Forthcoming in Chris Coyne and Rachel Coyne – Floors and Ceilings.docx

Forthcoming in Chris Coyne and Rachel Coyne – “Floors and
Ceilings - the economics of price controls”, London: IEA
Hobart Paperback.
The Simple Economics of Wage Floors
W S Siebert January 2015
Birmingham University
ABSTRACT
The paper surveys minimum wages setting and finds adverse
employment effects broadly in line with conventional economic
models. UK studies generally report small effects, but the UK is
poorly suited for measurement given confounding changes in
welfare benefits and no regional variation. Clarity is found in
better empirical settings such as Canada, with good minimum
wage variations and provincial differences, and in the OECD
country panels. Case studies are also reviewed including South
Africa (minimum wages as a white supremacy weapon),
Portugal (extended collective agreements being analogous to
minimum wages, and reducing employment), and Greece (the
minimum encouraging temporary work). Alternative ways of
helping the poor via encouragement of stable families, more
competitive school systems, and subsidies for low paid work are
advanced.
“My daughter’s ambition is to get a job in an office. She has
Down’s syndrome. She thinks that, if she works hard, someone,
somewhere will give her a job. At £6.50 per hour, it’s never
going to happen. But at £2 per hour? Maybe.” (Letter to Daily
Telegraph 17/1/0/14, from Candice Baxter)
“There is now no sizeable lobby in the UK campaigning for the
abolition of the minimum wage….In a poll of experts by the
Institute for Government the minimum wage was voted the most

successful UK government policy of the past 30 years, ahead of
the Northern Ireland peace process” (Manning 2013, 65)
Introduction
A wage floor such as the minimum wage makes payment of low
wages illegal. Such a floor clearly tends to reduce unskilled job
opportunities, yet it is only one example of floors under
working conditions placed by regulation. Other floors on terms
and conditions of employment relate to requirements for
protection against unfair dismissal, or against discrimination, or
for the provision of pensions via“autoenrolment”. Moreover, we
must remember that high welfare benefits also place a type of
floor under wages, since for many it is not worth working for a
wage lower than the welfare payments they can receive. The
adverse effects of these floors can compound each other,
particularly in a high tax environment, as we will show. High
floors can also be imposed by union power, especially via
extended collective agreements as in France.
The minimum wage from the beginning has been justified by the
Low Pay Commission (e.g. LPC 2000, para 3.18) as a means of
achieving “equity in the workplace”. But, in most private sector
businesses, equity is already achieved, in the sense that wages
approximate the revenue product of the marginal worker.
Private sector competition drives this result though the public
sector of course does not fit this model so easily. If low wages
are made illegal, then what happens is that the least productive
workers cannot be employed. This result is demonstrated most
clearly in the case of disabled workers, as shown in our opening
quotation above. As Candice Baxter points out in her letter, her
daughter could gain employment at £2 per hour, but certainly
not at £6.50. One’s heart goes out to her. The celebrations of
the politicians in the Institute for Government, shown in our
second quotation from Professor Manning, are premature.
Wage floors and other regulations of working conditions grow

together with centralised government, and are a part of the EU
dirigiste tradition. The 1989 EU Charter on Fundamental Social
Rights of Workers Rights marks a watershed (see Addison and
Siebert, 1994), and has subsequently become the Social Chapter
of the 1992 Treaty of Maastricht and 1997 Treaty of
Amsterdam. The Social Chapter sets floors to most aspects of
employment conditions, including “fair remuneration”, working
hours, freedom of association/unionisation, training, equal
treatment for men and women (and others), compulsory worker
consultative councils, and health and safety. In EU terms
(Commission 2006, p5), “the purpose of labour law is to offset
the inherent economic and social inequality within the
employment relationship”. In other words, decent wages and
conditions are due to the efforts of politicians. Thus, the role of
free markets and freedom of movement in defending the under-
privileged is misunderstood.
Setting minimum wages is easy, but deals with the symptoms of
low pay, not the causes. The political payoff from minimum
wage laws is immediate. The dispersion of wages is reduced,
and, since more women are low paid, so is the difference
between male and female average pay (another misleading
statistic). Yet nothing is done about the real problems in the
labour market and the education system (see Kristian Niemietz
2012). The low level of skills acquired by children from our
many single parent families is ignored, as is the worklessness
among these families (see below)[footnoteRef:1]. As for really
disadvantaged groups such as the disabled, the minimum wage
may do much harm. Opportunities may also be reduced for
students who are prevented from taking low paid internships
(and may have to volunteer instead), and for those whose main
work is in the home, but who would like to obtain some work to
supplement household income or gain the benefits of socialising
at work. The best that can be said of the minimum wage policy
is that it is irrelevant to real problems of inequality and
worklessness. More likely, it is part of a package combined with

other floors on working conditions, strong unions and high
taxes which make matters worse – as exemplified by Greece. [1:
26% of dependent children aged 0-18 live in single-parent
families in the UK, which is almost twice as high as in France
and Germany. The proportion of children being brought up in
jobless families is consequently also high, around 20% (see
OECD 2011a Tables 1.1 and LMF1.1A) which reduces these
children’s education and employment prospects.]
Our plan is next to consider research into the UK’s national
minimum wage, which is difficult given the lack of regional
variation and the confounding effects of high levels of welfare
payments. Then, we will take up results from Canada and the
US where provincial variation in the minimum gives a more
suitable design for minimum wage evaluation. We will also
discuss the interesting case of South Africa where minimum
wages were for a time used as a weapon in the struggle for
white supremacy. Here we will also discuss results from long
OECD country panels, which arguably give the best design for
minimum wage evaluation. Finally we will extend the
discussion to consider effects of minimum wages set by
collective agreement. Such minima are more detailed and
intrusive as shown by Martins’ (2014) study of the “30,000
minimum wages” set by collective agreements in Portugal.
UK Evidence on Employment Effects
The UK is the worst place conceivable to test for minimum
wage employment effects. Changes in the minimum have been
quite small, they are country-wide (so there is no clear
counterfactual), and they are carefully tailored to the
unemployment situation so as not to exacerabate unemployment
unduly. (The economists on the Low Pay Commission are
apolitical, and well aware of negative employment effects).
Compounding the problem is the changing welfare system which
also affects employment. We should remember that in 1999, at

the same time as the minimum wage was implemented, the
government introduced Working Family Tax Credits designed to
encourage work which would obviously tend to counteract
minimum wage effects in the opposite direction. However, the
UK research does need to be considered, if only to show that we
need to be careful before concluding (see for example Leonard
et al 2014) from small measured UK minimum wage effects that
conventional labour market models do not work.
The confounding effect of movements in welfare entitlements is
shown in Figure 1. Here simple demand (D) and supply (S)
curves are drawn for the unskilled labour market. If a minimum
wage is imposed, equilibrium moves from point E to point A.
However, if welfare benefits are brought in, or raised above the
minimum, then employment falls further, to point B. If welfare
benefits are pre-existing, then the impact of the minimum wage
on employment will be muted. The diagram is a simplification,
because apprentices and trainees will continue working for less
than welfare benefits, as we discuss later. Also, welfare benefits
– certainly in the UK – may vary with income from
employment, so that some people receive some benefits even if
they are earning a wage below the welfare floor. But the
tendency remains – there is an interaction between the welfare
system and the minimum wage.. Moreover, if welfare benefits
are reduced, or reformed via tax credits conditional on work,
employment will increase, confusing minimum wage effects.
Table 1 shows welfare trends, including the important housing
assistance component. Unfortunately this series on net
replacement rates is not available prior to 2001, however we can
analyse most of the period since the introduction of the
minimum wage. As can be seen, replacement rates have declined
in France and Germany (the Hartz reforms), increased for single
people in the US, and increased for families but not for single
people in the UK. In fact, the UK’s family replacement rates are
now amongst the most generous in the OECD (Niemietz 2012,

p46). However, some of the welfare is contingent on working at
least 16 hours, and so encourages some work. In fact, Gregg et
al (2012, p22) estimate that employment of single women rose
by 4% when tax credits were introduced: this worked against
minimum wage effects oon employment.
Figure 2 demonstrates two important points about the progress
of wages after the minimum was introduced. First, we see that a
substantial number of people were freely working for low wages
in 1998 prior to the implementation of the minimum. About 6%
of the workforce is in that lower tail which grades slowly down
to zero, reflecting the alternatives and productivity levels of the
individuals concerned. Here Mrs Baxter’s daughter would have
found her job.
Secondly, we see that even after the minimum was introduced,
many wish to be paid below it. Low pay is a continuing
phenomenon, with currently about 200,000 adults (21 and over,
i.e. 1% of the adult workforce) paid below the minimum (LPC
2014, p133). In fact, the real total is probably double this figure
(Kay 2007, p35) when we add the large number of under 21s.
Much of this non-compliance occurs with apprentices, who are
quite happy to receive low wages while training, as do students
in general. In fact, about 70% of 18-20 year old hairdressing
apprentices (LPC 2014, p134) currently refuse to accept the
minimum wage, for which of course the Low Pay Commission
and trade unions wrongly blame the employer. A further group
are the interns and volunteers, who do not enter wage
distributions like Figure 1 at all, but whom the Commission sees
as unfairly avoiding its system. The important point is that
many people see it worthwhile to work for low or no wages.
This is particularly true for students and others training in order
to raise their future wages.[footnoteRef:2] [2: See Gorry [2013,
p72) for a good paper on how the minimum wage obstructs
training: “Inexperienced workers are unable to pay for their
training through reductions in their wages. To gain experience,

