Minimum, Maximum and Living Wages

A-level Economics

Wage intervention in the labour market

One of the problems created by labour markets is low wages. Wages are important to workers because they use earned money to buy goods/services which provide them with their needs and wants. There exists inequality in the free market economic system – some people earn millions a year while some people only earn thousands. Those who are on the lowest wages are at great risk of not being paid enough to purchase necessities.

Governments can intervene in labour markets to correct this problem by setting a minimum wage law. In the UK, the laws around wages have been changed somewhat in the past year.

Over 25s are now paid the National Living Wage (NLW), which is £7.83 per hour. Those aged 21-24 are paid £7.38ph and this is called the National Minimum Wage (NMW).

Here is a full table of the current minimum wage rates of 2018.

25+: £7.83ph (NLW)

21-24: £7.38ph (NMW)

18-20: £5.60ph (NMW)

16-17: £4.20ph (NMW)

Apprentice: £3.70ph (NMW)

Why is there a distinction between NMW and NLW?

This has caused a lot of controversy recently. The UK government has been accused of setting the NMW at too low a level; a level which is too low to live on if you support yourself, pay bills, raise children etc.

Therefore, the NLW has been introduced for over 25s, which is set at a higher rate than lower age groups. This is meant to raise living standards for those on the lowest wages, ensuring that they are paid a living wage (a wage for you to be able to purchase your necessities and not be in poverty).

However, the living wage calculated by the Living Wage Foundation is far higher than the NLW. Read more below about this topic.

Why do we have minimum wage laws?

1. Minimum wage laws are there to protect workers from being paid unfairly low wages. It allows income to be more fairly distributed, to help with income inequality.

2. It also encourages people to work because a minimum wage allows people to earn a minimum standard of living. This should increase labour participation rates (the percentage of the people in the population who are willing and able to work).

3. Minimum wages are generally set higher than what the free market wage, so living standards should be higher for workers than under free market conditions.

4. It should also reduce the number of people claiming benefits because if wages were lower than the current minimum wage rates, we should see an increase in replacement ratios.

What are the downsides of the NMW?

Minimum wages can potentially cause unemployment. If the NMW is set above the free market wage rate, then this will cause an imbalance between demand and supply.

1. More people will be willing to work (an increase in supply)

2. Less firms will be looking to hire because wages have increased (a reduction in demand)

This can be shown on the following diagram.

If unemployment is caused as a result of the government setting a minimum wage, then this would be an example of government failure. This is because by trying to increase living standards by increasing wages, the government has decreased living standards for those who are unable to find work.

However, despite minimum wages being set in the UK, there is little evidence to suggest that minimum wages have caused a significant impact on unemployment levels. This could be because firms that earn supernormal profits are able to pay wages above the free market wage level (they can afford to).

Also, don’t forget that minimum wages are used to help tackle inequality and poverty – and there are benefits to be had from that.

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Advantages and disadvantages of the minimum wage

Advantages:

Boosts productivity - helps increase productivity of the lowest income workers – higher pay could mean workers work harder to keep their jobs

Reduces poverty - helps those on the lowest incomes to earn a fairer wage

Increases participation rates – more people looking to get a job if there is a minimum wage rate above the free market wage

Higher tax revenue for government – higher wages means more taxes paid on income

Lower replacement ratio – less people will claim benefits if the minimum wage is high enough

Disadvantages:

Increases wage costs for firms – firms may have to cut jobs, so this could cause some added unemployment

Decreased international competitiveness – other countries may have lower wage rates so firms begin to produce goods and services abroad to become more price competitive

Doesn’t reduce poverty that much – the minimum wage is unlikely to be high enough to make such a big difference to the standard of living. Many accuse the minimum wage of being too low (lower than the living wage). Some people are also unfit to work (sick and elderly), so the minimum wage will not help them.

The Living Wage

The living wage is a wage that is considered to be the minimum wage a person needs to live (their basic needs being covered). In the UK, this is higher than the current minimum wage levels.

The living wage is calculated by the Living Wage Foundation (LWF). At time of writing, the living wage is calculated to be £8.75 in the UK and £10.20 in London (because it’s more expensive to live in London).

Although the living wage has been worked out by the LWF, firms are not forced to pay employees this wage rate. As mentioned before, the minimum wage that applies to firms and the minimum wage rate is £7.83 (called the National Living Wage), about 11% lower than the UK living wage and approx. 24% lower than the London living wage. Perhaps the government thinks if it raises minimum wages even higher, it would cause too much unemployment and decrease the UK’s international competitiveness.

However, many employers do commit to paying employees at the living wage or above.

[Don’t get confused between the National Living Wage and the UK Living Wage. The National Living Wage is the minimum wage for over 25s. The UK Living Wage is calculated independently by the Living Wage Foundation]

Go to the Living Wage Foundation website to see in more detail

Maximum Wages

The government can also intervene in labour markets and set a maximum wage. Maximum wages put a cap on what workers can earn. To be effective, the maximum wage needs to be set below the market equilibrium wage.

The reasons maximum wages might be considered:

Helps decrease inflation rates -> prevents the wage-price spiral -> improves economic stability

Limits inequality –> lessens the incomes of the highest earners

Reduces labour costs for firms –> firms want to hire more workers –> decrease in unemployment

The reasons why maximum wages might not be considered:

Productivity can worsen -> high wage rates incentivise workers to work harder. This is the founding idea behind capitalism. If you work hard, you get rewarded for your hard work.

Some feel this is unfair -> if people are working hard, then isn’t it fair to be rewarded for your hard work?

Brain drain -> those with the highest skill sets could be incentivised to move away from the country and find another country to live in. Emigration of the highest skilled workers could rise, leaving the economy with an overall reduced skill set.

Wages in the Public Sector

If you work for the public sector, it means that you are employed by the government. Therefore, the government can have a big impact on wages in these industries e.g. health care, education, defence etc.

The government’s main responsibility is to manage the economy well and make the country a nice place to live (to improve everybody’s welfare). Therefore, you’d think that the government would condone paying workers at a fair level, to ensure welfare is improving among the working population.

However, in recent times this has not been the case. The government has introduced pay cuts and freezes among its workforce. The government has even clashed with trade unions on this topic which has caused many strikes to take place. It’s useful to know that the government is a monopsony employer, so it’s a good thing that trade unions exist in the labour markets in the public sector. When a monopsony employer and a trade union exist in a market, this is called a bilateral monopoly. [If you’d like to learn more about this, please go to the revision page on trade unions]

The primary reason behind this is because the government is trying to reduce the level of its debt, therefore it is trying to minimise its annual spending. However, in doing that the government could cause a recruitment crisis in the public sector. If wages are lowered too much then people will not want to work for the government, therefore public services could fail. Instead, many have looked for jobs in the private sector and no longer wish to work for the government.

So, in summary we have learned:

1. Minimum wages

2. Living wages

3. Maximum wages

4. Wages in the public sector