Who’s afraid of minimum wages?

 

A recent decision by the tech giant Amazon to ensure that workers are at least paid a minimum wage of US$ 15/hour – which is almost twice the US Federal minimum wage of US$ 7.25 an hour  – has renewed attention on the role that minimum wages can play in influencing labour market outcomes. Critics might argue that this portends potentially adverse consequences because Econ 101 says that minimum wages cause unemployment or at least restrict employment opportunities.

Is that really the case or does Amazon know something that avid followers of Econ 101 do not?  Amazon’s position is supported by an evaluation by the European Commission (EC) of 14 OECD countries which makes the following optimistic assessment:

The evidence suggests that a well-managed minimum wage policy through statutory minimum rates or collectively bargained wage floors can be effective at improving the wages of low paid workers without negative effects on employment rates.

What about emerging economies? Consider Table 1 which provides comparative on a sample of emerging economies.

Table 1

Country Minimum wage/Average wage Employment rate
South Africa 0.3 0.43
China 0.33 0.69
India 0.4 0.5
Indonesia 0.69 0.63
Philippines 0.87 0.59
Thailand 0.65 0.71
Poland 0.4 0.5
Russia 0.18 0.65
Turkey 0.38 0.46
Argentina 0.59 0.56
Brazil 0.45 0.59
Chile 0.45 0.56
Colombia 0.6 0.63
Mexico 0.28 0.57
Average 0.47 0.58

Source: Derived from Stijn Broecke, Alessia Forti & Marieke Vandeweyer (2017) ‘The effect of minimum wages on employment in emerging economies: a survey and meta-analysis’, Oxford Development Studies, 45:3, 366-391

A cursory examination of Table 1 suggests that it is possible to have high minimum wages that co-exist with above-average employment rates (that is, above the sample average of 58%), the cases of Colombia, Indonesia and Thailand being most notable in this regard. A more rigorous meta-analysis for the aforementioned sample of emerging economies arrives at the following conclusion.

… minimum wages have had little detectable impact on employment. While more vulnerable groups appear to be more adversely affected by minimum wage rises, the effects tend to be small on average. These findings are very much in line with the growing consensus around the impact of minimum wages on employment in more advanced economies…

The study also points out that many empirical investigations in this field suffer from a ‘negative reporting bias’, that is, there is a tendency to report negative results (minimum wages reduce employment). At least 70% of the estimates that were reviewed were actually statistically insignificant. The mean value of the ‘elasticity’ derived from 746 estimates is 0.047, that is, a 10% increase in the minimum wage might reduce aggregate employment by, at best, 4.7%.

It is worth noting that the results of this meta-analysis are in line with the findings of World Development Report 2013 which pointed out that ‘…most estimates of the impacts of (labour regulations) on employment levels tend to be insignificant or modest’ (WDR, 2013: 261). Even if there is a modest and negative impact of minimum wages on employment, this can be offset by the possibility that minimum wages can alleviate the incidence of low pay and thus reduce working poverty.

Of course, minimum wage policy needs to be combined with complementary measures, such as education and skills policies, active labour market programmes and social protection measures in general, to tackle the problem of low wage employment. Nevertheless, the EC evaluation, combined with the aforementioned meta-analysis of the minimum wage-employment nexus are highly relevant to the case of low and middle-income economies that are typically characterised by a significant incidence of low pay and working poverty. A reduction in working poverty, while desirable in itself, can also boost aggregate demand by enlarging the size of the domestic market and become a new source of job creation.

One could still argue that minimum wages, in general, are problematic for developing countries that rely heavily on foreign direct investment (FDI). High minimum wages might deter FDI which usually is motivated – so goes the argument – by the incentive to locate in low-wage labour markets. The problem with this line of reasoning is that it is incompatible with the predominant finding in the academic literature that FDI creates a ‘wage premium’, that is, affiliates of multinational companies pay significantly higher wages than their domestic counterparts while boosting both employment and productivity. Thus, it is unlikely that foreign firms would be deterred by minimum wage legislation.