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The National Minimum Wage Notes

Economics Notes > Political Aspects of British Economics Notes

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Paper 4: Political and Sociological aspects of Economics Essay What justification is there for the introduction of the National Minimum Wage?
The introduction of the National Minimum Wage (NMW) in 1999 in Britain was designed to address problems of low pay and wage inequality. Pay inequality has risen in Britain since the late 1970s. Between 1979 and 1996, the earnings of the bottom 25 per cent of male wage earners fell from 80% to 73% of median average earnings, while for the top 25% they rose from 125% to 138%.By setting a wage floor, the NMW can help to lift the incomes of the poor to a higher level and reduce the growing wage gap. This assumes that higher wages for the lowpaid and small wage inequality is a goal a society should strive for, as long as it does not get in conflict with other objectives. In addition, the relative deterioration of the wages of the low paid has increased the reliance of many workers on state benefits. The number of families receiving state family benefits has increased from 50,000 in 1988 to 700,000 in 1997, imposing rising costs on public finances. With no NMW, employers have an incentive to limit the gross pay in order to maximise the employee's entitlement to state topups, thereby reducing their own costs. The introduction of the NMW shifts the burden of providing a decent income for the lowpaid from the public finances to the private sector. One of the big problems associated with the NMW is the fear of job losses. According to the classical theory, a wage floor above the competitive wage will lead to less workers hired and thereby increase unemployment. This is depicted in Figure 1. The amount of job losses depends on the elasticity of the labour supply and labour demand. The sectors most likely to be affected by the NMW are those with predominantly low wages: Cleaning, hairdressing, hospitality etc. These sectors have a low substitutability of labour to capital and thus a rather inelastic labour demand curve. Employers would rather accept the higher wages and take a strain on their profits than lay off people. Higher pay for lowincome earners is likely to increase the employee's motivation on the job and thus lead to higher productivity. With higher productivity, the marginal product of every 1

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