Home > Uncategorized > Minimum Wage should be replaced!

Minimum Wage should be replaced!


My friend Richard Hudson posted a graph on facebook last night illustrating how wages in six income brackets have changed from 1980 to the present day.

Wages from 1980-2011

This graph is only for illustrative use only.

The minimum wage was introduced in 1997. As you can see from the graph, the introduction increased the lowest-paid wages slightly but they end up stagnating whilst the 3 highest income brackets wages increase. Now correlation does not mean causation but I believe that the minimum wage has profoundly impacted the lowest 3 income brackets and has been a leading factor in the wages stagnating at the bottom.

Why?

Behavioural economics.

Behavioural economics is the study of how we humans make decisions in our everyday lives. It has this concept called anchoring. An anchor is simply a price that we use to determine how much a product is worth and it is usually the first price we see. Let me explain with an experiment.

Drazen Pralec (Professor at MIT), George Lowenstein (Professor at Carnegie Mellon University) and Dan Ariely (Professor at Duke University) asked 55 future marketing pros to jot down the last two digits of their social security number and then asked the students if there willing to pay this amount in dollars for a number of products. The students were then asked to actually bid on the items in an auction.

This part of the experiment was trying to prove something called arbitrary coherence.That is whilst the initial price is “arbitrary” like for example the minimum wage but that once they are established in our minds they not only shape present prices or wages but future prices or wages. This makes them coherent.

Drazen held up the products (a Cotes Du Rhone 98, a Hermitage Jaboulet La Chapelle 96, a cordless trackpad, a cordless keyboard, a design book and a one pound box of belgian chocolates by Neuhaus) and did some spiel that the Hermitage was a better wine than the Cotes du Rhone etc. The students were given a piece of paper with the products on, and as instructed they wrote the last 2 digits of their social security number at the top of the page, converted that into dollars and answered a simple yes/no if they were willing to pay that price for the products. They then wrote down what they would be willing to pay for each of the products.

Now you wouldn’t expect the writing down of the last 2 digits of their social security number would have any effect but it did. The students with the highest ending numbers (80-99) bid highest and those with lowest ending (1-20) bid lowest. Of course once the students were willing to pay a certain amount for the Cotes du Rhone they judged the price of the Hermitage relative to that first price.

What does this have to do with the minimum wage and its effectiveness?

The minimum wage is providing that initial arbitrary price in which we judge how much low-paid/low-skilled jobs are worth. Because there isn’t upward pressure on the minimum wage so that there is long-term increase in the minimum wage, it means that low-paid jobs aren’t increasing in the way that they should be.

Now the minimum wage is important. If you want to see its importance view this video (hat-tip to @rosiecosy for the video):

I agree with almost everything he says. My problem with the minimum wage is not the social floor it provides but that it is providing an anchor for low-skilled/low-paid jobs and therefore holding those wages back.

Lets look at different proposals:

  • A high pay anchor i.e. set the top rate of pay that anyone can earn and use people’s in built relative judgements to set appropriate highest/lowest wage ratios.
  • Set a highest/lowest wage ratio either legislative or through tax incentives. So if management increases their pay, they’ll generally have to increase workers pay.
  • We could encourage mutual companies
  • Encourage workers to be shareholders and give shareholders more power to hold the executive of a company to account and put downward pressure on top pay and provide upward pressure on workers pay.
  • Encourage companies to put workers on renumeration boards

Now, I disagree with the setting of a high pay anchor. I don’t think the government should legislate how much anyone can earn. The second method, I am generally in favour of but I think we need to be careful in implementing so that we don’t have workers comparing themselves to CEOs around the world, and therefore have a UK based branch(es) whilst they are abroad earning much much more than the workers in the UK.
The last 3 points, I agree with especially the 4th point. I believe that is the most liberal solution. The question is what is the best way to go about it. Should it be a legal entitlement?

Nick Clegg was on the Andrew Marr show saying that the government was going to get tough on executive pay. I think we need some joined up thinking on the issue of wages. There is irrationality at the bottom and the top when it comes to deciding wages. I believe it is these irrationalities that is creating the huge inequalities in income. The question is what is the right solution (and for me what is the most liberal solution) in order to fix these irrationalities so that we can have a more equal society.

Please feel free to leave comments. I’d really enjoy hearing your comments on this issue.
P.S. The experiment described in this post was from Dan Ariely’s “Predictably Irrational”. If you enjoyed the experiment, there are loads more in the book. It is a highly fascinating book.

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Categories: Uncategorized
  1. December 10, 2011 at 00:18

    Nice topic I agree with what you just said. It totally makes sense.

  1. January 1, 2012 at 07:38
  2. January 10, 2012 at 18:30

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