to measuring cups).

Sadly there is reluctance in Britain to pursue either of these paths. Our education system has been slipping compared to those in other nations and our financial system, with its addiction to low interest rates and focus on consumption, is inimical to capital accumulation. If the government is worried about low pay it needs to get serious about these issues. They are fundamental questions and attempts to mollify their symptoms with minimum wages are a waste of time.

This article originally appeared at The Cobden Centre