effects of raising minimum wage: theory, evidence and future challenges

Procedia Economics and Finance 6 ( 2013 ) 96 – 102

2212-5671 © 2013 The Authors. Published by Elsevier B.V.Selection and peer-review under responsibility of Faculty of Economic Sciences, Lucian Blaga University of Sibiu.doi: 10.1016/S2212-5671(13)00119-6

International Economic Conference of Sibiu 2013 Post Crisis Economy: Challenges and Opportunities, IECS 2013

Effects of Raising Minimum Wage: Theory, Evidence and Future Challenges

a, tefania u) b * aFaculty of Economic Sciences, Romania

bAcademy of Economic Studies, Bucharest, Romania

Abstract

Minimum wage is one of the most studied topics in economics. This paper examines some of the most important issues related to the effects of raising minimum wage, based on new contributions in theoretical and empirical research, roughly since 2008. Our purpose was to find in the literature an explanation for the recent raise of minimum wage, in some European Union countries and United States and to identify possible effects of this evolution. Most of the studies point little or no employment response to modest increases in the minimum wage, but we argue there are some other effects to consider. © 2013 The Authors. Published by Elsevier B.V. Selection and peer-review under responsibility of Faculty of Economic Sciences, Lucian Blaga University of Sibiu.

Keywords: minimum wage; recession; unemployment; labour market.

1. Introduction

The debate on minimum wage has focused for many years on the effects of introducing and raising minimum wage on labor market. Typically, the opponents of minimum wage emphasize its potential negative effect on employment. After many years of empirical research, studies seems to point fairly uniformly to the existence of small negative effects of higher minimum wages on employment and unemployment. More than thirty years ago, in 1977, the Minimum Wage Study Commission from United States undertook a review of the existing research on USA and Canada. As John Schmitt (Schmitt, 2013) says, four years and 17 million $ later, MWSC released a 250-page summary

* Corresponding author. E-mail address: [email protected]

© 2013 The Authors. Published by Elsevier B.V. Selection and peer-review under responsibility of Faculty of Economic Sciences, Lucian Blaga University of Sibiu.

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97 Silvia Mărginean and Alina Ştefania Chenic (Creţu) / Procedia Economics and Finance 6 ( 2013 ) 96 – 102

small and almost exclusively limited to teenagers and other youngremained the dominant view in economics, not only in United States and Canada. The recent crisis generated a need of fresh look to this problem and there are some important changes in the literature regarding the research methods, the topic of interest and even some new questions about previous results. In 2008-2013 some European countries and United States raised minimum wage as part of their recovery policies, and the disputes on the effects became very active.

2. Minimum wage: from theory to empirical evidence

Since 2008 the big questions about raising minimum wage became more focused on when, where and why rather than generally asking which the effects are on labor market. Some recent studies explain why the researchers have difficulties to prove the adverse effects of minimum wage raise on unemployment (Addison, Blackburn, & Cotti, 2013). Regarding US economy the authors show that because minimum wage has fallen in real terms and relative to the average of the economy, the increases directly affect smaller number of low wage worker and the effects on unemployment are smaller. Minimum wage elasticities for teenagers seem to have increased substantially particularly in states where unemployment rate was particularly high. Stronger evidence of a disemployment effect for low wage workers and teenagers are relevant in states with high unemployment rates.

Some authors manage to prove that changes in the legal minimum wage affect only those workers whose initial wage is close to the minimum (20%) (Alaniz, Gindling, & Terrell, 2011). Their conclusion is based on a broader approach, because they study the impact of changes in legal minimum wages on a host labour market outcomes including: wages and employment; transition of workers across jobs (in the covered and uncovered sectors) and employment status (unemployment and out of the labour force); transitions into and out of poverty.

The studies on the impact of minimum wages include the impact on average wages and the distribution of wages; employment, unemployment and hours worked; the distribution of wages and employment between the formal and informal sectors; the effects of minimum wages on tipped workers and social welfare; firms location decisions and minimum wages; the behavioural effect of minimum wages. (Alaniz et al., 2011; Amine & Lages Dos Santos, 2011; Azar, 2012; Boeri, 2012; Méjean & Patureau, 2010; Wang, 2012).

Anyway, the general opinion is the effect of minimum wage on employment should be studied focusing on labour market outcomes in specific sectors of the economy that tend to pay workers at or close to the minimum. Consequently, many studies focus on fast-food restaurant sector and retail. Mainly, all these studies supported the idea that minimum wages slightly lower employment. Addison et.al. (Addison, Blackburn, & Cotti, 2009) study shows that the general impact of the minimum wage in the retail sector is not consistent with the reductions in employment suggested in prior research for the retail trade sector as a whole. Their conclusion is based on a study focusing on employment effects of minimum wage in specific subsectors of the retail trade sector. Using data from 1995-2005, they examine how employment levels vary with the current minimum wage in every particular state. The results provide little support for the presence of disemployment effects. Many of their estimated elasticity suggest that increasing the minimum wage may modestly increase sectorial employment. The arguments could be monopsony and efficient-wage. The mobility of labour force in the sectors with a large number of employees with minimum wage is high, so a higher minimum wage tends to stabilize the workers; they are not migrating to other sectors. Also, we could estimate a positive demand effect, if the minimum wage raises the purchasing power of these groups of workers.

