The Minimum Wage Against the “Invisible Hand”... How Can We Minimize Its Side Effects?

[Market Economy Op-Ed] Groups That Benefit and Groups That Lose Can Reverse at Any Time

The most efficient allocation of resources is achieved when the actions of consumers and producers are left unhindered

Among the various economic policies pursued by the Moon Jae-in administration, the most controversial was probably the minimum wage increase. The Moon Jae-in administration actively pushed for higher minimum wages as one of its policies to raise household income under its income-led growth strategy, and as a result, the minimum wage rose rapidly in recent years.

In 2018, the year after the president took office, the minimum wage was 7,530 won, up 16.4% from the previous year, and in 2019 it was 8,350 won, up 10.9% from the previous year. Given that the annual increase rate had remained in the single digits every year since 2003, this was indeed a sharp rise. As of 2020, the minimum wage is 8,590 won, up 2.9% from the previous year. After the 2020 minimum wage was announced, public debate over the minimum wage quickly faded. However, the impact of the sharp minimum wage increase on our economy is still ongoing.

At first glance, it may seem that the groups that benefit from and the groups that lose from a minimum wage increase are clearly divided. One might think that the group benefiting from a minimum wage hike is the group of workers subject to the minimum wage, because their labor income rises in line with the rate of increase in the minimum wage regardless of the employer’s intentions.

On the other hand, the group that loses from a minimum wage increase may be seen as employers who currently hire, or plan to hire, wage workers subject to the minimum wage. That is because they must pay higher labor costs corresponding to the rate of increase in the minimum wage.

However, the groups that gain benefits and those that suffer losses can change at any time. If, because of a minimum wage increase, employers lay off existing workers or reduce new hiring due to the burden of labor costs, then workers subject to the minimum wage, as well as job seekers who would otherwise earn wages around the minimum wage, are highly likely to become unemployed.

And if the wage increase resulting from a higher minimum wage boosts the motivation of workers subject to the minimum wage, or if employers are able to hire better-quality workers than before the increase, then worker productivity is likely to rise, increasing a business’s sales or profits.

Therefore, the pros and cons of the minimum wage system must be assessed by considering all gains and losses experienced by all people from every angle.

Then which is greater when the minimum wage system is implemented—the gains or the losses? Adam Smith, the scholar credited with founding economics, argued in his book The Wealth of Nations (1776) that when the actions of consumers and producers pursuing private interests are left completely unhindered, the most efficient allocation of resources results. This is the “invisible hand” theory, which emphasizes the principles of the market economy.

The minimum wage system sets a floor for wages, the price of labor, and is therefore a type of price control. Accordingly, price control measures such as the minimum wage system hinder the operation of the “invisible hand” and reduce market efficiency. The consequences of this loss of efficiency are already being observed throughout Korea’s labor market.

To begin with, in labor markets with many workers subject to the minimum wage—for example, convenience stores and restaurants—part-time jobs have disappeared, increasing unemployment. The stability of temporary and daily jobs has also declined. If employers are to reduce labor costs, they must either cut wages or reduce the number of workers employed. But when wage cuts become difficult because of the minimum wage system, employers have little choice but to reduce the number of workers. Since regular workers are not easy to dismiss, temporary and daily workers, whose contract periods are relatively short, are more likely to face non-renewal after their contracts expire or to be dismissed.

It has also become increasingly difficult for job seekers to find quality jobs, making it hard to break the vicious cycle in which the number of unemployed continues to rise. This is because employers have become more likely to prefer temporary and daily jobs, which are relatively easier to adjust, over regular jobs, where labor cost adjustments are more difficult.

Over the past three years, two consecutive sharp increases were followed by a moderate increase in the 2% range, further heightening uncertainty in the operation of the minimum wage system. It should be kept in mind that this increase in uncertainty can raise market inefficiency and further enlarge the costs of the minimum wage system.

If the minimum wage system is truly necessary to guarantee the minimum livelihood of wage workers, then we should be willing to bear the costs that come with its implementation. However, efforts to minimize those costs are also important. I believe that one way to minimize the costs of implementing the minimum wage system is to operate it in a stable manner so that the minimum wage determined each year is predictable.

Jinyoung Lee, Professor, Department of Economics, Information and Statistics, Kangwon National University

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Original title: '보이지 않는 손’ 원리에 반하는 최저임금제도...부작용 최소화하려면?

Author: Jin-young Lee

Date: 2020-02-07

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&pn=22&idx=22363