Cutting The Crap On The Minimum Wage Issue

The issue of the minimum wage has been a hot topic in recent years. The Obama administration wants to increase the US minimum wage from its current rather stingy $7.25 to a modestly more reasonable $10.10, though there is currently a “Fight for 15” movement to increase the wage for fast food workers to $15. Last year, Germany set their first ever minimum wage at €8.50. In some parts of the world, a “Living Wage” movement in which exemplary employers pay a “living wage” to employees well above the minimum wage is beginning to gain traction. Meanwhile, in my home country of Australia, where we enjoy some of the highest minimum wages in the world, the so-called “Productivity Commission” is set to undertake a review of the relevance and impacts of the minimum wage, probably with the aim of reducing it, though whether that will have sufficient political support is another matter.

Whenever the minimum wage comes up, conservative commentators – be they business leaders, journalists, politicians, or academic neoclassical economists – invariably attempt to stir up panic by asserting that any rise in the minimum wage, indeed the very existence of the minimum wage, will reduce employment. Tim Worstal[i] over at Forbes – who seems to be on some sort of personal crusade against the minimum wage – has called the notion that minimum wages cause unemployment “one of the most basic foundations of economics.” Republicans such as Senator Mitch McConnell[ii] have made alarmist claims that a rise in the minimum wage would cost up to 1 million jobs.

Superficially, the notion makes a certain amount of sense. The critics allege that the minimum wage, by raising the minimum price of labor above what the “market” would otherwise pay, causes a reduction in the demand for labor. In other words, employers hire less people because it’s more expensive than it otherwise would be. It’s the ye olde simplistic theory of supply and demand applied to labor. However, if the notion that conservative politicians, business people, and neoclassical economists are the true defenders of the low paid makes you uneasy, hold on to that sense of unease. The fact is, like many of the “most basic foundations of [neoclassical] economics”, the idea that minimum wages cause unemployment is pretty much bunk.

Most OECD countries have some sort of statutory minimum wage, though their are exceptions such as the Nordic countries (Denmark, Finland, Iceland, Norway, and Sweden), Austria, and Italy (I will discuss the Nordic countries later); while Germany as mentioned only recently introduced a minimum wage due to concerns that some workers were not sharing in their prosperity. I pulled up some OECD figures to see whether there is any association between the rates of minimum wages and unemployment. In table 1 below I have compared Organization for Economic Co-operation and Development (OECD) countries who do have minimum wages according to a couple of different indexes, and correlated this with unemployment. The figures are averages over the period 1993-2013 (see spreadsheet with workings in our artefact section), and are derived from OECD data.

Table 1. Average unemployment and measures of minimum wage equivalence, 1993-2013

Country Average Unemployment Average PPP Min Wage, hourly, 2013 USD Avge Ratio min wage to average wage
Australia 6.49 9.95 0.47
Belgium 8.22 9.99 0.41
Canada 7.90 6.85 0.39
Chile 8.04 2.16 0.33
Czech Republic 6.48 2.73 0.30
*Estonia 5.78 2.14 0.43
France 10.28 9.49 0.43
Greece 9.97 5.21 0.35
Hungary 12.81 2.84 0.39
**Ireland 8.17 8.66 0.43
**Israel 8.90 5.14 0.34
Japan 4.22 5.83 0.28
Korea 3.59 3.60 0.30
Luxembourg 3.74 9.88 0.33
Mexico 4.03 0.86 0.38
Netherlands 5.36 9.43 0.46
New Zealand 6.00 7.16 0.42
Poland 13.19 3.21 0.36
Portugal 8.57 3.65 0.35
Slovak Republic 15.10 1.90 0.37
Slovenia 6.83 5.10 0.37
Spain 15.97 4.65 0.33
Turkey 9.49 3.50 0.34
**United Kingdom 6.66 7.70 0.31
United States 6.05 6.86 0.30
Correlations to unemployment -0.25 0.07
*Min wage data starts at 1998
**Min wage data starts at 2000

 

