Will a New Minimum Wage Raise Prices?

By

Chimere iheonu

Date Published

June 5, 2024

Category

Political Economy

Introduction

On June 3, 2024, the Nigeria Labour Congress (NLC) declared an indefinite strike in a bid to force the government to increase the minimum wage. The NLC argued that there has been a substantial increase in the cost of living, with the headline inflation rate reaching 33.69% and food inflation at 40.53% in April 2024. The last time there was an increase in minimum wage, headline inflation was about 11.39% and food inflation was 13.73%.

The rising cost of living justifies NLC’s demands. However, some stakeholders suggest that the increase in the minimum wage will further lead to an increase in inflation. They argue that when income and demand increase, sellers will most likely increase the prices of the commodities they sell, leading to more inflation.

In this article, I provide a theoretical perspective on this argument. I also provide insights on why the increase in the minimum wage would likely not lead to an increase in prices in the middle to long term, if at all any price increase will occur in the short term.

What does theory say?

Two types of inflation link the increase in the minimum wage to inflation. The first is demand-pull inflation, and the second is built-in inflation. The idea behind demand-pull inflation is that an increase in the minimum wage would lead to an increase in income and demand, leading to a rise in prices as consumers compete for goods and services in the market. In the context of demand-pull inflation, the increase in the minimum wage would add to aggregate demand levels, putting pressure on prices.

Built-in inflation, on the other hand, relates the increase in the minimum wage to the increase in the cost of production, which further feeds into prices. When workers demand higher wages and are successful, it raises the wages that employers must pay. In order to maintain profit margins, employers must raise prices. In theory, this can cause a phenomenon known as price-wage spiral. This is because an increase in prices can erode the value of the newly raised minimum wage, further leading to new demands for a higher minimum wage, which further feeds into inflation. This cycle of inflation to wage increase to inflation is the hallmark of built-in inflation.

Will the increase in the minimum wage push demand-pull inflation?

Demand-pull inflation is mostly associated with an increase in the money supply. Nonetheless, an increase in the minimum wage can contribute to demand-pull inflation through an increase in consumer spending. The increase in demand can put inflationary pressures on prices, especially if businesses are operating near capacity. However, many businesses in Nigeria are not operating at full capacity, and productivity levels are not close to their potential.

There have been several reports of firms shutting down due to increased production costs and low demand. The increase in consumer spending, therefore, should have little or no impact on demand-pull inflation in the short term. However, the increase in demand would mean that producers would adjust production capacity to meet demand, which should fizzle out whatever impact new demand levels have on prices. Nonetheless, the increase in consumer spending should increase employment opportunities as businesses improve production volumes to meet the increase in demand.

Will the increase in the minimum wage push up built-in inflation?

The effect of the increase on built-in inflation should be muted if the minimum wage increase only applies to local, state, and federal government workers. I argue that the private sector would not pursue the implementation of the new minimum wage immediately due to past antecedents, the underdeveloped nature of unionism within the private sector, and the informal nature of most private businesses.

Since the private sector wouldn't be immediately impacted, the overall wage pressure wouldn't be as strong, putting no pressure on their cost structure. Intuitively, this suggests that while the increase in the minimum wage will not significantly affect built-in inflation, it could help improve the economy by improving aggregate demand, aggregate supply, and reducing unemployment.

Conclusion

The increase in the minimum wage is a positive step towards addressing the inflationary impact on the quality of life of many Nigerians. It will boost consumer spending, which can provide a stimulus to the economy by encouraging businesses to produce more to meet the increase in demand. This effect is positive for employment numbers.

The concerns about the minimum wage further impacting inflation will not hold as Nigeria’s production capacity is below its potential. While there could be a slight and immediate inflationary pressure, with time, businesses would adjust to the increase in demand, fizzling out whatever inflationary pressures there are as a result of the increase in the minimum wage.

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Disclaimer: This information in this article is NOT investment advice. It is intended for information and entertainment purposes only.

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