they must maintain employment in a segment of the labor
market characterized by high job separation rates” – their
probability of unemployment consequently rises.]
A good study of adverse employment effects is provided by
Dickens et al (2012), who focus on part-time women where
coverage by the minimum is about 10%, twice as high as for
full-timers (LPC 2014, Fig 2.1). They establish a counterfactual
by comparing part-timers whose wages are raised by the
minimum to those paid just above that level, i.e. 10% above.
This comparison group will have similar skills and welfare
benefit options. They find that the introduction of the minimum
in 1999 caused the year-on-year probability of part-time women
retaining a job to fall from around 0.70 to 0.65. Another way of
putting this finding is that before the minimum wage, median
job duration was about 1.9 years for part-time women earning
around the minimum, falling to 1.7 years after the minimum,
that is, a fall of around 10%. They do not find effects caused by
the up-ratings as they have been too small to have much effect.
For example, the recent up-rating from £6.31 to £6.50 gives a
maximum uplift of 1.5% to about 5% of the workforce. As well
as being small relative to welfare benefit changes, minimum
wage increases have been lower in times of recession. Overall,
this means that it is difficult to detect effects of changes in the
minimum wage, but this result does not mean that higher
increases in the future will be harmless.
While minimum wage increases so far have been small, a
further piece of research by Rebecca Riley (2013) brings out the
negative effects of the altogether larger change that the
introduction of a minimum wage equal to the “living wage”
would have (see also Siebert 2014). Currently the “living wage”
is calculated to be £7.65 outside London, and £8.80 in London
(Living Wage “Commission”, 2014). Such a change would mean
wage increases for about 25% of the workforce rather than 5%,

and raise labour costs of young unskilled (non-university)
workers by as much as 14% in sectors such as hotels and
catering, and retailing. Riley shows not only that the demand
elasticity for labour is negative, but also that cross-price
elasticities are generally positive, precisely in accordance with
conventional economic theory. In other words, when the wage
of the young inexperienced and unskilled group goes up, their
employment falls, and the employment of substitutes such as
educated workers and older workers increases. Thus, 300,000
young unskilled workers will lose their jobs, but some skilled
and older workers will gain, so the overall loss of jobs is
reduced to 160,000. Increasing the minimum wage to the living
wage change would thus enable the older, better educated
workers to gain at the expense of unskilled youth, as happens in
France, but of course with serious long-term consequences for
those trapped outside the labour market.
The current dark situation for Britain’s unskilled youth is shown
in Tables 2 and 3, covering the period since the minimum wage
began. Table 2 shows that labourforce participation has declined
for all the disadvantaged groups except the disabled (whose
participation remains low). Admittedly it appears that our youth
participation rate is still better than that in France. But the UK
lags on another measure which is shown in Table 3, the percent
of 15-19s in the not in education, employment or training
(NEET) group. Here we see that the UK’s percentage has been
growing and at 9.5 % is the worst of the five major economies
shown, and worse than the OECD average. In summary, Tables
2 and 3 show that the inequality of life chances has been
growing, despite the Low Pay Commission’s mission to reduce
“inequity in the workplace”.
People who reject the orthodox explanation for the small UK
minimum wage effects need an alternative, They bring forward
ideas of single buyer power (i.e., “monopsony” – see Manning
2013), or of “efficiency wages” (Leonard et al 2014) to explain

the perceived market failure. Ironically, these two theories have
diametrically opposed views of what happens in free markets.
The monopsony theory implies that wages are too low: firms
operate with unfilled vacancies, because raising wages enough
to eliminate the backlog would require pay increases for all. But
the efficiency wage theory implies that wages are in a sense
“too high”: wages are above the market-clearing rate because
paying well is a cheap way to help supervisors generate extra
employee effort.
In fact neither theory fits well with the UK firm size structure
which is shown in Table 4. We see that the UK has 3.6 million
enterprises which only employ the owner, and obviously have
no monopsony power or difficulty with supervision. There are
also 1.2 million enterprises which employ workers, but the vast
majority of these, 97%, employ fewer than 50 workers, and
again can have no monopsony power or supervision issues. In
fact, it is only the 6 thousand firms that employ more than 250
to which these theories might apply. However, these firms tend
to pay higher wages in any case and so the minimum wage is
broadly irrelevant for them. It is much more likely that
unskilled and inexperienced workers lose from the minimum,
and indeed their unemployment rises more than proportionately
as the minimum rises, as shown in Gorry’s (2013) elegant model
Monopsony and efficiency wage theories would seem irrelevant
here.
International Evidence
It is fair to say that the UK evidence on the minimum wage does
not find large employment effects. It does find some disturbing
trends. However, the background to the UK’s minimum wage
ensures that any statistical analysis is likely to lead to
inconclusive results. For a more successful analysis, we need to
look at countries where there is high variation of the minimum
either for regions within a country, as in Canada or the USA, or
at the variation provided by cross-country panels. A country

with low welfare payments (e.g. the US) is also easier to
analyse. Let us consider first Canadian and US results, and then
examine South Africa which starkly underlines how minimum
wages can be misused by skilled workers to cut out unskilled
competition.[footnoteRef:3] [3: Another interesting country to
consider could be France with its exceptionally high minimum
(Gorry 2013). But France presents the same problems as the
UK, that is, lack of within-country variation, plus the
confounders of high welfare payments and high taxes. China is
also a possibility, with good variation provided by different
minimum wages in different cities. Fang and Lin (2013) provide
evidence of strong negative minimum wage effects using city
data which are better than the province data used by Wang and
Gunderson (2012) who find inconclusive effects at least for
Eastern China. However, China is too early to draw conclusions
from yet, since it is so large and heterogeneous with
complications of migrant labour and a large state-owned sector.
There is also research on minimum wages in LDCs in general,
bringing in non-compliance issues in the informal sector, which
we will touch on below.
]
Canada provides one of the best conditions for research into the
effects of minimum wages, since the ten Canadian provinces
have different minimum wage policies, sometimes with
considerable bite. Good time series data are also available. A
convincing body of Canadian literature has thus built up,
starting with Baker et al’s (1999) study of 9 provinces over
1975-1993. This study finds that a 10% increase in the
minimum reduces teenage employment by 2.5%, and that it
takes 6 years for the full effect to be revealed. Canadian data
are also used in the recent study for 1997-2008 by Campolieti et
al (2014, 587), who find a short-run elasticity of -0.16 for the
15-24 year group. Importantly, they note that their method
cannot capture long-run minimum wage effects (since they

follow individuals for only 6 months), and recommend doubling
this elasticity to derive the full picture. This would lead to a
long run elasticity of demand for labour of about -0.3, meaning
that a 10% increase in the minimum wage would reduce
employment by about 3% among the affected group. A similar
finding for teen employment is made by Sen et al (2011).
Interestingly, older workers’ employment appears to increase
with minimum wage increases (Fang and Gunderson 2009),
suggesting they are substituted for less productive youths, as we
have already seen for the UK. The minimum’s adverse effect
using good data thus becomes clearer.
A possible reason for the clarity of the Canadian effect is that
Canada’s minimum wage workers tend more to be in the
tradeable goods, exporting sectors. In this situation, a higher
minimum quickly undermines competitiveness and causes
employment reduction. The position is different if minimum
wage workers are concentrated in non-tradeable activities such
as retailing or construction (as in the UK). In this case, a rise in
the minimum wage simply “takes wages out of competition” and
this result can even be advantageous, especially for large firms
(see Cox and Oaxaca 1982, more recently Neumark and
Wascher 2008). Costs go up, but the increase is faced by
everyone, and prices can increase to offset this given the
absence of overseas competition. This factor might account for
the weaker disemployment results found in the US studies (e.g.
Addison et al 2012) of the restaurant sector noted below.
Magruder’s (2013) study of minimum wages in Indonesia
emphasises the importance of whether the sectors mainly
affected are in the tradeable or non-tradeable sectors.
Turning to research on the US, there is now much technical
controversy raised by the work of Allegretto et al (2011) and
Dube et al (2010), well summarised in the recent work by
Neumark et al (2014). The key problem is how to specify
control groups, whether by allowing for state-specific trends, or

