Minimum wages

I’ve been thinking and reading recently about the value of minimum wages. From what I’ve read most economic theory is against minimum wages on the ground that it increases unemployment. There is a fairly obvious argument with regard the fact that a minimum wage will price out people who would otherwise be able to get a job at a lower wage because, while their labour still has value to an employer, its less than the minimum allowable by law and they are thus shut out of the market.

Under this rationale a minimum wage may mean that some workers may get paid more, but they do so at the expense of those who would otherwise work. The minimum wage therefore creates unemployment and makes poorer those who would otherwise work.

I’ve no doubt that there is truth in this. Certainly if you raised the minimum high enough then it would undoubtedly cause unemployment.

On the other hand even if you could pay people 1 cent per hour the real effective minimum wage is considerably higher than that due to the training/management/hiring costs in your own time not to mention getting a decent return on any capital you may have invested for the employee to use and this is even if there was no other regulations on employment. A minimum wage below a certain point is going to have minimal impact on unemployment.

This is not even to mention that in systems where there is welfare available in the form of unemployment benefits, if the minimum is too low there will be little incentive to move off welfare and into work as the welfare is withdrawn and the tax rates kick in.

Because of the relatively discrete nature of employment, its also possible to think of scenarios where at least for small changes in the minimum wage the effect on employment will be essentially zero. ie. the demand is relatively inelastic. A raise in the minimum won’t be enough for any factory/shop etc to sack their least productive worker, nor will a small decrease make hiring any more likely because of natural boundaries (factory or shop physical size).

Empirically it appears to be somewhat of an open question, studies have found zero effect although historically most have found negative effects. The UK Low Pay commission report found no increase in unemployment but an increase in productivity in some effected service companies.

While there is no doubt if minimums are too high unemployment will ensue, I would tend to support the idea that situations can exist in reality where the minimum wage can be used to increase wages without increasing unemployment.

So if this can occur, what would be the likely effect under the scenario I’ve just outlined? It seems to me that the most likely outcome would be, where possible, for the extra increase to be passed on in higher prices. While an employer could potentially absorb an increase, nothing would change in the return the employer would want on his capital so likely he would try to pass on a marginal increase in prices.

The risk therefore is that even if you don’t cut employment, higher prices for basic services will effected the poorest group, the unemployed, the most harshly. This is essentially the converse of what is claimed for Wal-mart where their low wages and low prices results in lower general prices in a region, benefiting everyone (except the low paid workers), but particularly the poor.

The solution to this then appears to be income support either in the form of negative income tax, or a modified version of this that exists in the US, the Earned Income Tax credit (EITC).
The object of these structures is to provide income support to low income workers and ensure that the effective marginal tax rate as welfare is withdrawn is not so high so as to discourage additional work.

These have the advantage of being specifically targeted at low income households. Many minimum wage workers come from high income households being a second often part time income which won’t receive the EITC. Additionally by operating through the tax system they don’t distort either labour market, or the eventual prices but rather it is paid through the tax system and therefore progressively.

It seems to me that I can accept that minimum wages can be set and raised at least at fairly moderate levels, without meaningfully effecting unemployment rate. However, this does may reflect potential secondary effects such as rising prices which can have a negative effect on the poor. On the other hand we have other policy instruments which can potentially more effectively target the working poor and that these may provide better tools to effect the people who can find employment without putting the cost of it onto those least able to afford it.

My main concern about such schemes is that with no minimum wage, employers will pay proportionally lower wages, effectively splitting the payment with the employee. This would seem to be somewhere that minimums, even if relatively low, could effectively ensure that this does not occur to any great extent.

Rather than raising minimums the government should look to freeze it and reduce the taper rates for welfare, and raise minimum tax rate brackets as a way of more effectively assisting the welfare of poor workers while simultaneously encouraging people with greater incentives to work. As a further step a scheme such as the EITC could be implemented to increase this effect.

Advertisements

10 Responses to Minimum wages

  1. steve munn says:

    Good summary of the issues surrounding minimum wages, Steve. This is an issue on what I’ve spent plenty of time trying to work out in my head what the best policy mix should be but haven’t been able to reach a firm conclusion.