Often, minimum wage is perceived as an issue related to developing countries. Indeed, the study of the impact of minimum wages in developing economies include articles on Nicaragua, Brazil, Chile, Colombia, Costa Rica, Honduras, Indonesia, Kenya, Trinidad and Tobago, Turkey and South Africa (Alaniz et al., 2011; Bird & Manning, 2008; Dinkelman & Ranchhod, 2012; Gindling & Terrell, 2009, 2010; Lemos, 2009; Magruder, 2013). In the same time, we found important contributions related to developed countries, like Canada, USA, OECD countries or European countries as groups (Addison et al., 2009; Autiero, 2008; Bellou & Kaymak, 2012; Sen, Rybczynski, & Van De Waal, 2011). Nicaragua is a very interesting case because the country has a relatively high level of minimum wages compared to average wages, which means that minimum wages have potential to affect a large fraction of the


population; substantial variation in minimum wages both across industries and over time; a large proportion of private sectors workers not legally covered by minimum wages (the self-employed); a large sector of small firms where employers often avoid minimum wage legislation (Alaniz et al., 2011). The conclusions point to the same directions: minimum wages not only result in workers leaving the covered sectors, but also result in a reduction in new hires;

A very important question is about the most appropriate time to introduce or raise the minimum wage. The

controversial is related to the debate about introducing minimum wage in Germany in 2009. The debate is triggered by the rise of jobs with low salaries since the 1990s. Opponents of such regulation argue that raising real wage will raise unemployment, since employers will hire labour up to the point where real wages are equal to marginal products. Flaschel&Greiner (Flaschel & Greiner, 2009) show that the introduction of a general level of minimum (or maximum) real wages into a supply side macro model of fluctuating growth does not affect capital accumulation and employment. Instead, we will have less severe fluctuations in income distribution and employment. They emphasize that both minimum and maximum real wages are easier to implement in the prosperity phase of the cycle than in its stagnant or depressed phase. Bartolucci (Bartolucci, 2012) analyses the cyclical patterns of job termination. He finds a strong negative relationship between unemployment rates and quits at European level and a positive effect of the unemployment rate on the probability of layoffs; these suggest that in the 10 European countries quits are procyclical and layoffs countercyclical. The main idea is that in expansion, when the unemployment rate is low, the effects of raising minimum wage are weak.

Using data from 2005-2010, Addison (Addison et al., 2013) shows that even in a deep recession minimum wage increases do not appear to have particularly strong effect in reducing employment within the sector of the economy most likely to be affected by the minimum wage. They found no evidence that a severe recession is the worst time for a minimum wage increase, reporting a limited evidence of reduced employment within restaurants and among teenagers, as a high risk groups.

employment, simply asking why there is no effect of minimum wage on employment(Schmitt, 2013). The answer is related to other possible channels of reaction to a minimum wage increase. The paper identifies eleven such channels, but the most important are: reductions in labor turnover, improvements in organizational efficiency, reduction in wages of higher earners and small price increases. The others, such reductions in hours worked, reductions in non-wage benefits, changes in employment composition, efficiency wage responses from workers, reduction in profits, reduction in training, and increases in demand are not conclusive.

3. Facts, figures and recent European and Romanian evolutions

The debate on minimum wage in Europe is very active. The level of minimum wage established by EU countries through national legislation and sectorial agreements shows high differences among countries. In January 2013, according to Eurostat ("Wages and labour costs," 2013), 20 member states from 27 (Belgium, Bulgaria, Czech Republic, Estonia, Ireland, Greece, Spain, France, Latvia, Lithuania, Luxemburg, Hungary, Malta, Netherlands, Poland, Portugal, Romania, Slovenia, Slovakia and United Kingdom) and 2 candidates countries (Croatia and Turkey) have national legislation regarding minimum wage.

Minimum wages are between 157 EUR in Romania and 1874 EUR in Luxemburg. There are 11 countries with a minimum wage between 100 and 500 EUR per month, 5 countries with minimum wage between 500 and 1000 EUR, and a group of six states (UK, France, Ireland, Netherlands, Belgium, Luxemburg) with minimum wage over 1200 EUR per month. The exchange rate is an important factor, so the minimum wage expressed taking into consideration the prices differences between countries shows some changes. Applying Purchasing Power Parities (PPP) on consumption, the gap is lower, and minimum wage varies between 274 EUR and 1524 EUR (Romania and Luxemburg). The most important changes are for Estonia, Lithuania, Poland and Turkey which change their positions with two places. Hungary, Poland, Croatia and Turkey join the second group of countries.


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The UK experience with minimum wage is different. Minimum wage was 46% from average salary, a little higher than in USA. The negative effects were insignificant and the main benefit was the gap reduction among lower wages in UK and an increase with 5% of the lowest revenues.