by using contiguous states, which need not be good controls
since cross-border counties might not experience the same
shocks. Still, Neumark et al’s exhaustive analysis (2014, p627)
concludes that, when the time trends are correctly specified, the
elasticity of teen employment to the minimum wage remains in
or near the -0.1 to -0.2 range. Elasticity of employment in the
restaurant sector is lower, but still negative and significant at
around -0.05 or -0.06 (2014, p644). Thus the adverse effect
remains.
We cannot leave US minimum wage research without
mentioning the famous but weak Card and Krueger (1995)
studies of the response of fast-food restaurant employment to
increases in minimum wages. The best-known of these studies is
the contrast of New Jersey with Pennsylvania (which had no
increase in the minimum wage). This research is the basis for
stating that the conventional economic view that minimum
wages cause unemployment is a “myth”. But the New Jersey
versus Pennsylvania study is only based on 4 datapoints. The
fact that there are many restaurants in the 4 samples (New
Jersey before and after, and the control, Pennsylvania before
and after) is no help since the same minimum wage regime
applies in each. It is also worth noting that again we have the
restaurant sector, which is sheltered from international
competition, and so should have smaller employment reactions.
The work is sold as “a powerful new challenge to the
conventional view”, but it is misleading.
The evidence from South Africa shows what happens when
minimum wages really go wrong. South Africa under white
control, before 1994, had what it described as a “civilised
labour policy” aiming to favour white employment (Van der
Horst 1942, 250; also Siebert 1986). A pillar of this policy was
high minimum wages and extended collective agreements which
meant that only white workers, who were generally better
educated than non-white workers, could gain employment.

Minimum wages were thus used as a weapon against the
majority. The higher costs that resulted were not so much of a
problem when it came to employment because tariff barriers
prevented imports competing with domestic businesses. The
high minimum wage system continues to this day with extended
collective agreements in particular supporting a strongly
unionised African labour elite (Schultz 1998). For example, a
union worker in manufacturing receives 70% more than a non-
union worker (Schultz 1998, p700). The system has since been
extended to agriculture and domestic service. In agriculture the
pay increase has been large (Bhorat et all 2012), 17%, and
employment has contracted considerably, by 14%. In domestic
service, again protected from international competition, the
effects might not have been so bad (Dinkelman 2012, Hertz
2005), but only 25% of households appear to comply. Thus, we
see a policy originally designed to hurt African workers is now
being carried forward by African politicians and unions
themselves, and still hurting African workers.
Finally, let us consider the evidence from international cross-
country panels. This research design gives the most variation in
minimum wages, and thus helps create more robust studies.
Negative employment effects from minimum wages are clear in
all the studies. Admittedly there are some difficulties of
comparability. In particular, countries such as Germany, Italy,
Denmark and Sweden have no national minimum wage as such,
but use legally enforceable extended collective agreements.
Still, such agreements are effective minima (see below). There
is also the difficulty of allowing for widely different welfare
regimes, and these studies typically use the OECD’s index of
gross benefit replacement rates which leaves out housing
benefit that are important in the UK[footnoteRef:4]. However,
hopefully the gross replacement rates capture the trends, and in
any case the studies all control for country and time fixed
effects. [4: Hence Addison and Ozturk’s (2012, Table 2b)
replacement rate for the UK averages only 20%, much lower

than the actual 60% shown in Table 1 above.]
Neumark and Wascher (2004) provide the first comprehensive
treatment, analysing 17 OECD countries over the period 1975-
2000. Their main finding (2004, p243) is that the minimum
wage elasticity of teenage (15-19) employment is significantly
negative, in the -0.2 to -0.4 range. More recently there have
been OECD-based international studies by Dolton and
Bondiabene (2012) of youth employment, and Addison and
Ozturk (2012) of female employment. Dolton and Bondiabene
(2012) also find a large negative effect of minimum wages for
youth employment, with an elasticity of -0.3 to -0.4, most of
this result coming in recession as might be expected. Addison
and Ozturk (2012, Table 4) find a negative effect for the adult
female employment-to-population rate, with an elasticity of -
0.14 in the short run, and more in the long run when lagged
effects are taken into account. Interestingly, there is an
indication in this study (2012, Table 7) that the elasticity is
larger (-0.34) in countries and time periods when employment
protection law (EPL) is strict, as we would expect (see below).
Thus, there is an unambiguous picture of strong negative
minimum wage effects on lower-productivity groups in the
international panel-based literature, which provides arguably
the best foundation for research.
Collectively set minimum wages
Collectively set minimum wages arise when a collective
agreement is extended by law to third parties within an industry
or sector. A detailed set of minimum wages (and conditions)
covering many job types and levels is thereby established for
the industry or sector. Martins (2014) shows how the process
works in the case of Portugal. Such extensions are the result of
so-called “erga omnes” (towards others) regulations, and have
the aim of reducing non-union low-wage competition. They are
common (see Murtin et al 2014) in countries where the unions

are politically powerful – for example, are part-funded or
privileged by the state as in Greece or France or South Africa –
but where local union power is low (again, France and
Greece[footnoteRef:5]). In these circumstances, unions have the
power to bring about these regulations and also need to, since
non-union firms are so prevalent. The picture is given in Table
5, where we see that France, Spain, Portugal, Germany and Italy
all have high use of extensions arrangements. The important
point is that erga omnes regulations enable the setting of
detailed minimum wage floors, floors that are determined by big
business and labour in the capital cities – Athens, Rome, Paris –
with little concern for conditions in the provinces. Hence, a
straitjacket of minimum wages is thrown over the country. [5:
The UK used to have an erga omnes arrangement for unions to
petition for extension of their agreements, but Thatcher
dismantled it (see Addison and Siebert 2000) with the 1980
Employment Act. The “fair wages resolution” requiring
government contractors to observe terms no less favourable than
those obtaining under collective agreements was also dropped at
this time.]
Research on this type of minimum wage setting builds on the
literature of union power raising unemployment, which of
course has long been controversial because of the many factors
that influence unemployment. Steven Nickell’s (1997) famous
study of unemployment in OECD countries in the 1980s and
1990s shows union agreement coverage strongly raising
unemployment, but his “bargaining coordination” variable
washes out this effect, suggesting that cooperation between the
two sides of industry (corporatism) could engender responsible
unionism. Recent work on these lines is reported in the
OECD’s (2011b, p152) study of inequality using the OECD
panel of countries over 1984-2007. Here there is shown to be a
well-determined negative effect of collective bargaining
coverage on employment rates. High tax rates and employment

protection legislation hurt too. The most recent work using the
OECD panel is by Murtin et al (2014) with a more extensive
model, this time of unemployment. Their main innovation is to
use collective agreement coverage extension, as shown in Table
5, which they find interacts with taxes (also shown in Table 5)
to raise unemployment. Their minimum wage variable also
raises unemployment, again more so when taxes are high.
These interaction results can be explained with the aid of Figure
3. Again we have the conventional demand (D) and supply (S)
curves for unskilled labour, and start with a no-tax equilibrium
at E1. Now, assume a tax is imposed, so that the net demand
curve for labour shifts inwards to D|net tax as shown. Without
the minimum wage or collective agreement floor, the new
equilibrium would be at E2 with a lower wage, and less
employment (but no disequilibrium unemployment). However, if
there is a wage floor, the wage cannot fall so much, and the
employment fall to B is greater, as shown. At B there is also
disequilibrium unemployment. Therefore, according to this
simple model a rise in tax sweeps more into the minimum wage
and extended collective agreement net, causing unemployment.
The empirical results support this theoretical observation.
There are also instructive results from two country case studies
of Portugal and Greece involving extended agreements. As can
be seen from Table 5, both of these countries have used such
agreements extensively, though they are now restricted by
recent debt bailout agreements[footnoteRef:6]. Martins’ (2014)
analysis of Portugal over 2007-11 links unemployment to
extensions of agreements to non-parties, and shows that average
employment levels in affected sectors drop by 2% in the four
months following extensions, as firms stop hiring, and close
down. Since the wage increase is 2% to 4%, the implied
elasticity is between -0.5 and -1 (Martins 2014, 14). Peripheral
employment of temporary workers and sub-contractors
meanwhile increases, as we would expect. This temporary