The OECD does a couple of things to make the data comparable. One is to compare the minimum wages according to Purchasing Power Parity (PPP), which is to say taking into account what a given amount of money can actually buy in different countries. When the average level of minimum wages by purchasing power parity is compared with average unemployment over the period, the correlation coefficient is actually slightly negative (-0.24), which is to say that, to the extent that there is any correlation at all, those countries with higher average minimum wages over the period actually had lower unemployment than those with lower average minimum wages. That said, the correlation is pretty weak, I wouldn’t try to claim that higher minimum wages caused lower unemployment. Another measure is to compare according to the ratio between the minimum wage and the average wages prevailing in that country – the correlation here is a mere .07, or as good as nothing. In other words we can’t even draw a positive correlation, let alone a line of causation, between minimum wage levels and unemployment.

But don’t just take my word for it. A whole bunch of studies[iii], including large meta-analyses and reviews of the literature, have found no effect on employment from minimum wages. Among the most prominent of these was a meta-regression analysis of over 1,400 studies. Some studies[iv] actually contend that minimum wages have a slightly positive effect on employment!

Here’s the real kicker: even the most important and strident academic critics of the minimum wage haven’t been able to show that minimum wages raise the unemployment rate and destroy jobs. This may be shocking, given that they are so devoted to opposing the minimum wage and continue to propose in shorthand that the minimum wage costs jobs, but it’s true. Studies which purport to show that the minimum wage affects unemployment almost universally can only support what can be called a substitution effect[v]: which is to say, when minimum wages are raised, it’s possible that employers replace some workers with others. Studies focus almost exclusively on “youth” or “teens”, and in their wide ranging review of research David Neumark and William Wascher actually criticized at least one study for focusing on total employment. They concluded that substitution of labor with other labor is the main effect of the minimum wage.

Because this is often couched in terms of raising “youth unemployment” or costing jobs, I feel some clarification is in order. Labor-labor substitution means no net loss of jobs. What it does mean is that when minimum wages are raised, employers may become choosier about which employees they hire, and those perceived as lower skilled (including “youth”) may be overlooked in favor of those perceived as having better skills, who might not otherwise have a job absent a decent minimum wage. But the total number of jobs is not increased or decreased. Meanwhile, those who do have a job are receiving a better wage than they otherwise would, meaning that the net effect for workers as a group is positive, even if the worst outcomes proposed by the (academic) opponents of the minimum wages are realized. I also don’t see why young people should be more deserving of jobs than adults, which isn’t to say that I necessarily even accept the conclusion that this substitution effect occurs.

This brings us to the “why” question: i.e. why doesn’t the minimum wage raise unemployment? Well, there are a bunch of reasons, some of which I will discuss here. One reason is perhaps that the minimum wage works more or less the way most proponents (and earners) of the minimum wage probably think it does: minimum wages redistribute money which would otherwise be extra profits to increase low-paid workers’ wages. Unless the employer raises their prices to an extent which reduces consumer demand, which might work out worse for them in the long run anyway, they still need to produce the same amount of goods/and or services to meet current consumer demand, and it’s unlikely they are employing any more workers than they think they need in order to produce said goods/services in the first place. So they can’t profitably reduce the number of workers in response to the wage increase, and instead just absorb the cost and allow their margins to be reduced. A study published in the American Economic Journal: Applied Economics supported this empirically, finding that minimum wages raised wages and reduced profit margins with no effect on employment.[vi] D’uh.

There is also the fact that, in terms of the economy in aggregate, extra money spent on employee wages doesn’t just sort of disappear into the ether. When employees, especially low paid employees, receive pay raises, they tend to spend the extra money on, you know, goods and services. The kinds of goods and services which businesses produce. The kinds of goods and services that businesses need to employ people in order to produce. In aggregate, the increased wages received by workers can actually contribute to the continued availability of employment needed to produce the goods and services they buy. It’s a sort of virtuous cycle.

