by Eric Pan.
Did you know that Australia has the highest minimum wage in the world in 2019 when adjusted to inflation and purchasing power?
Hell yeah! You might say. Higher minimum wage means that we can make some decent pocket money at a part-time job and still enjoy ourselves while we toil and moil at uni. But how does minimum wage actually work?
Technically, the minimum wage is the minimum amount of remuneration employers must provide to workers for work period, which cannot be reduced by collective agreement or an individual contract.
Interestingly, the concept of minimum wage hasn’t been around so long. The minimum wage was fist introduced in New Zealand in 1894 and in its early day’s minimum wage was considered as a temporary measure that would be phased out eventually.
Australia is one of the first countries to establish a permanent minimum wage scheme, most industries pay an award rate above the minimum wage. Award rates vary across industries and are negotiated by industry-specific unions and moderated by the Fair Work Commission. In Australia, only 2% of the population of workers are on the minimum wage. Thus, the minimum wage is really targeted at supporting the most vulnerable workers in our country.
At its core the minimum wage is set to prevent the exploitation of workers. All workers should be paid a sufficient level of income to afford a decent standard of living. I think this is a strong moral and social argument.
However, many economists argue that the minimum wage is a counter productive way of protecting workers. Economic theory suggest that minimum wage creates an inefficient allocation of labour that leads to unemployment and underemployment.
Let’s think about the economic theory for a minute. But before, we begin, it is critical to think about wage as a price. Wage is merely the price of labour and like any other prices, wages are determined by the law of supply and demand.
If coffee now costs $15 per cup, you would surely buy less of it and cafes will struggle to survive. The same thing happens to wages. When you introduce a minimum wage, the cost of labour increases and employers a squeezed. To survive, form can either raise the price of goods or reduce the cost of labour. The latter is preferred because employers need to maintain their customer base to protect their profit margin. Therefore, some workers will be made redundant to have their working hours reduced to compensate for the increased labour costs.
The truth is minimum wage inevitable creates unemployment and underemployment as a by-product. However, the magnitude of the impact depends on the height of the minimum wage. For these, reasons, pro-market economists argue that a free market approach is a much more efficient way of creating better wages and lower employment rate.
Denmark, Sweden, Norway, Finland, and Singapore do not have minimum wage system, yet they consistently produce high wages for workers, low unemployment rate, and are ranked highly for standard of living among developed nations.
Instead of minimum wage, these countries allow workers and firms to interact freely in the labour market whilst advocating for collective bargaining between forms and labour unions. Labour unions negotiate wage increases independently with businesses to ensure workers are fairly compensated.
Without a minimum wage, wages can increase through competition in the free market. Unemployment and underemployment fall subsequently as workers have the choice to work for less money if they want. I think it’s better to be employed and earning a little less compared to being unemployed and earning nothing at all.
So theoretically, a high minimum wage creates higher unemployment and underemployment. But how does this theory stack up against the real world we live in? Empirical research on the Australian labour market has not found a significant causal link between minimum wage and unemployment in Australia. Researchers found that the minimum wage has had a little impact of employment via hours worked and job losses.
A market oriented labour market like the one in Denmark could function well in Australia. However, minimum wage system has worked well for us for a long time without creating an adverse impact on our labour market. At the current level, the minimum wage is high enough to provide a decent standard of living and is low enough to incentivize workers to upskill through education and training to increase their earning potential. I think the system is working well, and I would not be inclined to change the system at this point.