    I wonder if their is a positive relationship between higher minimum wages and greater income equality? For example, if a firm has 20 or so employees and has to pay a relatively high minimum wage, is it more likely to do this by paying realtively lower wages to its more efficient/skilled employees as an alternative to raising prices?

    I also find the notion that there is a link between very low minimum wages and poorer employee productivity interesting. Specifically, if an employer can hire a worker for $6 an hour, as in the USA, the worker may be viewed as cheap and expendable fodder. On the other hand, if the worker must be paid at least $10 an hour the employer may be more likely to value the worker and provide him/her with training, better conditions and so on so that productivity is maximised.

    Irrespective of the above, minimum wages that are too high will undoubtly suppress growth in unskilled employment. As Australia’s minimum wage is high by world standards, I suppose my preferred policy would be to freeze minimum wages for a couple of years and increase the tax free threshold so that low wage earners suffer no net loss. I would then claw back some money for the public purse by putting in higher tax rates for incomes over $100,000.

  2. Steve says:

    Steve thanks, I wanted to put the bits and pieces I’ve been reading together to try and get things straight in my mind.

    As for the perscription that you have in your last paragraph, I roughly concur, although I think I would rather claw back money by reducing the amount of concessions – negative gearing and the like that are worth the most to high income earners. Actually if it could be funded I’d support cuts at the top if it were to claw back the money through concessions.

  3. One issue that has been quite important in Australia in the past (although I’m not clear what effect the latest major employment changes has had) is that the way our minimum wages have worked is that they flowed through to award wages at quite high levels. So a change to the minimum wage also change award levels for quite a number of higher awards.

    I think that has had a bigger effect on our employment market than a high minimum wage per se – our minimum wage still isn’t that much higher than the dole.

  4. steve munn says:

    Steve, I agree with clawing back money by reducing the degree to which people can minimise their tax. As regards negative gearing, I think (but may be wrong) the Hawke Government abolished it for awhile with disasterous results; the number of rental properites shrunk too quickly and rents skyrocketed. Possibly stricter rules on negative gearing combined with rent subsidies/more public housing would be better.

    I’m a big fan of the Nordic Model high-taxing welfare state. As such I would be happy to see tax rates as high as 60-65% once someone is earning $200,000 p.a. or more.

  5. Sacha Blumen says:

    Nice post Steve – it’d be nice if the “debate” concerning related aspects of WorkChoices (to do with the Fair Pay Commission and the potential for minimum wages in real terms to decline over time and the removal of the no disadvantage test for AWAs) talked about effects of minimum wage policies in a way more like the way that you have written about it here.

    In relation to the inelasticity of employment as a function of minimum wages in individual firms or workplaces, I can see how it may well be inelastic to some degree on the small scale, but it might be different in very large workplaces. In relation to the idea that if you pay people less, they may be less productive, theoretically, if this is true, this may result in more people being employed to achieve the same output.

    It seems to me that one of Rafe Champion’s (and other people’s) ideas that having a “high hurdle” in the form of a minimum wage may restrict the opportunities some people have to enter work, if true, might be alleviated by abolishing minimum wages and instituting govt subsidies so that people on very low wages have a reasonable income, as you mention. This might, however, be a way for employers to cost-shift wages onto govt.

    To me, it’s great if policies can help people have opportunities to prosper, and if some policies (eg having minimum wages) are preventing people from gaining employment, then that’s quite a bad thing, and it’d be great for careful thought to go into looking at it! But all these are just theoretical musings.

  6. Sacha Blumen says:

    Slightly obliquely, I e-mailed my union, the Community and Public Service Union, about its attitudes about any relation between minimum wages and other labour conditions and levels of employment and unemployment twice in the last six months, and am yet to receive any reply. The initial e-mail I sent to them is at this page http://blumensacha.wordpress.com/2006/06/15/the-cpsu/

  7. james says:

    Steve, although you do mention it, I would have thought more could be made of the distortion/inefficiency introduced into the labour market – ie regardless the effect on unemployment levels, we’re biassing production priorities. Although no rock painter should live in poverty, I still don’t want them being paid *for* rock painting. Is there any way of quantifying the cost of this misallocation to the whole economy ?