Romania is a very interesting case among EU countries both for the evolution of minimum wages and for the effects of minimum wage policies on labor market for many reasons. First, we have to emphasize that using nominal values in analyzing an economy with high inflation rate it is not relevant. As we can see in Figure 1, minimum wage was about 30% from average salary, with a maximum of 37,7% in 2003 and a minimum of 27,9% in 2007.

Fig. 1. Nominal values for minimum and average wages in Romania 2001-2012 Source: National Institute of Statistics, 2013

Empirical and theoretical contribution in the last 30 years emphasized the low impact of minimum wage policies on unemployment, suggesting often a high inertia of labor market. Moreover, Romanian labor market seems to have a lot of rigidities and particular ways to be related to other macroeconomic variables. The relationship between unemployment and real GDP and even with employment (as we can see in Figure 2 and Figure 3) show that that unemployment is one of the most rigid macroeconomic variables in Romania. For example, the big fall in GDP encountered in 2009 had no effect on unemployment rate; labor market reaction was more significant on number of employees.


Fig. 2. Real GDP growth and unemployment rate in Romania 2001-2012

Fig. 3. Unemployment and employment in Romania 2001-2012

and National Institute of Statistics data, 2013

caused a drop out in the number of employees but unemployment rate raise very slow, and remains below 8%. We have two possible arguments: unemployment rate is a lagging indicator, with a high inertia, and low elasticity so the raise from six percent to 8 percent in 2008-2011 is the maximum reflection that we can expect. We also have inflation, budgetary deficits, public debts that absorbed a part of economic downturns. Romanian economy typically reacts this way. Another argument set could include external migration, black economy, early retirement and other ways to exit

So, what could we expect regarding the minimum wage and its correlation to the general evolution of the economy?

The link between real GDP and labor market could be studied using more relevant indicators than nominal minimum wage, such as minimum wage growth rate, average salary growth rate, and growth rate of the ratio between minimum wage and average wage. In 2001-2008 when GDP registered high levels of economic growth, minimum wage growth in nominal terms had two major push 2003 (when MW raised more than 40%) and 2008 (almost 30% raise). In the same period, average salary growth rate was generally higher. What happened after 2009? Average salary growth rate is lower (about 5%, not 20%), one explanation being the lower inflation rate and the minimum wage increase more than average salary. The exception is 2012 but for 2013 Romania decided two raises of minimum wage.

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Fig. 4. Ups and downs in wages and GDP: Romania 2001-2012

Source

The average salary evolution is related to the general economic evolution of the economy. The crisis started in 2008 in Romania and the labor market reaction was surprisingly fast and elasticity is over 1. Minimum wage is the result of income and social policies, so is not related to the real economy. We have to accept that there are very different drivers of minimum wage comparing to other labor market variables. The relationship between minimum wage and average salary is not a question of labor market equilibrium. This is not about the effects on the demand and supply on this market. The average salary could be interpreted as a mirror for the real economy evolution, but the minimum wage remains only a question of social protection and maybe of countercyclical policies.

Unemployment rate is the most rigid component of the labor market in Romania, but the minimum wage determined as a percentage of average salary is not related to the labor market evolution at all. As we saw in the first part of our paper, the effects of minimum wage raise on labor market are very limited in all countries and regions.

4. Conclusions

The effects of minimum wage raise on employment are much disputed in the literature. We found three possible debates and ways to organize the review of recent literature on the effect of raising the minimum wage: employment and unemployment effects; geographical, demographic and sectorial specificities; the relationship with business cycles.

We think that the research on the effect of raising minimum wage on employment is not relevant any more. Arguments came from theory, empirical evidence and examples like Romania. Another conclusion related to our literature review is that any study on the effects of raising minimum wage has to be conducted at national or regional level because the effect depends on the share of minimum wage paid workers, the relative minimum wage (expressed as share of average salary), legal and cultural characteristics who is paid at minimum wage, how many teenagers work, etc. Studies focusing on groups of countries are in most cases irrelevant. For example, in Romania it is not relevant to study the effects of raising minimum wage based on in workforce is low. The age of the first job is significantly higher than in other countries, like US or Canada.

So, why should we care about minimum wage? There is a paradox: even minimum wage is a restriction imposed on labour market but the effects are on other markets. When we raise the minimum wage, nothing happen in terms of employment and unemployment, so we have to think there are other parts of the economy and other markets that support the effect. Research challenges in this context are to identify the markets and the point which elasticity changes and the economy became more sensitive to minimum wage policies.

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Many EU countries, including Romania decided to raise minimum wage in recession. In this context, debates on the effects of minimum wage raise in Romania are not about the employment, but on the austerity and budgetary effect of this raise. The decision was part of a set of measures carefully negotiated with International Monetary Fund, so we are probably expecting a favourable effect on budget. The effect on labour market, on employment and on firms profits are not emphasized as big issues in minimum wage policies. In the future, the research have to focus on inflation and firms profits effects, because the overall effect on employment is low; on the other side, the benefits in terms of welfare and reduced poverty should be considered.

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effects of raising minimum wage: theory, evidence and future challenges

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