Across the world, more than 100 countries have an enforced national minimum wage (“How are minimum wages set?”, n.d.). Not only do they protect societies most vulnerable from exploitation, but they also increase equality among households and the workforce, which brings a wealth of benefits to both society and the economy. However, no major economy has a direct earnings limit. But what does this actually mean? In short, it is a cap of wage rates, the same as a price ceiling. Once in place, wage rates could not rise past a certain level.
In terms of how such a pay cap would work, this article shall focus on a CEO pay cap. This entails a maximum wage to be set very high, for say, at earnings over £200,000 a year. Such a pay cap would have vastly different implications and effects compared to a maximum wage installed in Cuba in the 1960s which limited wages of a much larger percentage of the working population at a lower rate.
There are a variety of methods for installing a CEO pay cap. In the Labour Party 2017 manifesto, one policy laid out was a maximum pay ratio of 20:1 in the public sector (“Labour manifesto at-a-glance: Summary of key points” 2017). In short, this means the highest wage can only be 20 times the amount of the lowest wage. As a wage setter, such a policy installed in the public sector would hopefully extend to the private sector.
Another method for installing a pay cap would be having very high marginal income tax rates. This would decrease the post tax income, and such revenue gain could be redistributed to lower income groups through public spending, thus narrowing the income gap.
Apart from the obvious points for such a maximum wage, like social justice and greater equality, what benefits would this pay gap bring to the economy?
As low income earners spend the majority of their income on necessities of life, they have a very high marginal propensity to consume (MPC). This is the proportion of an aggregate raise in pay that a consumer spends on the consumption of goods and services, rather than saving it (Anderson 2022). High income earners on the other hand have a low MPC as, often, with each additional £100 they spend a low proportion of it as have everything they already need. Instead, it is likely to be put in savings, thus not entering the circular flow and reducing the multiplier effect. The size of the multiplier relates to how much money is multiplied by in the economy/circular flow. For example, if I bought some bread from a bakery, that money becomes the income of the baker. If the baker then brought some carrots from the grocers with the money earned from the bread, the money would then become the income of the grocer. Therefore, the money initially spent on bread has become part of 2 people's incomes and thus tripled (it was the income for myself, the baker and the grocer). If I had simply put the money into my bank account, the money would not increase the income of the baker or grocer, and so not benefit anyone. Therefore, by redistributing income through a maximum wage, from high income earners to low income earners, the money in the economy will benefit more people as low income earners will spend their income whilst high income earners are likely to save.
Recent studies have also found that in economies of high inequality, productivity is actually lower (“The productivity and equality nexus”, n.d.). Previously, it was generally accepted that large income gaps created incentives to work harder to achieve a higher income. With new research having taken place, it is found that low income employees feel apathetic and disincentivised to work harder, as the idea of earning wages in the million seems a distant reality, with no hope of ever really reaching this goal. This creates resentment and disincentivizes workers, leading to low productivity and even potentially a fall in economic growth and Real GDP.
However, what of the arguments against such CEO pay cap? Well one argument is the ‘brain drain effect’. This refers to skilled workers, here being CEOs leaving the labour market due to low wages. If they were to take their skills elsewhere, to a country where they were to be paid higher wages, there would be a skill shortage from (E1 to E2).
But price elasticities of both supply and demand must be remembered. Having a CEO for a business is a necessity, it would not be able to run with no one incharge. This makes the demand for labour relatively wage inelastic. The supply of CEOs is also extremely inelastic. If the wage rate of CEOs falls, CEOs are extremely unlikely to move into another profession. Whilst they may move abroad for better wages, CEO positions are few and there are family and social ties to be considered which makes moving abroad unlikely. Therefore, the supply of labour is relatively wage inelastic. This means a maximum wage ceiling would look like this:
As you can see, in reality, the shortage in CEOs caused by a wage ceiling is in reality very small. This means that it is likely that the wage ceiling costs would not outweigh the benefits greater equality would bring.
Furthermore, it is important to remember that the demand for labour is measured using Marginal Product Revenue. This is, in short, the value to the firm of the marginal physical product produced by each worker (“Demand for labour” 2020). Therefore, this suggests that, as workers wages are measured by how much revenue they make for the business, CEOs are worth their cost. However, if this was to be true, does Elon Musk really make £5 billion a year for Tesla Motors (Melin 2021).With Tesla making a revenue of £50.8 billion in 2021, this would imply that Elon Musk is signal handedly responsible for 10% of Tesla's revenue. Well if this was accurate, where can we get more Elon Musks? Is Elon Musk really 1287901 times more productive than the average American worker earning £39,444 a year (Kopestinsky, n.d.). I'm sure some of us find these figures a bit dubious, leading us to question whether the traditional method of measuring demand for labour using MRP is suitable for such high earners. If the MRP method is not accurate for high wage earners, how can we use demand and supply models to assess the impacts of a wage ceiling?
To conclude, although price caps seem a form of extreme and potentially dangerous for a Government intervention, perhaps even threatening liberty, maximum wages provide the opportunity for a more productive and cohesive society and economy, bringing a wealth of benefits to all.
Anderson, Somer. 2022. “Marginal Propensity to Consume (MPC) Definition.” Investopedia. https://www.investopedia.com/terms/m/marginalpropensitytoconsume.asp.
“Demand for labour.” 2020. Economics Online. https://www.economicsonline.co.uk/labour_markets/demand_for_labour.html/.
“How are minimum wages set?” n.d. IZA World of Labor. Accessed March 29, 2022. https://wol.iza.org/articles/how-are-minimum-wages-set/long.
Kopestinsky, Alex. n.d. “What Is the Average American Income in 2021?” PolicyAdvice. Accessed March 30, 2022. https://policyadvice.net/insurance/insights/average-american-income/.
“Labour manifesto at-a-glance: Summary of key points.” 2017. BBC. https://www.bbc.co.uk/news/election-2017-39933116.
Melin, Anders. 2021. “Highest Paid US CEOs: Top Salaries in 2020.” Bloomberg.com. https://www.bloomberg.com/graphics/2021-highest-paid-ceos/.
“The productivity and equality nexus.” n.d. OECD. Accessed March 30, 2022. https://www.oecd.org/social/productivity-equality-nexus.htm.
Research compiled by: Charlotte Hurst
Written by: Charlotte Hurst