A perspective from Perth, Western Australia

Sunday, July 30, 2006

An interesting perspective on minimum wage

A friend of mine wrote an interesting piece on the minimum wage, which I essentially agree with, arguing that in an environment where employers (buyers in the labour market) have too much influence in setting wage levels, and that the minimum wage actually serves to correct an imperfect market, rather than impose unreasonable constraints.

It's obvious to me (and to most Australians I would think) that giving people money over and above survival allows them to recycle the money through the Australian economy rather than on low-profit survival stocks and getting heavily into debt.

I heard someone on the radio yesterday talking about the old arbitration commission, and how the unions "overbid" wages while business groups gave "reasonable" ones, and therefore when the amount is determined, the new wages were "overvalued". The guy was pushing for the removal of minimum wage, and had no problem telling everyone that such a thing will "be good for the economy".

Let it be said, first of all, that this is true in a perfectly competitive market. It is *not* true in a monopsony however. A monopsony is the inverse of a monopoly; there are many sellers but only one buyer. This situation can apply to the labour market, when there are few relevant employers.

Assuming that every worker gets paid the same amount of money for the same job, the marginal cost of employing workers in a monopsony increases very rapidly, resulting in less people being employed, and a wage that is far less than optimal for the economy.

The interesting thing about a minimum wage is that it actually pushes the intersection of the cost/revenue curves to the right (forcing it closer towards a competitive market system), thereby INCREASING both employment and wages at the same time. What is most remarkable about this situation is that even if the minimum wage is above the most appropriate wage there is still a net increase in total wealth generated, compared to the initial raw monopsony. In other words, even an over-valued minimum wage is better for monopsony based labour markets.

Monopsonies have been shown to exist in numerous labour markets, particularly in markets where the employer has (mon/olig)opoly traits. In a small economy like Australia, this is quite common (even if it is only done via cartels). In other words, a minimum wage causes a loss of employment/wealth on the "competitive" swing, but makes it up on the "monopsony" merry-go-round. At the very least, the social gains by ensuring availability of health/education/choice outweighs the costs.

The only thing that does fall in a minimum wage is the net profit of that single buyer, in a similar way that monopolies usually have lower profits when there are competitors around. But few people apart from the business themselves would say that a monopoly is good for the economy. If they wish to promote the idea that no minimum wage is good, they should at least be honest and say it's great for a small increase in *profits*. To say it's good for the economy is only partially true and arguably misleading. I don't see the business interest groups clarifying this though.



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