worker result is the same as that for the Greek study
(Anagnostopoulos and Siebert 2013), based on a survey of 200
provincial firms, which finds that low-paying firms, near the
minimum, are more likely to employ temporary workers. The
Greek study also shows that these effects persist even though
many Greek firms do not in fact pay the minimum they remain
small so as to avoid the attentions of the labour inspectorate.
The minimum wage and extended collective agreements coupled
with high taxes thus not only reduce employment, but also push
firms to be too small[footnoteRef:7]. [6: In Greece for example
(see Commission 2014 p49 and LABREF database), the
government in 2011 and 2012 agreed to reduce minimum pay
rates by 22% (32% for young people). It also agreed to suspend
extension of occupational and sector collective agreements, and
to allow firm-level agreements which could be less favourable
than the sector-level agreement. According to IndustriALL
(2014) measures such as this caused Greek sector agreements to
fall from 65 to 14 in 2013, and in Portugal (Martins 2014),
coverage fell from 1.8 million in 2008 to 290,000 in 2012.] [7:
Thus in Greece and Portugal firms are too small, with only 5%
employing more than 10 people, compared to an OECD average
of 15% employing more than 10 (see OECD, 2011c).
Alternatively, if policing of the extended agreements is
effective, as in South Africa, small firms can be prevented from
growing enough (see Magruder 2012). The point is, regulation
breeds regulation.]
Conclusions and thoughts on real help for the unskilled
Mnimum wages do have adverse employment effects broadly in
line with conventional economic models. UK studies generally
find small effects, but the UK environment is poorly suited to
measure such effects given the changes in welfare benefits, and
the lack of regional variation. Matters become clearer when we
turn to more suitable empirical settings which provide clear
evidence of an adverse effects of minimum wages on

employment.
Better ways to help the poor involve raising skills or, in the
shorter term before such policies take meaningful effect, the
provision of wage subsidies through the welfare system. When
it comes to raising skills, the family is crucial, together with
education. In fact, Table 6 shows that comparable countries all
have difficulties with families in poor circumstances, so the UK
is not alone. Admittedly, the first two rows show that the UK
has exceptionally high numbers of children in single parent and
workless households (see Kristian Niemietz 2012). Yet while
Italy does best on this criterion, as can be seen, it lags
otherwise. The intergenerational earnings correlation is 0.48 in
the UK which is high[footnoteRef:8], but no worse than in Italy
or the US. Moreover, inequality in disposable household
incomes, as measured by the Gini coefficient, is broadly similar
at around 0.30 to 0.34 in all the countries. Only the US stands
out as particularly unequal, but this result is to be expected
since the US is much larger and more heterogeneous. [8: Here
we correlate the incomes of fathers and sons. A low correlation
as in Germany, 0.32, is better because it shows that good
parental circumstances have less effect in improving the child’s
life chances than in the UK which has a much higher
correlation.]
Furthermore, taking adult language proficiency which is an
important measure of skill, we see a distinct gradient according
to family background, as is to be expected. Individuals from
advantaged backgrounds (having at least one parent with a
university degree) score about 1 point higher on a 1 to 5 scale
than the less advantaged. All the comparator countries have an
almost exactly similar effect, which points once again to the
fact that this problem is deep-seated. Encouragement of stable
families and better, less unionised and more competitive school
systems is difficult, but they are important policy priorities.

High welfare simply makes matters worse in the long term, as
well described by Charles Murray (1984, 2012).
A quick and well-targeted way of helping the working poor is
by subsidising low paid work, a policy which contradicts the
minimum wage. People have their earnings topped up by the tax
payer, and are therefore prepared to work for less, which
expands their job opportunities. In fact, such a policy has been
in place in the UK ever since 1999 when the Working Families
Tax Credit was introduced (Azhmat 2006), modelled on the US
Earned Income Tax Credit, and since expanded with Working
Tax Credit (see Bourne and Shackleton 2014). Figure 4 shows
how the policy works by reducing the wage that the employer
pays from W* to WL. The equilibrium on the original demand
curve moves to point A, to which is added the subsidy, and the
worker receives the higher gross wage, WH.= WL+SUB. It is
important that the wage the employer pays is allowed to fall,
though, and if the minimum wage prevents this fall, the policy
will not work, and we remain at C. In a sense, the employer has
to be paid some of the subsidy and his/her profits will increase
which has disturbed some commentators (e.g. Gregg et al 2012).
However, the result is more jobs which is what we want.
Tax credits conditional on work currently encourage about 2.5
million workers to work (see Browne and Hood 2012), but they
only account for about 5% of the amount paid out to working
age welfare recipients, and are dwarfed in particular by child
tax credits and housing benefits. Reform is needed to make
working tax credits more important (see Bourne and Shackleton
2014). This said, the way they lower wages (see Azmat 2006
and Hotz and Scholz 2000) is exactly as predicted by our
conventional labour market analysis.
In conclusion, there is no need for analysts (e.g. Holmlund
2014, or Schmitt 2013) to worry about “discernible effects" of
minimum wages on employment. The effects are discernible,

when properly measured. Hence it is indeed probable that the
UK’s dismal youth labour market performance since 1999 is
partly attributable to the imposition of the minimum wage –
interacting with high tax rates. This is also the case with the
poorly functioning youth labour markets of Portugal and
Greece, and others such as France and South Africa. Moreover,
the way in which more skilled workers displace the less skilled,
and temporary workers displace permanent workers is also in
line with conventional economic models. Obviously, in a
political world which denies productivity differences –
including skills, gender, age and disability
differences[footnoteRef:9] – the differential effects of minimum
wages are politically unwelcome This is all the more reason for
economists to stick to their guns and look for real, not fake,
ways to help the poor. [9: The disability pressure groups often
do the disabled no favours. For example, (LPC 2005 p124),
Mothercare for Children in Hospital Ltd (MCCH) cooed: “ the
minimum wage is a positive step to reducing stigma,
discrimination and workplace exploitation…it has acted as a
catalyst to change” etc etc. But Shaw Employment Services is
blunt: ”Both client and provider are finding that instead of
being more able to help the disabled achieve employment, the
Government, through the NMW, has inadvertently created the
first barrier” (LPC 2003, p105).]
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Table 1: Net replacement rates over 60 Months unemployment
France
Germany
United States
UK
No child
2 child
No child
2 child
No child
2 child
No child
2 child
2001
60.3
70.3
59.6
73.5
15.2
43.0
55.0
64.9
2012
53.6
63.2
49.9
70.4
24.8
42.8
51.0
72.4
Change 2012-2001
-6.7
-7.1

-9.7
-3.0
9.6
-0.2
-4.0
7.5
Source: OECD Benefits and Wages:
Statisticshttp://www.oecd.org/els/benefitsandwagesstatistics.ht
m (NRR_Over5years_EN)
Notes: Replacement rates are calculated based on incomes after
any tax and social security contributions have been deducted,
and any cash benefits received. Family qualifies for cash
housing assistance and social assistance "top ups". The figures
give unweighted averages relative to full-time earnings levels of
67% and 100% of average worker earnings. (Prior to 2001 only
gross rates not including housing assistance are available.)
Table 2: Adverse Changes in Employment for Unskilled
Workers
Labourforce participation rate (% of the population in each
group)
All working age
No qualific-ations
Disabled people
18-20 yrs old
16-24 yrs old
France
15-24
2000
71.7
50.8
37.7
61.2

69.7
35.6
2013
71.6
42.6
42.1
47.0
61.7
37.6
Change 2013-2000
-0.1
-8.2
4.4
-14.2
-8.0
2.0
Sources: Commission (2014, Table 2.11), and OECD
Employment Outlook (2014)
Table 3: NEETs – Country Trends
(% of 15-19 year olds not in education, employment or training)
France
Germany
Italy
United States
UK
OECD average
1997
2.9
5.0
15.2
7.1
8.0

9.2
2012
6.9
3.0
12.0
7.7
9.5
7.6
Change 2012-1997
4.0
-2.0
-3.2
0.6
1.5
-1.6
Sources: OECD Education at a Glance (2014), Chart C5.3, and
OECD Doing Better for Families (2011), Figure 1.15
Table 4: Firm Size and Employment, UK 2009
Number - Private Sector, 2009 (including pub corps and
nationalised bodies)
Enterprises (000)
Employees (mill.)
Enterprises. without employees
3620
0
Enterprises with employees
1220
18.2
Enterprise sizes:
1-4

795
1.8
5-49
390
4.6
50-249
30
2.6
250-499
3
1.0
500 or more
3
8.1
MEMO
Central and local govt
5
5.4
Non-profit
84
1.9
Source: BIS, Enterprise Directorate, 2010,
http://stats.bis.gov.uk/ed/sme/SMEStats2009.xls#'UK Whole
Economy'!A1
Notes: An enterprise is the smallest group of legal units which
has autonomy. It is based on the Interdepartmental Business
Register (IDBR) formed from VAT or PAYE records collected
by HMRC. Since the VAT threshold (£67k in 09) excludes small
firms, estimates of their numbers are then added using
Labourforce Survey figures of numbers of self-employed

(4.1m). Private households and temp agencies are excluded..
There is no lower bound for inclusion as an enterprise, hence
the smallest amount of enterprise activity counts – hence there
are many "no employee" enterprises which have only working
proprietors in the business. “Employees” have a contract of
employment, and include part-timers. Working proprietors are
self employed (but working directors of companies are counted
as employees).
Table 5: Collectively Set Minimum Wages, early 2000s
Can
Den
Fra
Ger
Gre
Ita
Nor
Por
SA
Spain
Swe
UK
US
Coverage* extension
4
0
79
48
30
46
15
49

