Minimum wage myth

April 3, 1998

ECONOMISTS' traditional opposition to a statutory minimum wage is misguided, according to a new theory presented by Warwick and St Andrews University researchers to the conference.

Evidence is emerging to contradict the economic theory that a minimum wage hurts profits and in particular forces small firms out of business, reducing employment opportunities.

Ted To and V. Bhaskar in their paper, Minimum Wages for Ronald McDonald Monopsonies say: "Economists have long recognised that a minimum wage can raise employment if a firm is the only employer in a local labour market. But it can also happen where there are many small firms as, for example, in the fast food industry."

The monopoly argument holds that just as a seller with a monopoly sets the price of their product too high, so the same monopoly sets wages too low.

"As people offered low wages are not willing to work, so a small increase in the minimum wage can have positive effects on employment," says Dr Bhaskar.

The paper argues: "It is difficult to believe that an industry as competitive as the fast food industry can be thought of as a monopsony (or monopoly). Nevertheless, insights from monopsony do carry over to cases where there are many small employers."

In particular, as not all jobs are the same, employers have some leeway in setting wages: "This gives them some market power and their behaviour subsequently resembles that of a monopolist."

To and Bhaskar say that their analysis explains recent research findings. In particular, a landmark study of a 1992 increase in the minimum wage in the fast food industry in New Jersey identified a subsequent slight rise in employment.

The government, with its welfare-to-work policies, has accepted the idea, Dr Bhaskar says.

"The government is trying to increase the incentives for people to work rather than claim benefit. In the budget, the chancellor reduced the rate of tax on low-paid workers. Tied to their plans to introduce a minimum wage, they obviously expect it will increase employment."

The size of the minimum wage is crucial, he adds. "The trade unions have called for Pounds 4.25, which business says is too high. Business has called for about Pounds 3.00, which the trade unions say is too low. Both of these are a bit off the mark."

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