More fundamentally, though, is the fact that markets just don’t work where one party is more or less powerless. In this, I’m reminded of the writings of the Classical Liberal economist and philosopher John Stuart Mill. On the one hand, Mill didn’t believe in raising the minimum wage above the “market” rate. On the other hand, though, Mill also didn’t believe that you could get to a “market” rate without negotiation with unions. According to Mill:

…demand and supply are not physical agencies, which thrust a given amount of wages into a labourer’s hand without the participation of his own will and actions. The market rate is not fixed for him (sic) by some self-acting instrument, but is the result of bargaining between human beings….. Still more might poor labourers who have to do with rich employers, remain long without the amount of wages which the demand for their labour would justify, unless, in vernacular phrase, they stood out for it: and how can they stand out for terms without organised concert? What chance would any labourer have, who struck singly for an advance in wages? … trade unions, far from being a hindrance to a free market for labour, are the necessary instrumentality of that free market; the instrumental means of enabling the sellers of labour to take due care of their own interest under a system of competition…[vii]

Unions as the “necessary instrumentality” of the free market. Wow. What this implies is that the powerless and deunionized workforces which prevail in a neoliberal environment, especially the low paid, are not really operating in a “free market”. They have no ability to engage in any sort of actual negotiation due to a manifest power imbalance between them and their employers. Therefore, they will, as Mill contends, “remain long without the wages which the demand for their labour would justify,” in the absence of some mechanism (like a statutory minimum, for instance) to correct for this.

This is particularly interesting when we consider some of the most notable exceptions to the rule of OECD countries having a minimum wage, the Nordic countries: Denmark, Finland, Iceland, Norway, and Sweden. These countries don’t have minimum wages and on average have lower unemployment rates than other OECD countries.[viii] However, this is not to say that they are exemplars of neoliberal countries benefiting from lower wages. That simply isn’t so, for a couple of reasons. These countries are notorious for their generous government benefits subsidized by high taxes. If that wasn’t enough to set an effective floor on wages, their wage setting system is highly centralized, not only at the lowest but at industry and occupational levels, set by an institutionalized role for centralized negotiations between employers and powerful unions (between 50% and 70% of workers in Nordic countries are union members, compared to 10% to 11% in the United States). Denmark has been given a perfect score for protecting worker rights by the International Trade Union Confederation[ix], the only country to receive this, and yet has some of the lowest unemployment levels in the world. This is complemented by a system in which unions and employers adopt a partnership model in their relationship, and businesses tend to have much longer-term views and are much less subject to the fickle whims of Wall Street than their counterparts in the Anglophone world. So, while there is no statutory minimum, in general no one is earning very low wages in these Nordic countries. They have sufficiently harnessed the market with measures other than a statutory minimum to ensure that their lowest paid workers aren’t left behind.

By Mill’s definition, then, the way in which wages and conditions are set in countries like Denmark would more accurately reflect “free market” rates than whatever rates can be negotiated by the powerless and deunionized workforces that have arisen in those countries which have more completely embraced neoliberalism. In the Nordic countries, a statutory minimum isn’t needed because of all of the other factors in place which ensure that the lowest paid workers earn decent wages and have a decent standard of living. But countries like the US exist in a different world: of anti-unionism, an anemic welfare state which has been under constant assault since the 1980’s, of businesses whose thinking extends little beyond a year if not the quarter, and where businesses are enemies of labor (or, at least, of wages) rather than being part of a social partnership. In this environment, the lowest paid have no hope for decent wages except to the extent that this can be moderated when society decides that everyone deserves a decent wage.

So keep all of this in mind the next time you hear this nonsense about the minimum wage causing unemployment. The assertion is at best misinformed, at worst consciously dishonest. In this it probably has something in common with characterizations of the wealthy as “job creators” and taxes on them as job-destroying; and with notions that the provision of welfare creates welfare dependency rather than being a safety net for those with little other choice. The lesson here is to be very, very suspicious when the privileged and powerful make counter-intuitive claims that the restriction of privilege or the provision of rights to the less powerful make the latter worse off. It’s rarely the case in reality.

