|Minimum wage does not correct a distortion; it is a distortion|
By Willem Buiter
Published: March 28 2006 03:00 | Last updated: March 28 2006 03:00
From Prof Willem H. Buiter.
Sir, I am bemused by the letter from my colleagues at the London School of Economics, Richard Dickens and Mirko Draca, in support of raising the minimum wage (March 24). Somehow, in the argument about the minimum wage, the burden of proof has been shifted from those who support (increases in) the minimum wage to those who
I am one of those who have reached the following startling conclusion after a lifetime of studying markets in a wide variety of settings: making something more expensive will reduce its use. With bigger words: when a government puts a floor under the price of some good or service whose economically relevant characteristics can be observed by both sides in the market, and when that floor is a binding constraint, then the demand for that good or service will be lower than it would have been without that floor. By how much is an interesting empirical issue. The minimum wage is such a floor.
Advocates of the minimum wage rebut even the qualitative theoretical presumption that making something more expensive will reduce its use, by stressing complex interactions between market power in the market for unskilled labour and in the markets for the goods it helps to produce. This seems hardly convincing for the UK.
The market for unskilled labour is not characterised by widespread monopsony or monopoly; nor is it subject to the informational problems that plague markets for complex services and goods, such as insurance markets. Most unskilled labour is employed in industries where there is quite fierce competition.
The minimum wage therefore does not correct a distortion, it is a distortion. There is no efficiency case for government intervention in the market for unskilled labour. Neither is there an equity case for addressing low labour incomes and for assisting the working poor, as opposed to targeting low incomes and poverty in general. Even if there were an argument for helping the working poor rather than the poor whoever they may be, the minimum wage is a clumsy way to go about it. Employment subsidies would be more efficient.
As there is neither an efficiency case nor an equity case for direct government intervention in the market for unskilled labour, there is no case for the minimum wage. If it does little harm, that is better than a lot of harm, but still not as good as no harm.
Willem H. Buiter,
Professor of European Political Economy,
London School of Economics and Political Science,
London WC2A 2AE
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