1

Free Markets and

The Minimum Wage

Philosophy and TradeElad WIND, May 2010

2

The Price SystemAdam Smith in The Wealth of Nations:

Prices emerge from voluntary transactions between buyers and sellers, each seeking his own interest such that everyone is better off.

Milton Friedman: “The price system works so well, so efficiently, that we are not aware of it most of the time. We never realize how well it functions until it is prevented from functioning, and even then we seldom recognize the source of the trouble”

The Invisible Hand • The price system is a mechanism that performs this task without

central mechanism.

3

The Role of Prices

Prices hold three inter-related functions:1. Transmit Information2. Incentive to adopt the least costly methods

of production3. Distribution of income

4

Minimum Price Surplus• Price floor – set above the market

equilibrium • Destroys the clearing and allocating function

of prices• Consumers – faced a higher price for the

same product, reduce purchases or even drop out of the market entirely.

• Suppliers – guaranteed a higher price, increase production.

• Surplus – a short run excess of supply is inevitable. An economic waste.

• Even worse, fixed prices signals to engage inappropriate economic activity that tends to aggravate the original situation.

5

Market Intervention ExampleUS gasoline ceiling price• President Nixon set maximum prices for

gasoline in 1973

Quality Deteriorates• Dealers sold gas on a first-come-first-served

basis• Drivers queued in long lines, a sight not to be

seen until then.

Black Market Evolves• Gasoline was held for friends, preferred

customers, the politically well connected and… those who were willing to pay a little cash on the side.

6

The Labour Market

Uncomfortably, behaves like every market.

Wishes are tempered by the reality of competition.

When you get a clogged drain• Most of us will call plumbers • We hire the one who quotes us

the lowest price.

When quotes are too high?• Most of us will grab a plunger and

a wrench, and give it our best.

• Labor markets is the combination of rational beings such as ourselves -high prices keep us at home.

Workers• Greedy

Employers• Stingy

7

Minimum Wage Intervention

Governments set the minimum wage out of noble intentions:

• Give low-skilled workers an advantage • Make life easier for the poor• US Fair Labor and Standards Act of 1938:

to provide for “the maintenance of the minimum standard of living necessary for health, efficiency, and the general well-being of workers.”

8

Min’ Wages in the Developed World

Countries w/o wage control:Brunei, Denmark, HK1, Norway, Singapore

Wage bargained by unions:Austria, Finland, Germany, Iceland, Italy, Sweden

Rates for example:FR: €8.82 / hourUS: $7.25 / hour, Federal2

1 – Minimum wages apply only for foreign labor2 – States and districts may set it higher

9

For Minimum Wage

10

Arguments For Minimum Wage

• A subset of consumers do raise their income as a cause:The benefits of the poor outweigh the added unemployment.

• Past experience: the unemployment effect is mostly on teenagers.

• Protect adults from teenagers willing to work for less.• Uncontrolled businesses have the power to abuse the labor.• Assures a minimal income to survive and pay the bills.• To raise the living standards and spending power of

individuals.• As a reflex: minimum wage law is seen as siding with labor,

siding with the poor, the underdog

11

Against Minimum Wage

12

Why not $100?

If minimum wage can be set arbitrarily, why stop at $7.50? Why not $100?

The principle remains at lower levels:• Wages are a function of productivity not

whim• A minimum wage set above workers'

productivity harms the intended beneficiaries

13

Low Skilled Workers Are Hurt

"Don't give a beginner a chance."Low-skilled workers compete for employers’ dollars with:

1. Skilled workers

2. Capital investments in technology– A receptionist invest in an automated

answering system – Fast-food served on paper and plastic hire

dishwashers

UnS S

14

Bouncing Up the Ladder

Jobs are means to improve skills

• Wages are tightly coupled with skill

• High minimum wage prevents from getting entry-level jobs

• Thus never develop the skills necessary

Minimum wage is set to support a family• Do young need to earn a wage as high?

“As a display of our compassion, we’ve raised the minimum wage! You’re welcome.”

15

Minimum Wage AbusesLobbies• Often unions and strong firms justify a raise in the min’ wage

– Strong firms suffer less from a rise in costs– A bigger portion of a smaller pie.– Unions know: an increase in min wage will lead to further raises

Compensate for Inflation• Indexing of the minimum wage to the inflation • Retain real spending power • But, production costs raise again

Public pressure • “it’s time that the government did something”. • Public tends to blame market failure on the free market and

16

A Comic Relief

17

To Conclude

• Interferences with the price system lead to unintended and unexpected consequences.

• The only way to increase wages is to increase worker productivity and to ease the inferred costs of running businesses