The National Minimum Wage

Should the UK’s national minimum wage increase or decrease? What is the minimum wage? This is a yearly debate in the UK and most countries. There aren’t any easy answers. This article will give you some tools to evaluate the benefits and drawbacks of a minimum wage and it will help you analyse if an effective minimum wage is possible.

What is a national minimum wage?

The national minimum wage is different from the living wage. It is calculated on the proportion of the median income earnings. The living wage is calculated based on the amount of money people need to get by.

The current minimum wage depends on the person’s age:

Effects of a minimum wage on labour markets

The effects of a minimum wage depends on the type of labour market.

There is a large pool of workers in an unskilled labour market, so it is very competitive. There are relatively few barriers to entry and employers can easily replace workers. Because of that, workers are sensitive to wage changes. A minimum wage in an unskilled labour market can ensure that employers pay workers fairly and not exploit them.

Fig 1. - Minimum wage in an unskilled labour market.

A minimum wage can benefit existing workers in an unskilled labour market. However, as illustrated in Figure 1, it results in fewer job vacancies in the market because Qs is greater than Qd. Thus, it can create unemployment, affecting unskilled workers actively seeking employment.

However, in a skilled labour market, a minimum wage won’t affect this particular labour market. This is because firms are happy to operate above the national minimum wage. You can see this in Figure 2 below. As the equilibrium wage is higher than the minimum wage, there is no change in the workers’ wages in this market.

Fig 2. - Minimum wage in a skilled labour market.

If firms refuse to pay above the minimum wage in a skilled labour market, workers will look for alternative job opportunities to be fully compensated for their labour.

Advantages of a national minimum wage

Many people argue that the minimum wage is a good idea for the following reasons:

• Reduces relative poverty: a minimum wage provides an appropriate income level for the lowest paid. These workers will have more income to improve their standard of living and thus reduce relative poverty.
• Increases productivity: according to the ‘efficiency wage theory,’ a high minimum wage can help create an incentive for people to work harder increasing their labour productivity.
• Increases incentive to look for employment: a minimum wage creates an incentive for the unemployed to get a job to earn an income. This will reduce a country’s unemployment rate. Firms gain more workers, which will increase their output and their profit.
• Boost economic growth: a high wage will create more disposable income for consumers and they will spend more in the economy. This consumer spending will boost the aggregate demand in the economy.

Disadvantages of a national minimum wage

Many people argue that the minimum wage is a bad idea for the following reasons:

• Increased labour costs: a minimum wage can increase the labour costs for some firms. They can pass these higher costs onto consumers through higher prices to cover the increase in labour costs.
• Increase inflation: a minimum wage stimulates an increase in inflation due to the increased spending powers of workers.
• Increased unemployment: labour costs are one of the major costs for firms, so a minimum wage could cause firms to cut jobs to keep profits. This would increase unemployment in a country and place a burden on the welfare state.
• Regional differences: the minimum wage could be too low in some regions. For example, London has higher living costs than other areas in the UK. A national minimum wage could be too low for a worker in London.

Effective national minimum wage

The impact of a minimum wage depends on where it is set. If the government is to set an effective minimum wage, they must consider a number of factors. Some of these factors include:

• Economic climate: if the economy is experiencing strong economic growth and low and stable unemployment rates, firms will be more inclined to pay higher wages. In this case, a higher minimum wage would be effective.
• Regional disparities: the cost of living differs across the UK. A minimum wage may be effective in the North of the UK but might not work in London. An effective minimum wage would account for regional differences.
• Elasticity of demand: in an unskilled labour market, demand for wages is inelastic. Any change in wages will affect employment as firms are very sensitive to wage changes.

The national minimum wage in the UK

The national minimum wage was introduced in April 1999. Before the introduction of the national minimum wage, there were a variety of systems to control wages. However, these were only focused on specific industries.

The national minimum wage was introduced due to the weakening of employees’ bargaining power and the growth of low pay employments, specifically in the service sector.

Since its introduction, the minimum wage’s impacts on the UK’s unemployment have been negligible. The UK’s unemployment levels have been naturally low, but they increased slightly due to the 2008 Financial crisis and the 2020 Covid pandemic.

Minimum wage trends in the UK

In 1999, the minimum wage for those aged 21 and over was £3.60. For those under 18, it was £3.00. Generally, the minimum wage increases annually. The table below shows the increase in the minimum wage over the last five years.

Annually, the UK’s national minimum wage increases to keep up with inflation and rising living costs.

Macroeconomic impacts of the national minimum wage

To conclude, let’ look at how a minimum wage can have an impact on a macroeconomic scale.

The minimum wage largely impacts the poorest in society. They earn more once there is a minimum wage. As they have a high MPC (marginal propensity to consume), consumption will increase, causing aggregate demand (AD) to shift outward. This leads to economic growth and higher employment as illustrated in Figure 4 below.

Fig 4. - Macroeconomic impacts of a minimum wage.

However, labour costs for firms increase as well, causing the aggregate supply (AS) curve to shift inwards. Higher labour costs will lead to UK domestic firms seeing a decrease in competitiveness. This would negatively affect the trade balance as other countries will demand fewer UK exports. As seen in the figure above, this puts inflationary pressure on the UK’s economy.