    Steve Munn’s explanation for the link between productivity and the minimum wage is very plausible but is not a scenario excluded by a properly operating market mechanism. That is, if it really does improve output, the employer is free to train their existing workers. And they’d have an extra 4$ to spend on this if they didn’t have to pay the higher wage…

    For the most part minimum wages seem like little more than a poor instrument of welfare policy.

  8. JC says:

    “Under this rationale a minimum wage may mean that some workers may get paid more, but they do so at the expense of those who would otherwise work. The minimum wage therefore creates unemployment and makes poorer those who would otherwise work.”

    It’s not necessarily the case, Steve. The min (like the 50’s and 60’s ) could be set below the rate at which the market can clear. It isn’t necessarily the case that a min will cause unemployment. The problem is setting it at the price it won’t. This is where the problem arises. The market knows best where to set wages.

    “Empirically it appears to be somewhat of an open question, studies have found zero effect although historically most have found negative effects. The UK Low Pay commission report found no increase in unemployment but an increase in productivity in some effected service companies.”

    Steve, the studies can never determine the rate at which labor will be cleared. We only know that as a look back in the case where authorities set the min.

    “While there is no doubt if minimums are too high unemployment will ensue, I would tend to support the idea that situations can exist in reality where the minimum wage can be used to increase wages without increasing unemployment.”

    Yes, you can, but if it is set too high the market will not be able to clear the surplus labor and the result is unemployment.

    “So if this can occur, what would be the likely effect under the scenario I’ve just outlined? It seems to me that the most likely outcome would be, where possible, for the extra increase to be passed on in higher prices. While an employer could potentially absorb an increase, nothing would change in the return the employer would want on his capital so likely he would try to pass on a marginal increase in prices.”

    You shouldn’t confuse the price of goods (final output) and the cost of labor. Prices are determined in the market where buyers are not concerned with the price of labor input. I couldn’t give a hoot if my Sony plasma is made in China or Japan or what the wages component of the cost is to make it. All I am concerned is how it compares to other screens on the market (quality) and its cost. The producer has to be able to compete away that labor to make that screen. All he is concerned with is the costs of input and the final price. If the cost of labor becomes too high to compete he lays off the labor. If he sees more demand for his product he hires more labor to produce more screens. In other words firms don’t care what they pay labor, all there are concerned with is the spread they can derive….. the costs of the input to the price of the output.

    “The risk therefore is that even if you don’t cut employment, higher prices for basic services will effected the poorest group, the unemployed, the most harshly. This is essentially the converse of what is claimed for Wal-mart where their low wages and low prices results in lower general prices in a region, benefiting everyone (except the low paid workers), but particularly the poor.”

    Walmart’s secret is being able to set its price for labor at a rate that is attractive to workers to go and work there and the product mix it sells. Being able to attract and constantly rotate marginal workers at low wages is an art that not many firms can perform like WalMart. The marginal workers are able to find work that wasn’t there. These workers just didn’t turn up in a vacuum before Walmart showed up. They must have been unemployed or were attracted to Walmart from elsewhere.

    “The solution to this then appears to be income support either in the form of negative income tax, or a modified version of this that exists in the US, the Earned Income Tax credit (EITC).
    The object of these structures is to provide income support to low income workers and ensure that the effective marginal tax rate as welfare is withdrawn is not so high so as to discourage additional work.”

    Fair enough. As long as the market is able to set the wage.

    “It seems to me that I can accept that minimum wages can be set and raised at least at fairly moderate levels, without meaningfully effecting unemployment rate. However, this does may reflect potential secondary effects such as rising prices which can have a negative effect on the poor. On the other hand we have other policy instruments which can potentially more effectively target the working poor and that these may provide better tools to effect the people who can find employment without putting the cost of it onto those least able to afford it.”

    As I said before., you can have a centralized wage system without it causing unemployment as long as the wage is set at the clearing rate. I have already discussed prices.

    There is no such thing as a free lunch. Employers can never pay less than the going rate for the min wage.

  9. Двери, окна, магазин в Чечерске, оптовая продажа, цемент, шифер, гипсокартон…

    […]Minimum wages « Criticality[…]…

  10. недвижимость в Болгарии…

    […]Minimum wages « Criticality[…]…

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: