Minimum Wage Debate.

Fiddling with wages by fiat can poison the job market. However, a moderate minimum wage,

when set by technocrats instead of politicians, may blunt this effect.

How Much is Enough?

Minimum wage  debate is on the air again. The State of California appears to be the standard bearer in the debate, proposing to raise its minimum wage to $10 an hour by 2016. It may be stated here that California’s proposal – a minimum wage of $10 an hour – is higher than that of any other state in the country, at least for the time being.[i]  No wonder the increase   inspired some copycats: In November 2013, the voters in  New Jersey approved a  proposal to raise that state’s minimum wage from $7.25 to $8.25, making that state the fifth state to increase its minimum wage in 2013.[ii] In states like South Dakota, Massachusetts, Idaho and Alaska, the push for a minimum wage hike has grabbed headlines throughout 2013 and continues today as if advocates and the state establishments are in a court battle. Meanwhile, in states like Maryland, Illinois, Hawaii and the District of Columbia, it is actually the elected officials who are leading the crusade for a  higher minimum wage.

If the position of the states is the biggest propaganda on the issue of minimum wage, the actions of organized labor and liberal groups are a close second. These groups have backed a wave of strikes by fast-food workers in the major cities of the countries, arguing that hourly wage hikes is justified by practical reasoning and a fair appraisal of the plight of the low skilled workers. Here’s the most surprising part: They are pressing for a  value that is more than twice the $7.25 federal minimum wage[iii], namely, a $15 hourly wage.

What is certain is that, by law, states are not allowed to set a minimum wage that is lower than the federal standard. However, they has the freedom of establishing a higher minimum wage than this standard stipulates. The state that currently pays the highest minimum wage to its workers – a wage of $9.32 – is Washington. Next in rank are the states of Oregon and Vermont, with minimum wages of $9.10 and $8.73 respectively. Illinois, the District of Columbia and Connecticut all have a state minimum wages of $8.25. [iv] The individual cities in the country seem to be adopting their states’ standards with respect to minimum wage hike: As of 2013, about 120 cities has made laws that required businesses that receive city contracts to pay their employees what they term “living wages,” which in some cases ranges from $9-$16 an hour.[v]

California’s passage of a $10 minimum wage, however,  was the  spark that ignited the push for action in this area by other states for one reason: It appeared to have set a standard which these states should aim for. But the most surprising thing about it is the enthusiasm with which many states are  endorsing minimum wage hike – particularly at this time when all efforts to increase federal hourly wage have stalled at the Congress. It should be observed here that the last time that Congress raised the minimum wage was in 2007. Since then, the Democrats in Congress have been canvassing for raising federal minimum wage to $10.10 per hour by 2015 – a strategy they want to use to lift their fortunes both locally and nationally.[vi] But unfortunately, it is unlikely that the Republicans – who currently controls the House – will approve it.

Market Sense – The Case for Moderate Minimum Wage

The debate about minimum wage is not limited to the U.S. economy alone: On both side of the Atlantic, politicians are warming to the idea that a critical purpose of labor law is to address the unequal bargaining power between workers and their employers by establishing minimum standards for wages, safety and other terms of employment –  measures that would enhance the quality of life of the lowest paid workers. Germany, for instance, is one of the few  advanced countries that do not have a national wage floor. However, as of December 2013, the incoming coalition government passed a resolution on across-the-board hourly minimum of 8.50 Euros ($11.50), starting from 2015. Even in Britain, which has a minimum wage since 1999, the opposition Labor Party are discrediting the perceived “freedom of contract” system that enshrined the right of employers to exploit, and workers to be exploited, and are thus cajoling firms into voluntarily paying higher living wages.[vii]

From a functional point of view, fiddling with wages by fiat is not a big hit with the free-market types. Generally speaking, in a competitive market anything that artificially raises the price of labor will cause employers to pay their workers more than the value of the additional products that the produce. And since employers typically are not willing to do this, such economically unsustainable minimum wage legislation will curb the demand for labor, and the very people who the intervention is supposed to help – that is, the least skilled workers – will be the first group to lose their jobs. This explains why Milton Friedman, a renowned economist, argued that minimum wage legislations are a form of discrimination against the low skilled workers. [viii] It also explained why he noted that a far more sensible means of reducing poverty is to top up the incomes of the working poor with public subsidies.

The unhappy truth is that there is no free lunch when the government mandates a minimum wage that is above the market wage rate. However, the case for action to help the low-paid has continued to grow due to the widening income inequality as well as the shrinking workers’ share of national income. More important, though, is that, in this era of austerity, when there are many other pressing claims on national coffers, addressing the problem through subsidies for the working poor can be an uphill task for the government. Besides, other policy options, including the use of confiscatory taxes, are neither realistic or attractive.

One evidence of the distributional effects of a minimum wage that is set above the market rate is provided by Linda Gorman, a writer for the Library of Economics and Liberty. She summarized the results of Australia’s experience on minimum wage legislation thus:

 “Australia provided one of the earliest practical demonstrations of the harmful effects of minimum wage laws when the federal court created a minimum wage for unskilled men in 1921. The court set the wage at what it thought employees needed for a decent living, independent of what the employers would willingly pay. Laborers whose productivity was worth less than the mandated wage could find work only in occupations not covered by the law or with employers willing to break it. Aggressive reporting of violations by vigilant unions made evasion difficult. The historical records shows that unemployment remained a particular problem for unskilled laborers for the rest of that decade.”[ix]

The above analysis do not mean that a moderate minimum wage is not desirable or practicable. As a practical matter, real labor markets are not perfectly competitive. Thus, given that workers who want to change jobs face costs and risks, it is still possible for the employers to set pay below its market-clearing rate. This implies that a minimum wage could boost pay with no ill effects on jobs,  provided that it is not set too high.

