Minimum wage laws were first introduced in Australia and New Zealand in 1824, adopted in Britain in 1910, and in the United States in 1938. The truly puzzling issue for economists is why a policy that does more harm than good has become so popular in so many places in the world. To date over 80 countries and territories have what could arguably be identified as statutory minimum wages with close to total coverage. Hong Kong will join them in May 2011.

Most economists are opposed to the minimum wage. According to a 1978 article in the American Economic Review, 90% of the economists surveyed agreed that the minimum wage increases the unemployment rate and decrease the labor force participation rate among low-skilled workers and would therefore worsen the plight of the poor worker. The only other policy issue to command greater consensus among economists would be their support for free trade.

Minimum wage decreases employment

Most non-economists believe that minimum wage laws protect workers from exploitation by employers and reduce poverty. They usually believe that all workers should earn a basic living wage and this is denied by some if not all “heartless” employers. Most economists like non-economists are very committed to helping the poor and that is why most of them chose to study economics in the first place. They have learned, however, to understand why minimum wage laws will not work and indeed cause unnecessary hardship for the very people they are supposed to help.

George Stigler writing in 1946 explained the reason in simple terms: although minimum wage laws can set wages, they cannot guarantee jobs. The laws are likely to price low-skilled workers out of the labor market. Unskilled workers, especially those who are very young or very old, will have a very difficult time finding a job if the person must, by law, be paid the minimum wage. It is like saying to a prospective worker that unless you can find a job paying at least the minimum wage, you may not accept employment. If some unskilled workers cannot find employment because of minimum wage laws then poverty could be worsened, not alleviated.

Empirical studies of the effects of minimum wage laws have mushroomed in recent decades. Using a Google Scholar search for publications in the past 25 years shows that some 2000 scholarly items have been published with “minimum wage” in the title. The total number of such publications in the past 100 years was identified by Google to be 3000. Both figures are almost certain to be underestimates of the true number of publications on the subject.

The studies cover a variety of countries. Together they have found that increases in minimum wages reduce employment. Estimates of job losses in the US suggest that a 10% increase in the minimum wage would decrease employment of low skilled workers by 1-2%.  Without surprise the job losses for black US teenagers have been found to be even greater because they have fewer skills. The effect in Canada on teenage employment associated with a 10% increase in the minimum wage is estimated to be a drop of 3-5%.

Changes in remuneration hurts workers

A curious episode occurred in the early 1990s. Based on a telephone survey of 410 fast food restaurants in New Jersey and Pennsylvania, David Card and Alan Krueger, two well known economists from Princeton, challenged the consensus view that higher minimum wages shrink employment opportunities. Their results using Pennsylvania as the control group appeared to demonstrate that a minimum wage increase in New Jersey apparently resulted in increased employment there. A huge academic debate involving some half a dozen Nobel laureates raged at the time.

A detailed re-examination of the Card and Krueger findings using payroll records from a similar sample of restaurants over the same time period showed that the minimum wage increase had led to a decline in employment in New Jersey fast food restaurants relative to the Pennsylvania control group. Card and Krueger eventually retreated from their earlier position and conceded that it probably had no effect on total employment in New Jersey.

Even without the payroll records’ study, their findings were of limited value because their study focused only on nationally recognized fast food chain restaurants, and were silent about the least visible businesses, such as small local restaurants, like pizza and sandwich shops. Most economists would predict that some of these restaurants would go out of business, jobs would be lost, and the retail restaurant business at the fast food end would become more concentrated in the hands of the large chains.

A similar prediction could well apply to Hong Kong and in less than a few years’ time we might see fewer local neighborhood eateries surviving unless we turn a blind eye to violations of the new minimum wage law or if the law is rendered unenforceable when only loyal family labor is involved.

In addition to making jobs hard to find, minimum wage laws also harm workers by changing how they are compensated. When minimum wages rise, employers will seek to control total compensation costs by cutting benefits. Fringe benefits such as paid leave and breaks, free room and board, insurance, subsidized child care and transport costs, and on-the-job training are an important part of the total compensation package for many low wage workers. In extreme cases, employers convert low wage full time jobs with benefits to high wage part time jobs with no benefits. Decreasing on-the-job training is particularly detrimental because it worsens future opportunities for the unskilled young worker in building up human capital.

Minimum wage laws have been advocated as a policy measure to alleviate poverty.  After hundreds of studies, no evidence have been found that raising the minimum wage has had any effect on reducing poverty rates in the US or in Canada. The ineffectiveness of minimum wage laws in alleviating poverty is one of the most consistent findings.

Evidence from Canada and US

Canadian researchers have profiled low wage earners and poor households in Ontario (2004) and Quebec (2006). They found 89.3% and 86.5% of low wage earners (those that would be earning the minimum wage level) in Ontario and Quebec, respectively; do not live in poor households. In other words, poor households have few low wage earners. They just have a single breadwinner, whose wage is above the minimum level. Minimum wage earners are concentrated in non-poor households with multiple earners. They just happen to be their lowest wage earning member.

