3 - The impact of higher wage floors on labour markets

Summary

The exchange of a person’s labour for a wage is a voluntary transaction between a worker and an employer at an agreed price. If the price is artificially set at a higher wage rate than the employer is willing to pay, the employee will not be hired. This simple truth causes some free market economists to argue against any “wage floor” (a minimum or living wage) that seeks to adjust wages according to any criterion other than the free operation of the labour market. To do so risks destroying jobs.

While that is the conclusion of neoclassical economic theory (on which prevailing modern economic models are based), many economists have suggested that in practice, the world is not that simple. The way that wages are actually fixed only imperfectly reflects what firms could pay for labour and still make a profit. The bargaining power of workers and employers is unequal. In some cases the ability of workers to move to higher-paying jobs if their work is undervalued (as market theory would predict) is restricted, sometimes because their firm is the only one hiring for a particular job type in a local area. Moreover, even if as the theory predicts, a rise in wages causes a fall in employment levels, the size of these effects needs to be taken into consideration. In 2015, the UK government announced a large increase in the minimum wage for over-25-year-olds by 2020. It estimated that this would eventually result in pay rises for six million workers, but reduce jobs growth by 60,000 (Office for Budget Responsibility 2015: 204). If that proves true, for every hundred people whose pay increases, one job (which does not yet exist, but theoretically would have by 2020) will not be created. Many people might think this is a reasonable way of improving workers’ lives overall, rather than insisting that no pay increase can ever be worthwhile if it means fewer jobs.

This chapter considers the effect of wage floors on the labour market. “Wage floor” is here taken to mean any minimum pay rate that is agreed or enforced outside the context of market bargaining.