Effects of $20/hour minimum wage far from clear-cut

There is no conclusive evidence that higher pay leads to job losses

This Government is going to raise the minimum wage to $20 an hour by 2021. Anyone who has done Economics 101 knows the effects of a higher minimum wage. It will cause higher unemployment as firms reduce staff or some firms go under. The labour market will be distorted and unable to reach its fabled equilibrium. Standard economics textbooks tell us this. It is accepted common sense.

There is just a wee problem with this theory which is taught to all young students who undertake an introductory economics course. There is no conclusive evidence or study to prove that a higher minimum wage leads to more unemployment. In fact, there is some research to suggest the total opposite.

No economist would ever suggest a government can create a high wage economy simply by passing a law that all employers should pay higher wages. The average wage rates in an economy are ultimately determined by the value of output of the workers in that economy. This is why economists bang on about the need to raise our productivity in New Zealand. If New Zealand workers were able to increase the value of their output then wages should rise. Our standard of living would increase.

But a government can influence how the value of national output is distributed. A key tool it can use to do this is by setting a minimum wage.

Current economic theory sometimes called neoclassical economics teaches that wages in different industries are ultimately set by the demand and supply of workers in each industry. A brain surgeon is paid more than a truck driver purely due to demand and supply.

According to this theory people earning very low wages are a natural outcome of market forces. Even if these wages are insufficient to meet their basic needs. To mess with this natural order invites disaster and ruin.

But this theory is based on some major assumptions. It assumes there are no power imbalances between workers and employers. Workers compete for jobs and employers compete for workers. Bargaining power is equal.

It assumes firms are all operating in highly competitive markets and are not making excessive profits. They cannot afford to pay more to their workers. Competitive market forces ensure wages in different industries are set “fairly” through supply and demand in the labour market. A government should never mess with this natural order.

The early classical economists such as Adam Smith and David Ricardo had a far more realistic view of what determines wages in an economy. They believed the share of national product that was paid as wages was determined by the relative bargaining power of workers versus employers. This bargaining power can be heavily influenced by such factors as union power, unemployment levels, benefit levels and the minimum wage rate. The early economists believed in most industries, employers would generally have the upper hand in wage bargaining.

So what will be the effects of a $20 per hour minimum wage? The answer is far from clear-cut.

If a cleaning company has to pay higher wages to its workers it may be able to pass this higher charge to its customers. The owners may end up making lower profits. The owners may find more efficient methods of production with fewer workers. The irony in that case is that a higher minimum wage has led to improved productivity.

Or the business may fail. Those workers may then find better paid jobs in other sectors of the economy that have benefited from increased demand due to the higher minimum wage.

Economics is a fascinating subject but it is not a pure science. There is no clear answer in many situations despite the dire predictions by those who know best.