10
57
1
9
4
Use of erga omnes clauses
No
No
High
High
High
High
Some
High
Some
High
No
No
No
Union density
31
75
9
28
30
34
56
25
25
15
81
34
14
Govt rev % GDP
40
55

50
45
38
47
57
40
27
36
54
40
31
Sources: Murtins et al (2014), Industriall Global Union (2014)
http://www.industriall-
europe.eu/committees/CB/2014/Increasing%20cover%20rate-
EN.pdf; Visser (2013), Godfrey (2007), OECD Government at a
Glance (2013, Table 3.11.
Notes: * coverage extension measured as collective agreement
coverage minus percentage unionisation
Table 6: Inequalities – Country Comparisons
France
Germany
Italy
United States
UK
% children (0-18) in single-parent households, 2007a
14
15
10
22
26
% children (0-14) living in jobless households, 2011b
10
7

8
8
19
Intergenerational earnings correlation, late 90sc
0.40
0.32
0.49
0.50
0.48
Gini coefficient of inequality of household disposable incomed
0.29
0.30
0.33
0.37
0.34
Average adult literacy proficiency levele
Both parents<upper secondary educ.
2.0
1.8
1.9
1.8
2.1
At least one parent with tertiary educ.
3.0
2.8
2.7
2.9
3.1
Sources: a OECD Doing Better for Families (2011) Table 1.1; b
OECD Doing Better for Families (2011) Table LMF1.1.A; c
Corak (2013, p82); d OECD Divided We Stand (2011), Fig 6.1.
(income is household income, corrected for household size – the
Gini coefficient varies between 0 for perfect equality, and 1 for
perfect inequality); e OECD Education at a Glance (2014, Chart
A4.4) (literacy score is from the OECD programme for

International Assessment of Adult Competencies, with
proficiency graded from worst (1) to best (5)).
(
D
S
Welfare benefits floor
W*
A
B
Unskilled Labour
E
Minimum wage floor
)
Figure 1: Welfare benefits confound minimum wage

employment effects
Figure 2: Effects of the minimum wage on earnings - 1998 and
1999 compared
Source: Low Pay Commission Report 2000, p19
(
Unskilled Labour
Minimum wage or collective
agreement
floor
D|
gross
S
W*
E
2
B
E
1
D|
net
tax
TAX
)

Figure 3: Minimum wage magnifies disemployment effects of
tax
(
Unskilled Labour
W*
SUB
D|
gross
D|
plus
subsidy
S
W*
W
L
W
H
B
A
Minimum wage or collective
agreement
floor

C
)
Figure 4: Subsidising work
5
Leading Change
Leading Change

Carlos Ghosen was named CEO of Nissan took over the Renault
company in April of 2005. The new position would continue to
head Nissan as well as Renault. Ghosen was well known for his
ability to turn struggling companies into profit driven thriving
businesses and that was the hope of the new assignment with
Renault.
Issues
In March of 1999, the ninth carmaker in the world asked Carlos
Ghosen to lead as its CEO after a failed merger with Volvo.
Nissans strength in product design and manufacturing and
Renaults engineering quality made the merger all the more
necessary. Renault would help with international expansions
and Nissan would get rid of its short-term troubles of poor
production portfolio and its diminished brand value.
As one of the youngest to head companies of this size, Ghosn
knew he had to make an impact, for the Japanese were not
accustomed to a dictatorship type of leadership. Therefore, he
knew dictating his expectations could lead to low morale, and if
too lenient, it could slow change. Therefore, Ghosen brought
the need for urgency in operations by mobilizing them. Just as
Nissan’s employees were reluctant to except failures and
blamed other departments or economic changes on most of the
problems, which resulted in the lack of urgency and the resolve
to just live with the problems. Ghosen believed that human
tendency is to resist change and anything new of different from
the status quo. However, he belied by excepting changes, people
will be stronger, because they would have a better
understanding of the differences and find ways to discover the
root cause of the issues. Proposed
Solution

s
Ghosen formed Cross-function teams with employees being
directly involved in the process. Doing so helped Ghosen
explain his plans and gain acceptance more easily. In these
cross-functional teams, the employees were asked to look
beyond their responsibilities, and obtain a better understanding
of other departments. Once the teams were in place it became
much easier for the employees to see and own responsibility
whenever something went wrong.
Just after appointing the teams, they were asked to submit their
plans to achieve the maximum output in each of the areas. By
listening to the employees and asking their opinions in the
reform process, was monumental in the way Ghosen lead his
vision for reform. He avoided impersonal meetings and stressed
the importance of face-to-face communications.
Once both companies became one, Ghosn choose to promote
Transparency, Performance, and Value. Ghosn believed that
blending the strengths of the employees at each of the
companies, innovation excellence of the French and the
dedication towards the manufacturing of the Japanese, which
created synergy in purchasing, manufacturing, information
systems and platform sharing, but also maintained both
companies autonomy by keeping their own brand identities and
corporations.
Ghosn’s goal was to making the company recognizable by the

consumer as one of the best automakers in quality, value,
service and generate a total operating profit among all other
leading automakers by keeping a high profit margin and
continued upward growth. Renault took an equity stake in
Nissan with the understanding that Nissan would have the same
opertunity at a later time. This would enhance both Renault and
Nissan’s performance by creating a community interest and
cross shareholdings.Barriers to Change/ Emotional Bonds
The differences in culture between the French and Japanese
could have been very difficult, however Ghosn kept an open
mind focusing on the economic benefits and the turnaround of
the company’s. Goshn had to make tough changes such as
haying off more than 21,000 people and closing five factories in
order to increase Nissans profit margin. He also changed the
policy of the lifetime employment and hired more women,
which both were frowned upon. Goshn also demanded at least
20% savings from suppliers over a 3-year time period and the
ability to use global contractors.
Personal reflection
I think Goshn took whatever measures necessary to get both
companies producing at profitable pace and I think his decisions
on were based on that fact, which proved profitable in the end.
Conclusion
The commitments of the Nissan Revival Plan had been met one
year prior to its expected schedule, and the launch of new

models was created at a very high rate. Nissans profitability
contributed to Renault’s net income and higher profitability and
global presence. The President of Nissan was concerned about
the complacent nature of Nissan because of poor markets.
However, he also expected more flexibility to ensure employees
work closer to the consumer’s needs.
References
Spector, B. (2013). Implementing organizational change:
Theory into practice (3rd ed.). Upper Saddle River, NJ: Prentice
Hall
Leading Change 4
Copyright © 2014 Cengage Learning
*
*
Chapter 17
The Economics of Labour Markets

2.bin
THE MARKET FOR THE FACTORS OF PRODUCTIONFactors
of production are the inputs used to produce goods and services.
The demand for a factor of production is a derived demand.A
firm’s demand for a factor of production is derived from its
decision to supply a good in another market.
THE DEMAND FOR LABOURLabour markets, like other
markets in the economy, are governed by the forces of supply
and demand.Most labour services, rather than being final goods
ready to be enjoyed by consumers, are inputs into the
production of other goods.

The Production Function and the Marginal Product of Labour
The production function illustrates the relationship between the
quantity of inputs used and the quantity of output of a good.
Table 1 How the Competitive Firm Decides How Much Labour
to Hire
Copyright©2014 Cengage

Figure 1 The Production Function
Quantity of
Apple Pickers
0
Quantity
of Apples
300
280
240
180
100
1
2

3
4
5
Production
function
The Production Function and the Marginal Product of Labour

The marginal product of labour is the increase in the amount of
output from an additional unit of labour.
MPL = (Q2 – Q1)/(L2 – L1)
The Production Function and the Marginal Product of
LabourDiminishing Marginal Product of Labour
As the number of workers increases, the marginal product of
labour declines.
As more and more workers are hired, each additional worker
contributes less to production than the prior one.
The production function becomes flatter as the number of
workers rises.
This property is called diminishing marginal product.