Evidence from Europe and United States

The above argument is supported by empirical evidence from both Europe and America. In flexible economies a low minimum wage do not always decrease employment among low-skilled workers. The United States has one of the rich world’s lowest federal minimum wage – at about 38 percent of median income. Broadly speaking, most independent studies conducted within the country find no serious harm to employment from federal or state minimum wages. Britain has a similar experience: At around 47 percent of median income, with a lower rate for young people, that country’s minimum wage also does not seem to cause job any loss.

In rigid labor markets, however, high minimum wages can hit employment hard. France, for instance, has a wage floor that is more than 60 percent of the median for adults and a far bigger fraction of the typical wage for the young – the highest among the rich countries. It is thus not surprising that France has shockingly high rates of youth unemployment, which, as of 2013, was as high as 26 percent for 15-20 year olds.[x]

The above explanations  has brought to light two lessons  in  the system, usually obscured by near – unanimous commitment to setting or changing minimum wages at almost any cost. The first lesson is ensure that the minimum wage level is pretty low, specifically, to set it at a level that is less than 50 percent of the median wage, while, at the same time, implementing lower levels for the less productive workers such as the young and the long-term unemployed. Given that Germany’s proposed level is, by one calculation, 62 percent of the median wage, it risks breaking this rule. As a matter of fact, in the eastern part of the country, which is considered to be the country’s less productive region, only 17 percent of the workforce is paid less than 62 percent of the median wage, which suggests that jobs will be lost in the region. In a similar vein, the proponents of minimum wage hike in Britain are calling for a value that is 20 percent higher than the minimum wage and, as a concession to practicality, it must be conceded that that could hit employment. On the positive side, even though America’s  proposed increase is big, the minimum wage would still be about 50 percent of the median wage.[xi]

Second, the politicians are not qualified to set minimum wages. Let’s face it: Even  though minimum wage legislations may sound so populist in the heat of a  campaign, it often does not work so well in the real world of profits and losses when it is set by the politicians.  They should delegate the power of setting minimum wages to technocrats. In Britain, minimum wage levels has generally advanced gradually because the floor is adjusted annually on the advice of economists and statisticians working with the Low Pay Commission,  and not by the politicians. In contrast, the American politicians are the people who set the federal floor and, unfortunately, they often adjust it irregularly in huge increments – a method that is foolishly simplistic because it favors neither the employers in the country nor the workers themselves.

The bottom line: The world governments need to realize that minimum wage legislations are merely a palliative approach to poverty reduction. Hence, such legislation should not be allowed to distract their attention from addressing the more fundamental causes of low wages and poverty, namely, lack of education and skills.

NOTES

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[i] Prah P.M.(2013): Many States Looks to Raise Minimum Wage. The Pew Charitable Trust. Retrieved January 8, 2013 from http://www.pewstates.org/projects/stateline/headlines/many-states-look-to-raise-minimum-wage-85899505219

[ii] Livio S.K.(2013): New Jersey Voters Approve Constitutional Amendment Raising Minimum Wage. New Jersey Online. Retrieved January 8, 2014 from http://www.nj.com/politics/index.ssf/2013/11/nj_voters_approve_constitutional_amendment_raising_minimum_wage.html

[iii] National Council of State Legialators(2013): State Minimum Wages. Retrieved January 8, 2014 from http://www.ncsl.org/research/labor-and-employment/state-minimum-wage-chart.aspx

[iv] Ibid

[v] Wallace G.(2014): Seattle Mayor - $15 Minimum Wage for City Workers. CNN Money. Retrieved January 8, 2014 from http://money.cnn.com/2014/01/05/news/seattle-minimum-wage/

[vi] Martin J, Shear M.D.(2013): Democrats Turn to Minimum Wage as 2014 Strategy. New York Times. Retrieved January 9, 2014 from http://www.nytimes.com/2013/12/30/us/politics/democrats-turn-to-minimum-wage-as-2014-strategy.html?_r=0

[vii] The Economist(2013): Minimum Wage – The Logical Floor. Retrieved January 9, 2014 from http://www.economist.com/news/leaders/21591593-moderate-minimum-wages-do-more-good-harm-they-should-be-set-technocrats-not

[viii] Wilson M.(2012): The Negative Effects of Minimum Wage Laws. Cato Institute. Retrieved January 9, 2014 from http://www.downsizinggovernment.org/labor/negative-effects-minimum-wage-laws

[ix] Gorman L. (2008): Minimum Wages. The Concise Encyclopedia of Economics. Retrieved January 9, 2014 from http://www.econlib.org/library/Enc/MinimumWages.html

[x] The Economist(2013): Minimum Wage – The Logical Floor. Retrieved January 9, 2014 from http://www.economist.com/news/leaders/21591593-moderate-minimum-wages-do-more-good-harm-they-should-be-set-technocrats-not

[xi] Ibid