What are the consequences of minimum wages on unemployment levels in an economy?

IntroductionA minimum wage is the lowest wage that employers may legally pay to workers. It is the price floor below which workers may not sell their labour. Although minimum wage laws are in effect in many jurisdictions, differences of opinion exist about the benefits and drawbacks of a minimum wage. This topic has been the focus of research for a few years now. It derives its impact from the fact that it is policy decision which directly affects the employment and remuneration levels. It has a direct impact on the labour force. In this I have tried to check if the predictions made by the theoretical models are actually in line with the reality by performing some basic macro level analysis.Theoretical AnalysisBasic Economic Model:Figure 1 shows a hypothetical competitive local labour market. The intersection of the market demand curve for labor and the market supply curve determines the competitive wage with employment level. Wh= wage level of high skill work force (without minimum wage), Wl=wage level of low skill work force (without minimum wage) and W bar= minimum wage level for the entire labour force.

Figure 1Effect on unemployment: The theory says that minimum wages increase unemployment in the less skilled labour force as shown in Figure 1 above. When the minimum wages are set at a level which is higher than the market determined wage level for low skilled workers, unemployment will increase as shown. Firms will give higher wages and hire less people. In case of high skilled workers the presence of a minimum wage might push the average level of wages up as the base level of computing wage would increase.Other practical considerations: Supporters of minimum wages might believe that these laws mainly help to boost the incomes of full-time adult workers in low-income families, some of whom are supporting children. However, the data generally do not support that view. Most workers earning the minimum wage are young workers, part-time workers, or workers from non-poor families. Only 20.8 percent of all minimum wage workers are family heads or spouses working full time, 30.8 percent were children, and 32.2 percent are young Americans enrolled in school.The popular belief that minimum wage workers are poor adults (25 years old or older), working full time and trying to raise a family is largely untrue. Just 4.7 percent match that description.Indeed, many minimum wage workers live in families with incomes well above the poverty level. (Wilson, 2012) Effect of minimum wage on gender wage gap: Most countries report that the minimum wage has undoubtedly been important for raising income levels among female workers and facilitating a reduction in the gender wage gap. These countries include, in particular, Bulgaria, Cyprus, Greece, Ireland, Malta, the Netherlands, Slovakia, Slovenia, UK, and, to a lesser extent, Lithuania. In France, women appear to be 'trapped' in part-time work, as the minimum wage is not effective in giving access to full-time employment. This highlights the problems of low-wage traps. There are no or hardly any academic debates on such gender equality questions in the Czech Republic, Hungary, Latvia (where women and men appear to be employed to a similar degree on minimum wages), Poland, Romania, Slovenia and Spain. (Lesch, 2005)Finally, there has been a recent initiative calling for a Europe-wide minimum wage. In April 2005, researchers from Germany, France and Switzerland presented 'theses for a European minimum wage policy', according to which every country in Europe should guarantee a national minimum wage that corresponds to 60% of the average national wage. (Lesch, 2005)Empirical AnalysisData: Minimum wage and unemployment data for European countries for the past 10 years has been used. It was downloaded from Eurostat website. The description of the data used is as follows:Minimum wage statistics published by Eurostat refer to monthly national minimum wages. The data shown here apply to the situation on 1st of January each year. In some countries the basic national minimum wage is not fixed at a monthly rate but at an hourly or weekly rate. For these countries the hourly or weekly rates are converted into monthly rates. The national minimum wage is enforced by law, often after consultation with the social partners, or directly by national intersectoral agreement (this is the case in Belgium and Greece). The national minimum wage usually applies to all employees, or at least to a large majority of employees in the country. Minimum wages are gross amounts, that is, before deduction of income tax and social security contributions. Such deductions vary from country to country.Methodology:One way of checking if there is any relation between minimum wages and unemployment might be to compare the performance of countries who have set minimum wages and the one who have not. For this analysis I have divided the countries in 2 groups.Group A: The list of countries in Europe which have set minimum wages are Belgium, Bulgaria, Czech, Republic, Estonia, Ireland, Greece, Spain, France, Latvia, Lithuania, Luxembourg, Hungary, Malta, Netherlands, Poland, Portugal, Romania, Slovenia, Slovakia, and United Kingdom.Group B: The list of countries which do not have a minimum wage are Denmark, Italy, Cyprus, Austria, Finland, Sweden, Iceland, Norway, Switzerland, Germany, Macedonia, and Croatia.To gauge the effect of the magnitude of minimum wage I have divided the countries in Group A into 4 sub-groups depending on the level of minimum wage set. As shown belowAverage minimum wage (Euro/Month)

Sub-Group 1181.975

Sub-Group 2329.155

Sub-Group 3405.46

Sub-Group 41195.488

Results:Figure 2 depicts the average unemployment rates of these 2 groups of countries. There is a change in the trend depicted from 2008 to 2009. The reason for this is not known but this trend is also observed in all the other graphs in this report. For simplification if we just consider the graph after 2009 we can see that the unemployment rates are higher in countries that have implemented minimum wages. Although there can be many reasons for this trend which may be specific to the countries selected. But it has to be considered that country specific variation will get diluted as these values are averaged for a group of countries.

Figure 2Figure 3 depicts the growth in minimum wage levels and the unemployment over time in countries belonging to group A. Again if we consider the period after 2009 we can see that the unemployment rates have been growing steadily along with the minimum wage levels.

Figure 3It has been mentioned in the theory that the people who are most affected by the minimum wage are low skilled workers. These are the people who have would have gotten wages lower than the minimum wage had they been set by market forces. Figure 4 depicts the average unemployment rates in the 4 sub-groups considered. Apart from the exceptional increase in unemployment for sub-group 2, we can see that in general the unemployment rates are higher in countries having higher levels of minimum wage. This is as expected by the theory.

Figure 4Another effect of minimum wages is that they tend to lift the average wage levels in the economy. Although this analysis has not been done but if we consider the countries in Sub-group 4 we can see that all these countries also have the highest wage levels in Europe.ConclusionThe evidence is in line with the theory that minimum wage under certain circumstance can lead to increase in unemployment. For most of the countries analysed it can be argued that the minimum wage levels set are not high enough to cause harmful effects on the employment levels. But there are countries in Sub-Group 4 which have the highest levels of minimum wage in Europe almost as high as 5 times that of the lowest Sub-Group. And the unemployment levels are higher in these regions. For these groups, the most effective solution in terms of employability would therefore be to lower the minimum wage. But this could reduce the attractiveness of work for some groups (for example, young people). A second-best solution would be to offer employers a reduction in non-wage labour cost for those employed at or around the minimum wage. ReferencesLesch, L. F. (2005). Minimum wages in Europe. Retrieved from www.eurofound.europa.eu.Wilson, M. (2012). The Negative Effects of Minimum Wage Laws. Retrieved from http://www.downsizinggovernment.org/.