The Production Function and the Marginal Product of
LabourDiminishing marginal product refers to the property
whereby the marginal product of an input declines as the
quantity of the input increases.
Figure 1 The Production Function

Quantity of
Apple Pickers
0
Quantity
of Apples
300
280
240
180
100
1
2
3
4
5
Production
function

The Value of the Marginal Product and the Demand for
LabourThe value of the marginal product is the marginal
product of the input multiplied by the market price of the
output.
The Value of the Marginal Product and the Demand for Labour

The value of the marginal product (also known as marginal
revenue product) is measured as a money cost.It diminishes as
the number of workers rises because the market price of the
good is constant.
LabourTo maximize profit, the competitive, profit-maximizing
firm hires workers up to the point where the value of the
marginal product of labour equals the wage.
VMPL = Wage
LabourThe value of marginal product curve is the labour

demand curve for a competitive, profit-maximizing firm.
Figure 2 The Value of the Marginal Product of Labour
0
Quantity of
Apple Pickers
0

Value
of the
Marginal
Product
Value of marginal product
(demand curve for labour)
Market
wage
Profit-maximizing quantity
Input Demand and Output Supply: Two Sides of the Same Coin
When a competitive firm hires labour up to the point at which
the value of the marginal product equals the wage, it also
produces up to the point at which the price equals the marginal

cost.
What Causes the Labour Demand Curve to Shift?Output price.
A change in the price of the product:
An increase raises the value of the marginal product of labour
and increases the demand for labour.
A decrease lowers the value of the marginal product of labour
and decreases the demand for labour. Technological change.
Technological advance raises the marginal product of labour,
which in turn raises the value of the marginal product of labour.
Change in the supply of other factors.
EQUILIBRIUM IN THE LABOUR MARKETThe wage adjusts

to balance the supply and demand for labour.The wage equals
the value of the marginal product of labour.
Figure 4 Equilibrium in a Labour Market
Wage
(price of
labour)

0
Quantity of
labour
Supply
Demand
Equilibrium
wage,
W
Equilibrium
employment,
L
EQUILIBRIUM IN THE LABOUR MARKETLabour supply and
labour demand determine the equilibrium wage.Shifts in the

supply or demand curve for labour cause the equilibrium wage
to change.
Shifts in Labour SupplyAn increase in the supply of labour :
Results in a surplus of labour.
Puts downward pressure on wages.
Makes it profitable for firms to hire more workers.
Results in diminishing marginal product.
Lowers the value of the marginal product.
Gives a new equilibrium.
Figure 6 A Shift in Labour Supply

Wage
(price of
labour)
0
Quantity of
labour
Supply,
S
Demand

2. . . . reduces
the wage . . .
3. . . . and raises employment.
1. An increase in
labour supply . . .
S
W
L
W
L

Shifts in Labour DemandAn increase in the demand for labour :
Makes it profitable for firms to hire more workers.
Puts upward pressure on wages.
Raises the value of the marginal product.
Gives a new equilibrium.
Figure 7 A Shift in Labour Demand

Wage
(price of
labour)
0
Quantity of
labour
Supply
Demand,
D
2. . . . increases
the wage . . .

3. . . . and increases employment.
D
W
L
W
L
1. An increase in
labour demand . . .

MonopsonyDefinition of a monopsony: a market with a single
buyer. A monopsony is in many ways similar to a monopoly.
A monopsony employer will take into account that fact that the
supply curve for labour represents the average cost of labour.
(See figure 8)
The monopsony will employ fewer workers and at a lower rate.
Figure 8 The Wage Rate and Employment Level in a Monopsony

WAGE DIFFERENTIALSWhat causes earnings to vary?
Wages are governed by labour supply and labour demand.
Labour demand reflects the marginal productivity of labour.
In equilibrium, each worker is paid the value of his or her
marginal contribution to the economy’s production of goods and
services.
WAGE DIFFERENTIALSCauses

Compensating differentials
Human capital
Ability, effort, and chance
Signalling
The superstar phenomenon
1. Compensating Differentials
Compensating differential refers to a difference in wages that
arises from non-monetary characteristics of different jobs.
Coal miners are paid more than others with similar levels of
education.
Night shift workers are paid more than day shift workers.
University professors are paid less than lawyers and doctors.

2. Human Capital
Human capital is the accumulation of investments in people,
such as education and on-the-job training. The most important
type of human capital is education.
Firms are willing to pay more for highly educated workers
because highly educated workers have higher marginal products.
3. Ability, Effort, and Chance People differ in their:
Physical and mental attributes. This will affect their
productivity level and therefore their wage.
Level of work effort. Those who work hard are more productive
and earn a higher wage.Chance also plays a role in determining
wages

4. Alternative View of Education: SignallingFirms use
educational attainment as a way of sorting between high-ability
and low-ability workers.
It is rational for firms to interpret a university degree as a
signal of ability.
5. The Superstar PhenomenonSuperstars arise in markets that
exhibit the following characteristics:
Every customer in the market wants to enjoy the good supplied
by the best producer.
The good is produced with a technology that makes it possible
for the best producer to supply every customer at a low cost.

Above-Equilibrium Wages: Minimum-Wage Laws, Unions, and
Efficiency WagesWhy are some workers’ wages set above the
level that brings supply and demand into equilibrium?
Minimum wage laws
Market power of labour unions
Efficiency wages
1. Minimum wagesThe market for labour looks like any other
market:
The equilibrium price is the wage and equilibrium quantity is
the labour hired.Introducing a minimum wage.
If the minimum wage is above the equilibrium wage in the
labour market, a surplus of labour will develop
(unemployment). (See figure 9)
The minimum wage will be a binding constraint only in markets

where equilibrium wages are low.
Thus, the minimum wage will have its greatest impact on the
market for teenagers and unskilled workers.
Figure 9a How the Minimum Wage Affects the Labour Market

Figure 9b How the Minimum Wage Affects the Labour Market
1. Minimum wages Advocates for a minimum wage argue that

raising the standard of living of the working poor outweighs any
potential increase in unemployment. Opponents argue there are
better ways or combating poverty since:
A minimum wage raises unemployment
Some of those on a minimum wage are second earners in
households.
Those poor not in work do not gain the benefit.
Figure 9a

2. The market Power of UnionsUnions often raise wages above
the level that would prevail without a union.A union is a worker
association that bargains with employers over wages and
working conditions.A strike refers to the organized withdrawal
of labour from a firm by a union.
3. Efficiency Wages The theory of efficiency wages holds that a
firm can find it profitable to pay high wages because doing so
increases the productivity of its workers. High wages may:
Reduce worker turnover.
Increase worker effort.

Raise the quality of workers that apply for jobs at the firm.
THE ECONOMICS OF DISCRIMINATION
Discrimination occurs when the marketplace offers different
opportunities to similar individuals who differ only by race,
ethnic group, sex, age, or other personal characteristics.
Measuring Labour Market DiscriminationDiscrimination is
often measured by looking at the average wages of different
groups.However simply observing differences in wages among
broad groups—white and black, men and women—says little
about the prevalence of discrimination.

Measuring Labour Market DiscriminationEven in a labour
market free of discrimination, different people have different
wages. People differ in the amount of human capital they have
and in the kinds of work they are willing and able to do.
Differences in average wages among groups in part reflect
differences in human capital and job characteristics so by
themselves they don’t say anything about how much labour
discrimination.
Discrimination by EmployersFirms that do not discriminate
will:
Have lower labour costs when they hire the employees

discriminated against.
Tend to replace firms that discriminate.
Be more profitable than those firms that do
discriminate.Competitive markets tend to limit the impact of
discrimination on wages.
Discrimination by Customers and GovernmentsAlthough the
profit motive is a strong force acting to eliminate
discriminatory wage differentials, there are limits to its
corrective abilities.
Customer preferences
Government policies

Discrimination by Customers and GovernmentsCustomer
preferences:
If customers have discriminatory preferences, a competitive
market is consistent with a discriminatory wage differential.
This will happen when customers are willing to pay to maintain
the discriminatory practice.
Discrimination by Customers and GovernmentsGovernment
policies:
When the government mandates discriminatory practices or
requires firms to discriminate, this may also lead to
discriminatory wage differentials.

Becker’s Employer Taste Model People may have a ‘taste’ for
only working with certain groups of people. Those outside this
accepted group may end up being disadvantaged as a result.
OTHER FACTORS OF PRODUCTION: LAND AND CAPITAL
Capital refers to the equipment and structures used to produce
goods and services.
The economy’s capital represents the accumulation of goods
produced in the past that are being used in the present to
produce new goods and services.
OTHER FACTORS OF PRODUCTION: LAND AND

CAPITALPrices of Land and Capital.
The purchase price is what a person pays to own a factor of
production indefinitely.
The rental price is what a person pays to use a factor of
production for a limited period of time.The rental price of land
and the rental price of capital are determined by supply and
demand.
The firm increases the quantity hired until the value of the
factor’s marginal product equals the factor’s price.
Figure 10 The Markets for Land and Capital

Quantity of
Land
0
Rental
Price of
Land
Quantity of
Capital
0

Rental
Price of
Capital
(a) The Market for Land
(b) The Market for Capital
Demand
Supply
Demand
Supply
Q
P
P
Q

Equilibrium in the Markets for Land and CapitalEach factor’s
rental price must equal the value of its marginal product. They
each earn the value of their marginal contribution to the
production process.
Linkages among the Factors of ProductionFactors of production
are used together.
The marginal product of any one factor depends on the
quantities of all factors that are available.A change in the
supply of one factor alters the earnings of all the factors.A
change in earnings of any factor can be found by analysing the
impact of the event on the value of the marginal product of that
factor.

