The Economics of the Minimum Wage

The minimum wage debate is heating up once again, with the NDP and labour strongly pushing for a minimum wage of at least $10 per hour in Ontario and at the federal level (as recently recommended by the Arthurs Report.) Anti poverty groups and the Toronto Star now strongly endorse a decent minimum wage as part of an anti poverty strategy.

Predictably, the new momentum for a higher minimum wage has generated cries from business and employer-friendly governments that such a move is an “inefficient” way of fighting poverty, and will come at the cost of jobs.

With respect to the former argument, it is true that many low wage workers do not live in poor families, but very few low wage adults live in affluent families, and higher wages are one important building-block in strategies to assist the working poor. There is also no good reason why workers should have to put up with very low wages simply because they are cushioned by dependency on the earnings of a partner.

With respect to the job loss argument, individual studies by economists can be and are endlessly cited on one side or other of the seemingly endless debate. However, the consensus of even impeccably orthodox and mainstream economists is now that minimum wages set at “reasonable” levels do not have significant negative impacts on the employment of lower-skilled adults.

The latest OECD Employment Outlook – a re-appraisal of the original 1994 OECD Jobs Strategy which was very critical of minimum wages – reports that “a moderate minimum wage is generally not a problem”, can create important incentives to work for people on social assistance, and can lower the cost to governments of supporting the incomes of working poor families. (pp 86-88.) The OECD Employment Outlooks of 1998 and 2003 contain the detailed empirical studies which led to revision of the OECD view.

Similarly, the consensus of studies on the impacts of the minimum national wage introduced by Labour in the UK has been that it had no significant impacts on employment, and most studies of changes in US minimum wages at the state level find minimal impacts on jobs. Part of the reason that the UK minimum wage has worked so well is that it has been gradually increased a bit faster than inflation and average earnings,  reaching a new and much higher benechmark while still giving the job market time to adjust.

Most of the economic studies are a little less clear on why there is little or no impact on jobs. One major reason is that minimum wages apply across sectors and geographical regions, placing no single employer at a disadvantage. At the sector and local level,  it seems that higher minimum wages provide benefits as well as costs to employers – lower turnover, lower training costs, and more experienced workers. Left to their own devices, low wage employers actually pay less than they should if they really calculated the costs of a disposable workforce. Another reason for minimal job impacts is that, even if business costs increase a bit, the impact on prices is not enough to appreciably reduce demand.

While there is no hard and fast definition of a reasonable wage floor, one benchmark that has been used internationally is two-thirds of the median or mid-point hourly wage – which would be close to $11 in the case of Canada, roughly the level of Canadian minimum wages a generation ago. France, Italy and the UK all have minimum wages which are much closer to this benchmark than is the case for Canadian provinces, and many smaller European countries have de facto minimum wages at this level set by collective bargaining.

The cry from business and the right that decent minimum wages come at the cost of jobs flies in the face of the simple empirical reality that countries with relatively high wage floors compared to the median do not necessarily have low rates of employment or high unemployment. The proportion of full-time workers with low wage jobs (less than two thirds of the median hourly wage) is 22% in Canada, but just 7% in Sweden and 9% in Denmark. In 2005, the employment rate (the proportion of the 15-65 age groups with jobs) was actually higher in both Denmark and Sweden than in Canada. And there is no relationship between the incidence of low wage jobs and low unemployment in OECD countries. (See 2006 OECD Employment Outlook p. 175) In short, the argument of the right that countries cannot have both a decent wage floor and high employment/low unemployment is simply wrong.

Finally worth noting as a footnote is the fact that even the negative studies trotted out by employers and the right have to be read carefully. Most of the negative studies show a very small impact on total hours worked as a result of often significant increase in minimum wages. It may be the case that the fast food industry, for example, experiences higher productivity as a result of a more stable workforce, and shaves total hours of work But a small negative for hours does not mean that workers are worse off.

Think about it – if your employer asked you if you would be willing to work one hour less per week in return for a 10% hourly wage increase, what would you say?