Are incentives irrelevant?

Finland has begun an experiment where it will pay unemployed citizens a fixed monthly sum. The idea is based on a 'universal basic income'. Other countries are going to start similar experiments.

The idea of a basic minimum income, regardless of economic activity, is one that is very attractive to those who are concerned with addressing inequality. It is controversial because opponents say it will simply encourage idleness.

Traditional supply side economic theory says that if the difference between in-work and out-of-work income is too small then there is too little incentive to take up job offers. People remain unemployed until a better offer comes along. When the difference is large then the unemployed jump at a job offer, therefore governments have cut the real value of the unemployment benefit sine the 1980's.

Supporters say that it is more important to deal with inequality which has risen continuously since the 1980s. This was not promised by supply side theory which said that the initial the rise in inequality would be reversed due to faster economic growth. (Unkindly some say this is the 'trickle down' effect, but actually they envisaged faster productivity growth and so higher wages throughout the economy.)

Others point to the fact that the system is very cheap to administer. There are no tests, no adjustments (even if the recipient finds work) and so minimal clerical effort. Therefore government expenditure is partly offset by lower costs of administration.

It's something you may want to watch.

The Guardian covers the story here

The new VCE study design has downplayed the study of inequality. However at IB it is an important economic goal. There is an IA in this one that looks at the effects on LRAS and AD. Read the article carefully, I have not put in every important detail here.

A minimum wage for South Africa

South Africa has struggled with unemployment for many years. Until 1994 there was not an accurate figure, but it was thought to be as high as 40% and  it has never been less then 20%. In addition those in work earned low wages, often as 'day labourers' often working just one or two days each week.

It is perhaps surprising in a country with a background of inequality and low employment that no minimum wage has been established. It is now proposed that one is set.

There are arguments for and against this measure.

It will establish a wage floor that will protect the low paid from exploitation. This is very important when people are desperate for work and employers will allow competition to cut wages to below a 'living wage' level. (In effect the profits of firms are being raised through this.) It will also go some way to reducing inequality in the labour market.

Against it are the point that it might lead to more unemployment if the rate is set too high. Also it does nothing to raise the income level of those who do not work.

It seems unlikely that the minimum wage proposed is too high as the government appear to be starting at a low wage, perhaps with the idea of raising it over time. It seems more likely that it will force businesses to pay more to workers and prevent them from exploiting the large pool of competing labour they draw on.

There will be winners and losers in this, but it does seem a long overdue measure.

The BBC cover the story here

The concept of a minimum wage arises in the micro section of the IB course, but the concept of inequality is part of the macro course. Therefore this is something that could easily be turned into a Macro IA. Consider also the effect of AD of raising wage levels and the effect on AS of raising firms costs.

Penalty rates. A story to watch.

The Productivity Commission in Australia are looking at a variety of work practise's and this includes whether penalty rates are set appropriately.

Penalty rates are generally called 'overtime rates' in the rest of the English speaking world. It refers to the 'bonus' paid to workers who work extra hours over their usual working week or work at anti-social times, such as weekends. In Australia these rates continue to be set on a national level and for particular industry's.

Some argue that the rates set are too high. In some industry's the rates can be 200% of normal wages. The graph below shows the rates for the hospitality industry.

The traditional argument on penalty rates is that they lead to lower employment. The higher the wage rate then the lower the demand for labour. The same argument can be applied to the minimum wage. The graph below shows the effect of a penalty rate, PR, set above the market wage rate W. The effect is to lower employment by N - Nd hours when penalty rates apply. Notice that Ns - Nd hours of work are offered by workers, but are not taken up (involuntary unemployment).

Another way of looking at this is that penalty rates will cause firms costs to be higher. This leads to market prices being pushed up and so output, and so employment, in an affected industry is lower. The diagram below shows this with the industry or firm supply curve SPR reflecting the higher costs of penalty rates compared to no penalty rates, SNR.

There is some doubt about this analysis. When firms have a great deal of power relative to their employees, as they do in retail and hospitality, they might be able to force wage rates below market rates (W). This means that penalty rates protect workers from profit maximising employers. 

There is also not much evidence to suggest firms close down, or don't operate, when penalty rates apply. 

Below are some articles that look at this issue. The Productivity Commission will give its final report around July, it is worth being ready for it.

The ABC looks at Commission proposals here

Q&A fact check claims on penalty rates here

This is good analytical practice for IB and VCE economists. It might be a fruitful area for IA's or EE's for IB students.

Wages rise more slowly

The last time that wages rose as slowly as they did last year was 1997. Should we be surprised by this?

The previous post talked about unemployment being at a ten year high, and this should give us a clue to the wages data. When unemployment is high employers are under less pressure to grant wage rises because people might prefer to keep their jobs than force the issue and find themselves unemployed.

A.W. Phillips first identified this wage rise/unemployment link in 1960, using data from nearly one hundred years. There was a clear trade off between unemployment and wage rises.

 

The diagram shows the data up to 1913, the data from 1919 to  1957 looked identical. 

The link between wage rises and inflation was soon established and often the Phillips Curve is shown as a relationship between inflation and unemployment (a point not made by Phillips himself). So one good piece of news is that Australian inflation might be expected to moderate in the next six months. However the price is higher unemployment and some will feel that inflation is the lesser of two evils.

The article also suggests that Australians are going to experience lower incomes as wages rise less quickly than inflation. This is probably inevitable as the Australian dollar falls in value causing imports to be more expensive. Also it is part of the essential readjustment of wages to allow Australia to be competitive in the world market.

The ABC cover the issue here