The theoretical prediction that minimum wages reduce employment is a simple and general one arising from a presumption that the minimum wage is set above the market clearing level that would be determined in a competitive labour market.
Until April 1999 the UK never had a legally enforceable minimum wage. In that respect it used to stand out from other European countries. France, the Netherlands, Luxembourg, Spain and Portugal have national minimum wages set by the government. The Scandinavian countries along with Belgium and Greece have a national minimum wage set by collective bargaining. Denmark, Germany and Italy have different, negotiated minimum wages for different sectors of the economy covering virtually all workers in those sectors. In Japan minimum wages are negotiated at the regionallevel whereas in the USA and Canada there are both national and regional minimums.
Prior to the introduction of a national minimum wage, the UK provided wage protection for around 12 per cent of the workforce through Wages Councils, which had been established in 1909, composed of employer and employee representatives. In 1986 Wages Councils, which recommended minimum wages for young workers (under 21) were abolished, with all Wages Councils removed by the end of 1993. These Councils had no statutory power and it is doubtful that they ever had any disincentive effect on employment. In a study of the Agricultural Wages Boards for England, Wales, Scotland and Northern Ireland, Dickens et al. (1994b) found that they did raise wages and increase income equality for agricultural workers. However, the study concludes that there is 'no evidence that minimum wages have significantly lowered employment in any country', indeed they might have even preserved agricultural employment (p. 20). For the USA, Kennan (1995) demonstrates that the 17 increases in the US federal minimum wage between 1939 and 1991 have averaged 12 per cent. Yet even with the per hour federal minimum wage rising from the gap between the minimum wage in real terms and average hourly earnings is greater than in any previous period except perhaps the late 1980s (Kennan (1995 p. 1955). A further two 45 cents increases took the federal minimum wage up to $5.15 by September 1st 1997. Overall the correlation between minimum wages and employment in the USA is low, insignificant and sensitive to the sample period.
On 1 April 1992 the state of New Jersey increased its minimum wage to $5.05 per hour, while Pennsylvania kept to the federal minimum of $4.25. Contrary to the standard prediction, fast-food restaurant employment actually increased in New Jersey and fell in Pennsylvania. Card (1992) examined what happened when in July 1988 the minimum wage in California rose from $3.35 to $4.25 per hour. The employment rate for California teenagers rose relative to states with no increase in minimum wages between 1987 and 1989. Card and Krueger (1995) conclude their re-analysis of US studies by stating that 'the bulk of the empirical evidence on the employment effects of the minimum wage…suggest that increases in the minimum wage have had, if anything, a small, positive effect on employment, rather than an adverse effect' (p. 236). Keil et al. (2001) dispute this by producing results that show that rises in the US minimum wage during 1977-95 tended to reduce total employment. They calculate total employment elasticity to the minimum wage to be -0.11 in the short term, with a greater responsiveness of -0.19 in the long term.
For the UK, Dicken et al. 's (1994a) study of the impact of Wages Councils finds that 'counter to the conventional economic model, increases in Wages Council minimum rates of pay were associated with improved employment in the 1978 to 1990 time period' (p. 25). Machin and Manning (1996) report that since the Wages Councils were abolished wages appear to have fallen yet there have been no employment gains (p. 672).
In practice firms in the labour market offer workers different wages for what is essentially the same job. Low pay firms may well find themselves facing tight labour supply constraints compared to better paying firms. It may well take an increase in the minimum wage to force the low pay firms to offer higher wages and thereby attract an increase in labour supply and employment. If we adopt this approach then there are no simple and general predictions about the impact of minimum wages on employment in theory, and experience should teach economists to keep an open mind about the implementation of minimum wages.
It is interesting to compare the level of the UK's first national minimum wage, which the Labour Government introduced in 1999, with minimum wages in some other OECD countries. Experience from the USA suggests that a minimum wage, which is not particularly generous (38 per cent of average earnings), with no automatic increases does not adversely affect employment. Even after the 1997 increases, the federal minimum wage is worth less in purchasing power (in terms of the goods and services that it can buy) than it was in 1961. Figure 3.17 contrasts the nominal with the real value of the US federal minimum wage over the period 1960-2001. Note that whilst the nominal value of the minimum wage has risen from $1.00 per hour to $5.15 over that period, the effect of consumer price inflation has been to reduce its real (constant 1999 $) value from $5.18 to $4.85.