Ontario 2004 Low Income Families Families Above Low Income Threshold All Families
Low Wage Earners Below Minimum Wage Levels 10.7 % 89.3 % 100 %
All Earners 10.3 % 89.7 % 100 %

 

These findings are astounding. Even under the assumption of no negative employment effects, they imply that an increase in the minimum wage in Ontario and Quebec will only benefit 10.7% and 13.5%, respectively, of the poor households, who have low wage earners. Given that 10.3% and 13.1% of all households in Ontario and Quebec are in poverty, increasing the minimum wage is only slightly more effective as an anti-poverty measure as would be distributing money randomly across households.

 

Quebec 2006 Low Income Families Families Above Low Income Threshold All Families
Low Wage Earners Below Minimum Wage Levels 13.5 % 86.5 % 100 %
All Earners 13.1 % 86.9 % 100 %

 

The findings for the US in 2007 are similar. US researchers have found that 88.7% of low wage earners in the US do not live in poor households. Therefore, an increase in the minimum wage will only benefit 11.3% of the poor households, who have low wage earners.

USA 2007 Low Income Families Families Above Low Income Threshold All Families
Low Wage Earners Below Minimum Wage Levels 11.3 % 88.7 % 100 %
All Earners 10.8 % 89.2 % 100 %

 

In all these studies, if employment effects are taken into account, the results can only get worse. The gains from higher wages are so small that there is a significant risk that increasing the minimum wage will actually increase poverty. These results may seem counter intuitive, until one recognizes the fact that the vast majority of low-wage earners do not live in poor households.

It would be a good thing if those who are concerned with reducing poverty could stop wasting time on the minimum wage law. As anti-poverty measures go, increasing the minimum wage is pointless at best.

Neutralizing effect of political contests

If the logic of the economic case against minimum wage laws is so compelling and the empirical evidence against it so overwhelming then one wonders why it is still so popular with unionists and politicians.

Minimum wage increases make unskilled workers more expensive relative to all other factors of production, including and especially skilled workers. This explains why unions, whose members have historically been more skilled and seldom hold minimum wage jobs, invariably support legislation increasing minimum wages. It also explains why unions protect their members against competitive threats by assiduously helping labor authorities find and prosecute suspected violators of the minimum wage laws.

Politicians seeking office have discovered that advocating increases in minimum wages can often be a winning strategy in securing a constituency of voters, who stand to benefit from higher wages, as long as they do not alienate those threatened by unemployment. As is often the case, the threat of unemployment is more invisible, but the benefit of a wage rise is more immediate. Vote seeking provides an explanation for why a policy that does more harm than good is embraced in so many places.

In what I consider to be one of the most innovative studies ever published on the minimum wage laws in the US, Nobel economist James Heckman pointed out that the timing of legislation and by what amount should the minimum wage be adjusted is itself determined by a balancing of opposing interests. Factors like the number of unskilled workers who might be threatened with unemployment and the number of potential beneficiaries from raising minimum wages art important considerations relevant to unionists and politicians on both ends of the political spectrum. Opposing positions are balanced off and moderated in the political legislation process.

Heckman’s research showed empirically that the political persuasion efforts of minimum wage advocates and their opponents tend to cancel each other out in their often intense engagements. By the time new minimum wages take effect and the amount of adjustment is agreed upon through legislation, its most biting effects on wages and employment have been removed or rendered irrelevant. The legislation that is passed produces statistically insignificant increases in wages for covered workers, and therefore, will have little effect on the unemployment of unskilled workers. Minimum wage legislation becomes in the words of Shakespeare, “much ado about nothing”. They allow the political participants to return to their own constituencies to claim their own victory according to their own interpretation. This may be a very US specific outcome, where the democratic process is well developed and politicians have already perfected their election posturing and legislative negotiation skills to achieve maximum sound and fury, but little blood shed. Heckman’s findings suggest that minimum wage laws in the US are essentially ineffective and perhaps thankfully so. Still the effort that goes into all that lobbying and posturing is a waste for society.

Well known conservatives like Milton Friedman and George Stigler and their equally well known liberal rivals, Paul Samuelson and James Tobin, found common ground in opposing minimum wage laws. Paul Samuelson wrote in 1973, “What good does it do a black youth to know that an employer must pay him $2.00 per hour if the fact that he must be paid that amount is what keeps him from getting a job?”

Minimum wage laws have been condemned by economists for over a century. Professor Alfred Marshall, founder of the discipline of economics at the University of Cambridge, wrote in the 19th century, “…there is popularity in the doctrine of a living wage; so we had better leave politicians to praise it and set ourselves to criticize it.” This is the economists calling.

Sources:

J Heckman and G Sedlacek, “The Impact of the Minimum Wage on the Employment and Earnings of Workers in South Carolina”. In Report on Minimum Wage Study Commission, Vol. 4. Washington: U.S. Government Printing Office, 1981.

A Mascella, S Teja, and B Thompson, “Minimum Wage Increases as an Anti-Poverty Policy in Ontario”, Canadian Public Policy, Vol 35, No 3, September 2009.

Jean-François Mercier et Martine Poulin, «Les travailleurs au salaire minimum vivant sous le seuil de faible revenu au Québec», Regards sur le Travail10, Québec, Volume 7, n° 1 – Automne 20.

J Sabia and R Burkhauser, “Minimum Wages and Poverty: Will a $9.50 Federal Minimum Wage Really Help the Working Poor?” Southern Economic Journal, Vol 76, No 3, January 2010.

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