We’ve all heard some variation of the minimum wage debate before. People often talk about what workers deserve; a living wage that provides an acceptable standard of living—that it’s something everyone has an inherent right to. Economic conservatives, however, have long defended a low minimum wage, claiming that government action in the economy will lead to higher unemployment and a weaker economy.
As a result, the two sides of the debate argue too often on different fronts. A moral argument is being made for increasing the minimum wage, while an economic argument is being made against it. Today, I want to make an economic argument for a higher minimum wage and discuss why—in almost all cases across the developed world—government intervention to increase the minimum wage would be good for the economy.
Classical Theories
Classical economic theories have boiled economics down to one deceivingly simple idea: supply and demand. For example, if more people want something, but the amount that exists remains the same, the price will go up. This applies to everything we buy or sell on any kind of market—and that includes the labor market.
In the labor market, especially for low-skilled jobs, there is also supply and demand. Here, firms demand labor, while workers supply it to the market. The “price” of labor is the wage that firms pay.
The idea here is that if wages are too low, the supply of labor—the number of people willing to work for that much money—will drop. Remember, companies still need to hire employees, so they’ll raise wages until more people are willing to work for that much.
Basically, the classical theory asks workers, “If wages are too low, why don’t you just stop working and force companies to raise wages?”
But, alas, things in the real world aren’t actually this simple.
Oligopsony Power
The major flaw in this theory is that it assumes perfect competition and “rational actors”. Primarily, it assumes that if wages are too low, most workers will just refuse to work until wages go back up. In the real world, this really doesn’t happen—most people would rarely choose not to work over working for low pay. People still have bills to pay and families to provide for. Something in their bank account is better than nothing.
Workers are often powerless at the hands of large companies. Because people have to work to survive, firms can collectively say, “We will only pay you this much. Take it or leave it.” And most people will just take it, looking at their upcoming bills and believing that they’re powerless to change anything.
This is the idea of oligopsony power. An oligopsony just means that there are a limited number of employers, and collectively, they can exert power over workers due to a lack of competition. If all major employers in a large region, hypothetically, say that they’ll only pay $10 an hour, workers can’t do anything about it. They can’t find another firm to work for because they all pretty much pay the same. They’re practically forced to accept a low wage.
Now, some readers might be thinking about strikes, where all workers stop working and demand higher wages. While it’s true that some strikes are successful, in the majority of cases, it’s very difficult to try to get everyone to take a short-term loss of income for a long-term increase in pay. People recall all the bills they have due soon and they’d rather work than participate in a strike and lose income.
So Why Higher Than It Is Right Now?
In most countries, the minimum wage right now is so low that firms are still exerting oligopsony power over workers.
Even in Alberta, which has some of Canada’s highest minimum wages at $15 per hour, the true equilibrium in perfect competition is still much higher. That means that if workers were able to stop working—to a certain extent—until wages are increased to a reasonable, desired level, the pay for a job that’s currently at minimum wage would actually be significantly higher.
Since workers lack the power to prevent wage setting and foster greater competition in the labor market, the government must act to do so and minimize an imperfect market. The government must step in to raise the minimum wage.
What about Jobs? Unemployment? What about Small Businesses?
Right now, many large companies can easily take an increase in wages—they are already making a significant profit due to market control. Since these companies still need employees, the number of people who will lose their jobs wouldn’t be very high.
Are there people whose work could be rendered unnecessary, allowing the company to lay them off? Potentially. Remember, though, that companies are already incentivized to cut down on their costs and not employ anyone who isn’t necessary to their business. So ultimately, unemployment should not be an issue here.
But what about smaller businesses that are just scraping by? For small businesses, a hike in the minimum wage could mean letting go several employees, or else they would be forced to take a loss. This presents a serious problem, but we’re also forgetting something very important: increasing the minimum wage also means that people will be spending more money.
With higher incomes (especially with higher disposable incomes), people will visit more shops and buy more things. That increases the revenue of pretty much all businesses, including smaller ones. In the long run, rather than taking a loss, all firms would be able to keep all their current employees; they’re profits, indeed, may actually increase.
In fact, one of the most well-known studies on the minimum wage, conducted by economists David Card and Alan Krueger in 1992, concluded that when the minimum wage went up, employment actually also increased. That’s because when wages go up, spending goes up, more money flows around the economy, and firms’ revenues also go up. They can now afford to hire more people, even at higher wages.
And the Government?
With a higher minimum wage, government spending will likely go down, since fewer people will be reliant on government financial support programs like income assistance. That means more tax money will go towards other projects, like building infrastructure or paying for healthcare and education.
Overall, the economy should not suffer due to a minimum wage hike. Government revenue, therefore, would not be negatively affected.
Moving Forward
It’s difficult to put these ideas into concrete terms. I talk about a “higher” minimum wage, but I don’t really elaborate further on a number. The truth is, this type of speculative reasoning in economics is often nebulous and imprecise. The real world seldom works in such predictably obvious ways, and it will always be a challenge to calculate what a “proper” minimum wage should truly be.
So although I said at the beginning that I would set aside the moral argument, it is also important not to forget it. Completely disregarding economics, we have to remember that many people in the world aren’t able to live on what they’re paid, even though in a perfect world they should be. That’s also something to think about.