The US minimum wage does not appear to have had any impact on reducing income inequality, which has increased steadily since the late 1960s. By contrast the French minimum wage (the SMIC) is increased automatically in line with inflation and the rise in manual workers earnings, making it much more generous than the US minimum wage at 57 per cent of French average earnings. This appears to have played a part in holding virtually constant income inequality in France across the 1980s. However, there may have been adverse employment effects for young workers in France. Using US data for the period 1977-95, Keil et al. (2001) find that changes in the minimum wage have an elasticity on youth employment of -0.37 in the short term and -0.69 in the long term. This is in line with Burkhauser et al.'s (2000) conclusion that US 'increases in the minimum wage during the 1990s led to modest but statistically significant declines in teenage employment' (p. 676). They estimate the elasticity of teenage employment to minimum wage changes to be in the range -0.2 to -0.6. More generally the OECD (1998) Employment Outlook concluded, 'a rise in the minimum wage has a negative effect on teenage employment' (p. 47). Brown (1999) concluded that 'evidence suggests that the short-term effect of the minimum wage on teenage employment is small …centred on an elasticity of -0.10' (p. 2154). The UK appears to have drawn upon this international experience by setting the initial minimum wage at 44 per cent of average earnings, making it markedly less generous than other European minimums, with the exception of Spain. It also contained a lower minimum wage rate for younger workers aged 18-20 years old of £3.20 per hour compared to the adult (21 years plus) rate of £3.60 per hour in 1999.
Whether minimum wages are an effective means of combating poverty is debateable. Burkhauser et al. (1996) estimated that only around 20 per cent of the earnings increases brought about by the 1990-1 rises in the US minimum wage went to poor families. Addison and Blackburn (1999) concluded that while increases in US minimum wages did reduce poverty in the 1990s, especially for high-school dropouts, this was not the case during the 1980s.
In terms of personal characteristics, low pay was more common among female workers and manual workers. It was more of a feature of young workers. There was not too great a difference in the incidence of low pay between white and ethnic minority workers. One quarter of part-timers were on low pay and low pay was more of a problem for single parents. Low pay was more common in private sector and non-unionised establishments. The greatest incidence of low pay was to be found in the hospitality, retail and wholesale trade sectors. It was not a particular feature of large firms whereas one in five workers in small establishments were low paid. Although there is no automatic mechanism for changes in the UK minimum wage, the Government has increased it to £4.10 for adults and £3.50 for younger workers from October 2001.
According to Metcalf (2002), the minimum wage was expected to benefit mainly 'females, part-timers, youths, non-whites, those with short tenure, single parents and those with no other worker in the household' (p. 8). Given the fact that there do not appear to have been substantial adverse employment effects arising from the introduction of the minimum wage in the UK, and following the Conservative party dropping its opposition to the national minimum wage it looks set to become a permanent feature of the UK labour market. It should help those households at the bottom of the income distribution and so contribute to the growth of income equality. But its impact on poverty will be limited by the fact that the majority of poor families tend to be workless households.
Addison, John T.; Blackburn, McKinley L., (1999), “Minimum wages and poverty.” Industrial and Labor Relations Review. Apr, 52, (3), 393 – 409.
Brown, W., (1999), Low Pay Commission Research. British Universities Industrial Relations Association Newsletter. Issue 26. April.
Burkhauser, R., (2000), A Review of Recent Evidence on the Effect of the Minimum Wage on the Working Poor. International Seminar on Minimum Wages. Low Pay Commission: Occasional Paper 4. January.
Burkhauser, R.V., M. Smeeding, and J. Merz (1996), “Relative Inequality and Poverty in Germany and the United States Using Alternative Equivalence Scales,” The Review of Income and Wealth, 42, 381-400.
Card, David and Alan Krueger. (1995), Myth and measurement: The new economics of the minimum wage. Princeton, N.J.: Princeton University Press.
Card, David. (1992), “Using regional variation in wages to measure the effects of the federal minimum wage.” Industrial and Labor Relations Review. Vol. 46, No. 1, pp. 22-37.
Dickens, R., Machin, S. and Manning, A. (1994), ''The Effect of Minimum Wages on Employment: Theory and Evidence from Britain'', Centre for Economic Performance, Discussion Paper No. 183.
Keil, Manfred, Donald Robertson, and James Symons. (2001), “Minimum Wages and Employment.” CEP Discussion Paper No. 0497 Centre for Economic Performance, London School of Economics.
Kennan, J. (1995), The elusive effects of minimum wages. Journal of Economic Literature 33: 1949-1965.
Machin,S. and Manning, A. (1996), “Employment and the Introduction of a Minimum Wage in Britain”, The Economic Journal, Vol. 106, pp. 667-676.
Metcalf, David (2002), The National Minimum Wage: Coverage, Impact and Future*. Oxford Bulletin of Economics and Statistics 64 (supplement), 567-582.