ECONOMIC RENT
Economic rent is the amount a factor of production earns over
and above its transfer earnings.
Transfer earnings refers to the minimum payment required to
keep a factor of production in its current use. If economic rent
exists for any factor of production, the government could, in
theory, tax a portion of that rent without affecting the
employment of that factor in a particular use.
Figure 11 Economic Rent

Summary
The three most important factors of production are labour, land,
and capital.
The demand for a factor, such as labour, is a derived demand
that comes from firms that use the factors to produce goods and
services.
Competitive, profit-maximizing firms hire each factor up to the

point at which the value of the marginal product of the factor
equals its price.
The supply of labour arises from individuals’ tradeoff between
work and leisure.
Summary
An upward-sloping labour supply curve means that people
respond to an increase in the wage by enjoying less leisure and
working more hours.
The price paid to each factor adjusts to balance the supply and
demand for that factor.
Because factor demand reflects the value of the marginal
product of that factor, in equilibrium each factor is compensated
according to its marginal contribution to the production of
goods and services.
Because factors of production are used together, the marginal
product of any one factor depends on the quantities of all
factors that are available.

Summary
As a result, a change in the supply of one factor alters the
equilibrium earnings of all the factors.
Workers earn different wages for many reasons.
To some extent, wage differentials compensate workers for job
attributes.
Workers with more human capital get paid more than workers
with less human capital.
The return to accumulating human capital is high and has
increased over the past decade.
There is much variation in earnings that cannot be explained by
things economists can measure.

Summary
The unexplained variation in earnings is largely attributable to
natural ability, effort, and chance.
Signalling could partly help explain why more highly educated
workers earn higher wages.
Wages are sometimes pushed above the equilibrium level
because of minimum wage laws, unions, and efficiency wages.
Some differences in earnings are attributable to discrimination
on the basis of race, sex, or other factors.
Summary
When measuring the amount of discrimination, one must correct
for differences in human capital and job characteristics.
Competitive markets tend to limit the impact of discrimination
on wages.
Discrimination can persist in competitive markets if customers
are
willing to pay more to discriminatory firms,

or if the government passes laws requiring firms to
discriminate.
The UK’s minimum wage – not so good after all?
(words 1998)
W S Siebert, Feb 2013
Introduction
There has been a decline in labour market prospects for the
most vulnerable groups since the minimum wage was introduced
in the UK. There is not sufficient UK evidence yet to pin much
of the blame for this on the minimum wage, but the
international evidence points in that direction. Proposals for
imposing a “living wage” by soft or hard coercion could also be
damaging.
Brief history
The UK’s minimum wage began in April 1999, fulfilling a
promise of Blair’s new Labour government. Blair was
responding to popular demand, since the Conservative
government in 1993 had ended the old system of minimum
wages. Michael Forsyth, the Employment Minister at the time

said: “The biggest source of poverty is not low pay; it is having
no job. Wages councils destroy employment”. However, most
people, then and now, believe that there is a moral basis for a
minimum wage, and the coalition government has not moved
close to changing it.
The national minimum wage (NMW) system has some
interesting features. Firstly, it is set in a technocratic way by
experts who rely on research. Although the Low Pay
Commission has both TUC and CBI members, it also has
academic members, and an independent chair. Hence, a careful
sifting of the evidence on how the NMW bears on business –
including business in the regions plays a large part in the
debate. As such, changes in the NMW have responded closely to
changes in the health of the economy. The biggest exception to
this was in 2001 when the thrusting Stephen Byers saw electoral
advantage in pushing the youth rate up considerably prior to the
May 2001 election. The important point here is that the NMW is
set explicitly to weigh as little on unemployment as possible.
Secondly, the minimum wage is “national”, with no regional
differentiation. The Low Pay Commission’s terms of reference
from the beginning excluded such differentiation. Hence,
arguably, the level has always been too high for the north, and
too low for the London area. The NMW does, however, have

several age categories, with a youth sub-minimum, and an even
lower apprentice sub-minimum. Thus, it has been sensibly
conceded that young workers and apprentices are less
productive. Again, we see an effort to mute the unemployment
consequences of the minimum.
Despite this, the UK labour market is performing poorly for
unskilled workers, as shown in Table 1, and the question must
arise about the NMW’s role in this. We see that the 16-24
group’s unemployment rate has almost doubled to 24.7 per cent
over the period since 1999. In addition, as the lower panel
shows, their unemployment duration has worsened, with 28.2
per cent unemployed for over one year. In fact, as can be seen,
the UK’s youth labour market is now putting in as bad a
performance as France, long a youth unemployment blackspot
Employment effects
UK evidence. The minimum wage has been raised considerably
over the period since 1999. Hence, it makes a lot of difference
to unskilled workers’ earnings, and one would expect
unemployment consequences unless counter-balanced by strong
growth. The impact of the minimum wage can be seen in Figure
1. The 2010 distribution has had its lower tail cut off compared
with the 1997. In fact, the NMW has increased by 72 per cent
since 1999, considerably more than the 50% of the average
worker’s wage.

What effect has this had on job opportunities for the unskilled?
There are inherent statistical difficulties of identifying the
impacts of a policy that covers the whole of the UK. One way to
judge this issue is to examine regional variation, since the
NMW has more “bite” in poor than rich areas as shown in
Figure 2, which compares the hypothetical effect in a district
such as Cambridge with one such as Liverpool. Assume that
productivity and the demand for labour is lower in Liverpool.
The NMW requirement would move unskilled employment from
point d (dictated by the level of welfare benefits) to point c (the
demand for labour at the minimum wage). Meanwhile,
employment in Cambridge would be barely affected.
The first person to conduct this type of study was Mark Stewart
(2002), who used data for changes in wages and employment in
about 150 UK regions for the first year of the NMW. He found
no adverse effect, but with only one data point per region he
could not allow for region-specific trends or long-run effects.
His work has recently been updated (Dolton et al 2013, 26)
using all data including the recession, and concludes the regions
with more NMW bite indeed have lower employment other
things equal:
The elasticity is around 0.1 implying that a 10 percent increase
in the bite of the minimum wage [relative to the area

wage]would lead to a fall of 1 per cent of the employment rate”.
An alternative approach is to compare workers who have their
wages raised by the NMW with workers paid just above that
level (say, up to 10 per cent above the minimum). These
workers should have similar skills, and welfare benefit options.
This method was also pioneered for the UK by Stewart (2004).
He again found no adverse NMW employment effects, but was
only looking at one year of data.
In fact, the latest work using this approach by Dickens and
Riley (2012), using data up to 2010, does find unskilled workers
are hit harder. In particular, this research finds that the
probability of remaining in job (employment retention) is
reduced by about three percentage points by the NMW for part-
time women, the group who are most affected by the NMW
(10% compared to about 2-3% for full-timers). This result is
important because a 3 point reduction is large when measured
against an average retention rate (i.e. probability of remaining
in employment for one year) of around 70 per cent.
So, the UK employment picture for the most vulnerable has
deteriorated with the NMW. However, there is not enough data
to draw firm conclusions as to the cause as yet. What does the
international evidence suggest?

International evidence. Studying a panel of countries or states
(for example in the USA) offers a better way of analysing
minimum wages since there is more variation in the minimum.
An important study of long-run effects is that by Baker at al
(1999) for nine Canadian provinces for 1975-93. He found that
a 10 per cent increase in the minimum wage reduces teenage
employment by 2.5 per cent and that it takes about six years for
the full result.
There have been other international panel studies, all finding
adverse effects. Neumark and Wascher’s (2004) analysis of 17
OECD countries for the period 1975-2000 finds that a 10 per
cent increase in the minimum wage leads to a two per cent
reduction in the employment rate for younger people (15-24).
Recent work by Dolton and Bondiabene (2012) confirms these
estimates and also suggests that the impact of minimum wages
tends to double during a recession.
Finally, the work by Addison and Ozturk (2012) concentrates on
employment outcomes for adult women. They estimate that a 10
per cent increase in the minimum wage will reduce employment
by 1.5 per cent.
In sum, while the UK evidence is thinner due to statistical

problems, the research overall points to the minimum wage
reducing employment as conventional economic theory predicts.
In other words, the minimum wage undermines employment for
the least productive whilst raising wages for others. The
research also suggests that the workers who benefit are the
better-off. Thus, where there is high unemployment there is
heightened competition for jobs, with the better connected
workers – teenagers from better educated families rather than
the poor finding them (see Ahn et al. 2011).
Morality and new proposals for a “living wage”
Going beyond the NMW, the Joseph Rowntree Foundation and
others are calling for a “living wage” of £7.45 an hour. We are
told that “the moral pressures are winning out over the
economic pressures” (Hirsh 2012). Yet what moral virtue is
there in a policy that causes the loss of jobs for low-wage, low-
skill workers or which causes the lengthening of unemployment
duration? Countries with high minimum wages and/or high
social costs - such as France - have high long-term
unemployment (where nearly half the unemployed have been
jobless for longer than a year).
The living wage would be tied only to living costs and median
incomes and not to labour market conditions. As we have seen,
the unemployment effect of the UK minimum wage has been

reduced because of the pragmatism of those setting the rate. The
imposition of the living wage – regardless of labour market
conditions - would be a recipe for increased long-term
unemployment.
A functioning market would have much lower wages in
Liverpool than in Cambridge, which would attract business, and
relieve poor unemployed people. If the market were allowed to
work – which would require lower benefits as well as lower
wages since benefits form a floor under wages - then businesses
would move north. Of course, it is difficult to take on the
benefit system, but even tax breaks for businesses in
development areas would be better than a living wage. The
living wage would push wages up for favoured workers in large
firms and in government, but would do nothing for those
trapped within our dysfunctional “permanent” welfare system.In
fact, there are other policies, such as better schooling (and
reduced teacher union power), reduced regulation and taxes,
that could enable unskilled workers to become independent and
earn their their own “living wages”.
References
Addison John and Orgul Ozturk (2012). “Minimum Wages,
Labor Market Institutions, and Female Employment: A Cross-
Country Analysis”, Industrial and Labor Relations Review, 65:

