The impact of minimum wage on the level of employment and inflation in an economy

Dollars in a wallet - minimum wage

The Minimum Wages (MW) were practically executed at the start of the 19th century. According to the IMF working paper, currently, 90% of all countries and their governments have legalized the laws for MW within their economies. However, the fundamentals to define their roles in all countries varies i.e. in most of the Developed Countries (DCs) the MW is set on an hourly basis and in ‘under’ or ‘Less Developed Countries (LDCs)’ it is set on a monthly basis for all workers.

The minimum wage is the lowest possible wage for an employee per hour or month mandated by the federal authorities. They are mandated to raise the income level of unskilled employees. Both developing and developed economies enforce to execute the mandated national minimum wage laws. MW can vary state-to-state or region-to-region depending on the stability of the formal economy and grand domestic productivity. Like, currently, the minimum wage set by the federal bodies of United States is $7.25 per hour. Whereas, it varies from state to state ranging from $6 to $14 per hour.

High minimum wage and its impact on an economy

If any state or country mandates a high minimum wage, it would eventually influence the average labour cost, employment, and as well as inflation. According to the practitioners setting the higher minimum wage would increase the average wage bill that is supposed to be paid by the employers which increases the prices of goods or services they offer, and that leads to inflation in an economy.

Moreover, increasing the too-high minimum wage would also require employers to lay off employees to maintain operational costs and the workload shifts to others. As a result, unemployment increases and a significant shift can be observed in employment from a formal economy to an informal economy. This behaviour can highly influence the developing economies is related to the developed economies. Because the gap between formal and informal economies varies in both developed and developing economies around the globe.

Less developed countries (LDCs)

Minimum wage laws are important in the less developed (LDCs) or developing countries to combat poverty. These laws also provide the ability to purchase goods and services and it’s particularly for unskilled employees. Whereas, A considerable controversy remains in the developed economies in terms of their fulfilment of the objectives related to their GDP. As the behaviour is significantly supported by the ‘Segmented Labour Market Model (SLMM)’ which states that a higher minimum wage has an inverse relationship with employment and productivity in the formal economic setup.

This suggests that workers who can lose their jobs because of the minimum wage laws will find jobs in the informal economic setup where minimum wage laws cannot be enforced or executed. Thus, the real wage graph will show depressing behaviour, unemployment will increase and the output of the formal economies will highly be affected.


Developed economies

United States is one of the developed economies where the minimum wage ranges from $6 to 14 per hour. In 2010, employees of the fast-food sector demanded the rise of the minimum wage to $15 per hour they work. This demand was immediately drowned by the federal bodies because this rise would have a significant influence on overall GDP including employment and as well as inflation. This would have let the unskilled workers earn at least $30,000 per year which was difficult for the manufacturers and services providers to bear such a huge employment cost and wage bills.

Discussing the developed economies, A proportion of the scholars believe that increasing the minimum wage could help stimulate the economy. That is because it will increase the buying power of individuals. Economists believe historically that increasing the minimum wage would not allow an increase in inflation. But other economists believe that artificially increasing the minimum wage would cause unemployment and imbalance in the labour market, which ultimately drastically draw an increasing upward line of inflation in the graph.

The developing economies are not economically sound as developed ones. The rationale is that they believe in the free labour market laws to avoid wage-push inflation. If a person is willing to work on $5 per hour but the minimum wage has been mandated to at least $10 per hour. It is possible that the worker will not bid for the job. Whereas, maximizing wage bills would also lead employers to increase the prices of goods and services. This would ultimately lead to unemployment plus wage-push inflation.

On other hand, the arguments to support the existence of wage-push inflation are not much strong. Because the empirical evidence has suggested that the MW increase has had a very weak association with the prices of goods and services. The condition they connect with this argument is that the increase in the MW has to be a minimum (around 5% to 15%). Although, its impact on unemployment will vary in comparison the developed and developing economies. Thus, it requires a deep analysis and good support of the evaluability of data for designing any changes in the minimum wage laws in both developed as well as developing economies.

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