Minimum Wages Good and Bad

By TAN Kee Wee
(MediaCorp 938LIVE’s Money Talks, Monday, 18 October 2010, 7.20 am, 9.20 am, and 7.20 pm)

Why are there many young men and women who wish to get married, yet at the same time, there are many young men and women who are not married? Likewise, why are there many jobless workers, yet at the same time, there are many job vacancies?

The answer is because in the two situations mentioned, both parties have not found each other. Economists label these situations “markets with search frictions”. Such situations, which can be found everywhere, can lead to second best outcomes.

Last week, the Nobel Prize in Economics was awarded to three economists for their work in shedding light on this issue. They are Peter Diamond, Dale Mortensen and Christopher Pissarides.

Their studies, conducted in the 1970s, reveal that information gaps exist in the job market. Because of these gaps, both job-seeker and employer will not commit if they think a better alternative can be found. This delay and costly search process leads to unemployment.

Before this finding was revealed in the 1970s, the common belief in the West was that the availability of unemployment benefits made the job situation worse.

It may perhaps explain why many Asian countries in the 1970s chose to steer themselves away from becoming welfare states, preferring not to offer any unemployment benefits, nor establish any form of minimum wages.

For the past 40 years, the free market has served Asia well. Many Asians have grown very rich. But the gap between the rich and the poor has widened considerably.

In an effort to address this widening gap, Hong Kong recently proposed to introduce its first minimum wage law this year. That proposal sparked off renewed discussions, with the loudest voice coming from those who oppose it.

This is understandable. One of the dangers of implementing a minimum wage rate is that it could be the first step down the slippery slope to the dreaded welfare state, as history has shown.

In many quarters, the welfare state is dreaded because most end up as big inefficient bureaucracies constantly redistributing a shrinking pie.

Opposition to the welfare state is especially strong in Asia where many believe that wealth or poverty is largely determined by the gods. Man can do little about it.

While the work of the three Nobel Prize economists suggests that unemployment benefits may not fully explain the unemployment problem, their work also suggests that minimum wages might make job-seekers worse off.

How is that possible? Let’s look at the two behavior traits the trio found about job-seekers. Firstly, job-seekers do not like to spend time searching. And secondly, if job-seekers think that all employers offer the same minimum wage, they will stop searching and take up the first available job.

This behavior can lead to one good or one bad thing. The good thing is that a minimum wage would speed up employment since time is not wasted searching. But if the minimum wage is set too high, the employer suffers.

The bad thing is that when job-seekers stop searching, because they think that all employers offer the same wage, employers can exploit the situation, co-operate and set a low minimum wage. In this case, the job-seekers suffer.

Presumably bachelors behave like job-seekers, in the sense that they don’t like to search and will take what is given. Usually, friends and parents of the bachelor establish a minimum set of criteria as to what to look for in a wife.

If the minimum set of criteria is placed too high, the wife suffers because the husband falls short of her expectations. If the minimum is placed too low, the husband suffers because the wife does not meet his needs.