Readers Question: What are the factors that influence the fixing of a minimum wage?

• The UK’s first National Minimum wage was established in 1999 and was set at £3.60 for those over 21.
• It was feared by business that a minimum wage would cause unemployment.
• However, over the period between 1999 – 2007, in the UK unemployment fell from 6% to 5%, despite successive above inflationary increases in the minimum wage.
• Between 2007-11, unemployment increased because of the recession. Some economists argued the UK minimum wage was too high for the economic environment.

In 2011, the UK Minimum wage is set at:

• £5.93 – the main rate for workers aged 21 and over
• £4.92 – the 18-20 rate
• £3.64 – the 16-17 rate for workers above school leaving age but under 18
• £2.50 – the apprentice rate, for apprentices under 19 or 19 or over and in the first year of their apprenticeship.

Factors That Influence the Setting of the Minimum Wage

1. Equilibrium wages

In theory, if the minimum wage is set above the equilibrium wage rate it will cause unemployment and demand for labour falls. Therefore, the government will seek to work out the equilibrium wage rate that firms will be willing to pay. If minimum wages are increased substantially above the competitive equilibrium it can cause ‘real wage unemployment’.

2. Economic Growth

Unemployment is cyclical in nature. During economic expansion, firms’ demand for labour increases and they will be willing to pay a higher wage. However, in a recession, there is often stagnant wage growth and firms are more reluctant to employ labour. Therefore, some argue, in a recession it is a mistake to increase the national minimum wage rate as this will add to the unemployment problem. However, when the economy is growing e.g. 97-07, increases in minimum wage don’t cause unemployment.

3. Are Firms Exploiting Workers?

The theory of monopsony suggests that firms with market power can pay wages below the equilibrium level. A minimum wage can counterbalance this monopsony power and therefore, wages can be increased without causing unemployment. If firms have significant market power in paying low wages, a minimum wage can be introduced without causing unemployment.

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A two speed Europe refers to how, within the EU, economies are growing at different rates and are at different stages in the business cycle. For example, countries in the core of the Eurozone (Germany, Netherlands, France) have seen relatively good recovery since the recession. In these countries, unit labour costs have remained competitive, enabling a low current account deficit or even surplus.

On the other hand, another group of European economies (you could refer to them as the PIGS – Portugal, Ireland, Greece and Spain) have seen slower growth, higher unemployment and a tendency to have a current account deficit.

The problem of a two speed Europe is exacerbated by having a common monetary policy (same interest rate, same exchange rate and same policy on quantitative easing). This means it is difficult for economic policy to appease both different economic regions.

UK and Eurozone

This graph shows that the UK’s economy has mirrored the average growth rate of the Eurozone closely between 2005 and 2012.

However, it is worth bearing in mind that since 2007, the UK has pursued quite different economic policies to the Eurozone.

• 20% depreciation of Pound against Euro
• Policy of Quantitative easing. (increasing money supply)
• Fiscal expansion, (at least until 2010) since when it has been reversed.

I think it would be fair to say, the UK has managed to have the same growth as the Eurzone, precisely because it wasn’t in the Euro. The credit crunch hit the UK economy harder because of our exposure to financial sector but with greater flexibility we were able to reduce the depth of the recession.

Economic Growth of Selected EU countries

This shows that there is much greater divergence with a wider variety of economies. I took these statistics on growth forecasts from OECD site very recently. However, the forecasts for Irish growth look very optimistic given current state of Irish economy.

Unemployment in Europe

Looking at unemployment rates, the gap between different countries looks even more significant. Unemployment is one of the most pressing social problems (or should be if the ECB didn’t worry too much about inflation) This shows peripheral members of the EU like Spain, Greece and Ireland have a significant unemployment problem which has increased sharply since 2007. Yet, the ECB talks of inflationary concerns in Germany.

This is the most concerning issue within the Eurozone. Peripheral members struggling because of spending cuts and overvalued exchange rates. Yet, there is little macro economic policies to help deal with this negative output gap.

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