In his recent State of the Union address[1],
U.S. president Obama said: “Americans overwhelmingly agree that no one who
works full time should ever have to raise a family in poverty.” He then went on
with a plea for Congress to raise the minimum wage from $ 7.25 to $10.10 (US$)
an hour (a 15% increase) and promised to ”issue an Executive Order requiring
federal contractors to pay their federally-funded employees a fair wage of at
least $10.10 an hour”. At the same time, the Ontario provincial government is
set to rise from Can. $10.25 an hour to, possibly $11.00[2]. No doubt, other provinces will seek to follow and more than 30 U.S. states
are considering increases. Some cities are going even further.
The city of New Westminster in British Columbia, has been the first in Canada
to follow a trend established in the U.S. where more than 140 municipalities
have introduced legislation requiring employers who do government work to
provide a “living wage”—for New Westminster $19.62 compared to the minimum wage
of $10.25[3].
The “Love your Neighbour” principle would suggest that
Christians also would not want families to be “raised in poverty”. However, on
this issue also, we must “Count the Cost”—look at the unintended consequences.
The fact is that most economists have concerns about legislated increases in
wages. While increased minimum wages will, no doubt, benefit those who remain
employed, these benefits come at the cost of putting people out of work.
Noble laureate James Buchanan has suggested that “the notion that raising
minimum wages would have no adverse impacts on employment was equivalent to..believing
that water could flow uphill.”[4] Unfortunately, this fallacy readily attracts
votes of those unaware or uncaring about the negative consequences.
Consider an oversimplified situation, in which a company
produces a product which sells for $15, requires $3 worth of materials and one
hour of labour to produce. If the employee is paid $10 an hour, the company can
earn $2 on the product towards profit and other general costs (e.g. equipment,
factory maintenance). However, if that wage rate is increased to $12 an hour,
there is no contribution to profit and other expenses—no incentive to produce.
The employee will be laid off. If the
business is able to raise its selling price at all, it will sell fewer products
and the number of jobs will also be reduced.
While this example is simplified,
the results in the real world are similar. In the market, the wage rate that
can be paid depends on the value of what the worker produces (“marginal productivity
of labour”). If the price of labour goes up, some companies will produce less,
and reduce jobs (at least, not expand) or reduce the hours worked by their
employees. Moreover, an increase in the minimum wage will inevitably cause
wages in general to go up, since, obviously, those higher up will also want an
increase.
The negative impact of an increase in minimum wage has the
most effect on the poorest--those least skilled who will be the first to be
laid off and those unemployed who have the most difficulty getting another job.
When given a choice, employers will hire the most qualified. Young people with no
experience will have more difficulty getting that first job.
In his address, Obama also claimed that the increase “will
give businesses customers with more money to spend”. That, will be true for
those who retain their jobs but untrue for those who lose theirs. Moreover, if
businesses do pay the higher wages, that money has to come from somewhere—higher
prices by consumers who will have less to spend, less spending on new equipment,
less profits to shareholders who will also spend less. Thus the increased
spending by some is unlikely to be a net gain for the economy.
The “living wage” efforts will have even more negative
effects. U.S. research indicates that a doubling of wages (say from $10 to $20)
reduces employment among low-wage workers by 12 to 17%. Moreover, 72% of
workers benefiting from “living wage” laws were not poor.[5]
Thus, such laws do little for the most poverty stricken while ensuring that
taxpayers get less value for their money.
Now some, including president Obama, argue that the rise in
wages will “boost morale” and, therefore, supposedly, productivity. If, for
example, in the illustration above, the worker could be encouraged to increase
his output per hour by taking only 50 minutes instead of an hour to produce the product,
then there is room for a wage increase. However, productivity improvements are
generally considered to come from capital investment, education and experience.
It’s not clear to what extent “morale boosts” will have long-term productivity
effects. Studies tend to confirm that the net effect of minimum wage boosts are
not positive.
Thus, significant increases in minimum wages--particularly, in a period
when unemployment is still above normal--are questionable; they help only the poor who remain employed. Efforts to help the “working
poor” are, probably better directed through the tax system. Reducing taxes
through tax credits (including refundable ones for those paying little tax) can
achieve the desired effect without the negative job effects. Of course, that
means tax-payers in general will pay the cost. But, is that not better than
increasing unemployment?
Finally, if we must have minimum wage laws, a (lower) graduated youth wage (as exists in some other countries) could be discussed to deal with the serious problem of youth unemployment--which is double the average rate of unemployment. It might even be extended to the "long-term" unemployed, to help them get back into the work force.
Another option to explore is some form of "profit-sharing"--keeping base wages moderate but sharing profits when things are going well. But, that's an issue for the distant future.
[1] I will
make no attempt to review the whole address. It did include things that we
could all agree with and was short on detail on other issues.
[2] A National
Post report suggests this will be done retroactively back to 2010; that
would be ridiculous and impossible to implement. Can small businesses go back
and pay extra past wages without raising revenues?
[3] Charles Lammam, “Maximum Wage Damage”, National
Post , Jan. 28, 2014.
[4] Peter Foster, “MinimumThinking, National
Post, Jan. 29, 2014 Lamman op. cit quotes a “comprehensive review” of more
than 100 studies covering 20 countries and found the overwhelming majority of
studies concluded that minimum wage hikes negatively affect employment.
[5] Lamman, op. cit.
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