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[i] http://www.forbes.com/sites/timworstall/2015/02/03/proof-perfect-that-the-minimum-wage-costs-jobs/, see also http://www.forbes.com/sites/timworstall/2014/03/02/youth-unemployment-shows-the-effects-of-a-minimum-wage-that-is-too-high/ http://www.forbes.com/sites/timworstall/2015/04/14/truly-terrible-research-in-increasing-the-minimum-wage-to-15-an-hour/ http://www.forbes.com/sites/timworstall/2015/03/02/paul-krugmans-amazing-about-face-on-the-minimum-wage/ et a

[ii] http://www.politifact.com/truth-o-meter/statements/2014/oct/14/mitch-mcconnell/mitch-mcconnell-says-minimum-wage-hike-would-destr/

[iii] See for instance Doucouliagos, H. and Stanley, T.D. (2009) “Publication Selection Bias in Minimum-Wage Research? A Meta-Regression Analysis”, British Journal of Industrial Relations, 0007-1080: 406-408; Lee, W.S. and Suardi, S. (2011) “Minimum Wages and Employment: Reconsidering the Use of a Time Series Approach as an Evaluation Tool”, British Journal of Industrial Relations, 49(S2): s376-s401; Dracas, M., Machin, S. and Van Reenan, J. (2011) “Minimum Wages and Firm Profitability”, American Economic Journal: Applied Economics, 3(1): 129-151; Oesch, D. (2010) “What explains high unemployment among low-skilled workers? Evidence from 21 OECD countries”, European Journal of Industrial Relations, 16(1): 39-55; Schmitt, J. (2013) Why Does the Minimum Wage Have No Discernible Effect on Employment?, Report for the Centre for Policy Research, Washington

[iv] See Addison, J.T.; Blackburn, M.L. and Cotti, C.D. (2009) “Do minimum wages raise employment?”, Labour Economics, 16: 397-408; Slonimcyk, F. and Skott, P. (2012) “Employment and distribution effects of the minimum wage”,  Journal of Economic Behavior and Organization, 84: 245-264

[v] See for instance Neumark, D. and Wascher, W. (2006) “Minimum Wages and Employment: A Review of Evidence from the New Minimum Wage Research”, Working Paper 12663, National Bureau of Economic Research, Cambridge Massachusetts; Neumark, D.; Salas, J.M.I. and Wascher, W. (2014) “Revisiting the Minimum Wage-Employment Debate: Throwing Out the Baby with the Bathwater?”, International Labor Relations Review, 67(Supplement): 608-648

[vi] Dracas, M., Machin, S. and Van Reenan, J. (2011) “Minimum Wages and Firm Profitability”, American Economic Journal: Applied Economics, 3(1): 129-151

[vii] Mill, J. S. (2006) Principles of Political Economy: with Some of Their Applications to Social Philosophy, (Originally published 1871), Indianapolis, Liberty Fund, quote from p. 932

[viii] Though there are significant variations. The best performing are Norway and Denmark, with Finland the ugly duckling of the group (see spreadsheet artefact).

[ix] http://www.theguardian.com/commentisfree/2014/may/22/worker-world-index-employment-rights-inequality

 

Artefacts

(May 5, 2015)
Summary: Related Comments commentsJoe McIvor
Categories: JM05May2015

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bigjoeymcivor@hotmail.com'
McIvor is a casual academic and research assistant at Macquarie University. He completed his Ph.D. in Business at the University of Western Sydney. His doctoral research looked at the links between economic theory and the theory and practice of corporate social responsibility in a variety of contexts, as well as the limitations of markets in limiting corporate malfeasance and other negative social outcomes. He’s also helped produce a report in 2014 on the link between climate change and the workplace and looks forward be bringing academically informed critical economic analysis to ImportantCool.

One response to “Cutting The Crap On The Minimum Wage Issue”

  1. […] an earlier article for ImportantCool, I dispelled the myth that minimum wages create net unemployment. Nonetheless, […]

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