779-809.
Ahn, Tom, Peter Arcidiacono and Walter Wessels (2011). “The
Distributional Impacts of Minimum Wage Increases when both
Labor Supply and Labor Demand are Endogenous”, 29: 12-23.
Baker, Michael, Dwayne Benjamin and Shuchita Stanger (1999).
“The Highs and Lows of the Minimum Wage Effect: A Time-
Series Cross-Section Study of the Canadian Law”, Journal of
Labor Economics, 17: 318-50.
Commission (2012). National Minimum Wage - Report 2012,
Cm 8302, London: Low Pay Commission.
Dickens, Richard, Rebecca Riley and David Wilkinson (2012),
“Re-examining the Impact of the National Minimum Wage on
Earnings, Employment and Hours: the Importance of Recession
and Firm Size”, Research Report Commissioned for the 2012
Report, http://www.lowpay.gov.uk/lowpay/research/pdf/
Dolton, Peter and Chiara Bondibene (2012). “The International
Experience of Minimum Wages in an Economic Downturn”,
Economic Policy, 27: 99-142.
Dolton, Peter, Chiara Bondibene and Michael Stops, 2013.
“Identifying the Employment Effect of Invoking and Changing
the Minimum Wage: A Spatial Analysis of the UK”,
unpublished working paper, University of Sussex.
Hirsch, Donald (2012), “The Living Wage: Where Morality and
Economics Meet”, Joseph Rowntree Foundation,
www.jrf.org.uk/focus-issue/minimum-income-standards

Stewart, Mark (2002), “Estimating the Impact of the Minimum
Wage Using Geographic Wage Variation”, Oxford Bulletin of
Economics and Statistics, 64: 583-606.
Stewart, Mark (2004), The impact of the introduction of the UK
minimum wage on the employment probabilities of low wage
workers. Journal of the European Economic Association, 2: 67–
97.
Figure 1: Changes in the Earnings Distribution due to the NMW
Source: Commission (2011), Figure 2.9
(
Supply
D
C
ambridge
wage
a
Welfare
Labour hours

D
L
iverpool
NMW
b
c
d
)
Figure 2: Assessment of NMW Effects

Table 1: Adverse Changes in Employment for Unskilled
Workers
All, 16-65
No qualifications
16-24
France, 15-24
Unemployment rate (%)
1999
6.3
12.1
13.8
24.2
2011
8.1
17.0
24.7
22.1
Change 1999-2011 (% points)
1.8
7.9

10.9
-2.1
Unemployment duration (% of unemployed > 12 months)
1999
28.7
NA
15.3
France, total
40.3
2011
33.3
NA
28.2
41.4
Change 1999-2011 (% points)
4.6
NA
12.9
1.1
Sources: Commission (2012, Table 2.10), ONS (2012) and
OECD (2000, 2012)

6
Intermediate Business Economics and the Macroeconomy
UPDATED ESSAY NOTES
W S Siebert, 28/9/15
The essay task is to choose ONE area of economic policy from
the list below, regulated by a Singapore government authority
as shown. Explain the relevant economics that underlies the
area you choose. Summarise and evaluate the arguments for and
against intervention by the authority. (2000 words essay)
The areas are as follows, choose ONE:
1) Electricity supply and pricing – authority: Energy Market
Authority (EMA)
2) Competition and merger regulation authority: Competition
Commission of Singapore (CCS)
3) Environmental protection authority: Natural Environment
Agency (NEA)
4) Wage regulation authority: National Wages Council (NWC)
(we will be working on wage regulation for this essay, so u can
ignore the first three.)

Deadline: 4th November 2015; length: text 2000 words
(references, tables, graphs and appendices are excluded from
the count); at least one table and one graph must be included in
your essay, and at least 6 references
Basic Structure
A structure that highlights the economic issues and solutions
(and compromises) discussed in the module is required.Having
chosen your area, you might build on
· a situation that has been discussed in the lectures
· a problem you have read about in a newspaper or heard about
on the news
· a discussion you find on one of the Singapore authorities’
websites
But make sure it contains economic theory relevant to the area
you have chosen, e.g.:
Area
Economic theories
Sections in Mankiw-Taylor
Electricity
Natural monopoly, utility regulation
Chap 6 (basic competition), chap14 (economies of scale, natural

monopoly, e.g. slide 35)
Competition
Monopoly power, cartels, collusion
Chap 6 (basic competition), chap 14 (monopoly and competition
compared, e.g. slide 21), chap 16 (cartels)
Environment
Externalities, property rights, prisoner’s dilemma
Chapters 10 (e.g., slide 10) and chap 11 (public goods,
externalities)
Wages
Wage determination, minimum wages, welfare safety nets
Chap 17 (labour markets, e.g. slides 38-9), chap 18 (inequality
slides 36-7)
Introduction:
What problem are you analysing? Give the question or
hypothesis that is to be your focus. Give a brief overview of the
main issues involved. Typical questions or hypotheses in each
of the four areas are as follows:
· electricity and the EMA: the EMA has helped to ensure low
cost and dependable electricity for Singapore
· competition and the CCS: the Competition Commission
successfully promotes competition, as shown by its decision, for
example, to stop SITIC’s exclusive agreements
· the environment and the NEA: the NEA helps improve air

quality in Singapore which is difficult given cross-border haze
problems
· wages and the NWC: the NWC’s wage “guidelines” provide
better employment opportunities than a minimum wage.
Main body:
First, I suggest starting with economic analysis. Explain the
relevant economics behind the issues. Taking the four areas in
turn we have problems of natural monopoly in the case of
electricity supply and the EMA, collusion in the case of the
CCS, the tragedy of the commons in the case of Indonesia’s
fires, and labour market supply and demand and the problem of
low wages in the case of the NWC. Start with a simple
diagrammatic analysis if possible.
Then, take up the facts and statistics. Explain the reasoning for
the authority’s policies – go to the authority’s website, and
discuss why and when it was set up. Discuss its history and
achievements, and draw up a table if possible using statistics to
demonstrate its achievements. Comparison with other countries
is not necessary, but can be useful – the UK for example, has
regulation of electricity, and also has a minimum wage.
Conclusion: what have been the advantages and disadvantages
of the authorities policies? Try and use specific examples, and

relate to supply and demand analysis as taught in the module.
Final word: keep it simple. Use your chosen authority’s website
for the practical detail of what has happened in Singapore, and
use Mankiw-Taylor for the supply and demand foundation. Tell
a story about how Singapore’s government authorities help
solve basic economic problems, using graphs and data.

Requirements
· Clear structure, with Introduction; Main body; Conclusions;
References
· Introduction sets out your questions
· Main body: develop your arguments and analysis
· Conclusions – provide a brief summary and discuss
implications (if any) for business
· References need to be complete
Writing the essay
· Stick to the word limit
· You are not being judged on the elegance of your English, but
your paragraphs must have a structure:
· beginning, middle and end
· clear leading sentence, and concluding sentence to each
paragraph
· It is good to discuss matters with others in preparing the
essay, but write everything yourself

· Leave yourself time to proofread before submitting
Explaining the Economics
· In your essay, you should show that you can understand and
apply some of the economics we have covered in this module
· Explain the theory that relates to the case you choose (see
following slides)
· You may use diagrams for your explanation (e.g. contrasting
competition with monopoly, then showing possible welfare
losses)
· Use the economics to analyse different policy measures – i.e.
refer back to the theory when discussing policies
Plagiarism
· Make sure you use your own words when writing the essay
· All sources need to be correctly referenced
· Do not copy and paste: this is the best way to avoid plagiarism
· Use direct quotes only when absolutely necessary
· Beware of collusion: working closely with a friend on a
similar topic and writing very similar essays
· Your essay will be checked for plagiarism
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Summary of Advice
· Choose an area quickly and collect information
· Remember that to get a good mark you need to show that you
can understand and apply the relevant economics
· It is a short essay:– every word must be necessary
· Make sure your essay is written in your own words all essays
are checked for copying using Turnitin
· Any questions? Ask now or email me
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Forthcoming in Chris Coyne and Rachel Coyne – Floors and Ceilings.docx

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