Minimum wage: good politics, bad economics?

Is the minimum wage a good thing for workers? Writer Paul Fraumeni spoke with University of Toronto Professor Morley Gunderson, a respected economist who has done a good deal of research on this often controversial topic.

Gunderson is CIBC Chair in Youth Employment and a fellow of the Royal Society of Canada. Among his many honours, he has received the Industrial Relations Research Association Excellence in Education Award in Labour Economics and in 2011 he was the first Canadian to be elected as a Fellow of the Labour Employment Relations Association. 

Why do jurisdictions (nations, provinces, states, etc.) have minimum wages?
The main rationale tends to be to help fight poverty and I believe that is what gets the attention of the public. Other rationales are sometimes put forward including: reducing wage inequality, protecting the unprotected and most vulnerable who have little or no bargaining power, providing an incentive to leave income maintenance programs, increasing aggregate demand by increasing the spending power of low-wage persons, and pressuring firms to move up the value-added chain by eliminating low-wage jobs even if it means eliminating firms that rely on such low-wage jobs.

There are other more cynical rationales that have been put forward such as protecting higher wage firms from competition from firms that pay low wages, and reducing the need for unions since if governments can foster higher wages there will be less demand for unions to foster such higher wages. Many of these arguments can appeal to the general public; hence, politicians have an incentive to pay attention to them.

How is the amount of the minimum wage set?
Minimum wages in Canada are under provincial jurisdiction; hence, different provinces set their own minimum wage.  The federal jurisdiction covers less than 10 percent of the workforce. Since 1996, the federal government has abandoned its policy of setting its own minimum wage and now sets it equal to the minimum wage of the province/territory where the federal worker is employed.

Various factors come into play in setting the minimum wage and those factors will obviously vary across jurisdictions. Jurisdictions tend to pay attention to what is happening in other jurisdictions (including ones in the US) as well as how the minimum wage relates to the average wage in the jurisdiction. Attention is also paid to inflation that can easily erode the real value of a minimum wage. Parties on the political left are more prone to raise minimum wages than are parties on the right that may have a more business orientation. Political parties can also be influenced by media “blitzes” that raise the issue as is commonly done by the Toronto Star.

Does having a minimum wage actually help workers?
That is the key question that is hotly debated and contested.

A minimum wage can raise the wages of those who retain their job, but it can reduce the employment opportunities and hours worked of others as firms adjust to the cost increase. The adjustments are not likely to be overt in the form of laying off such workers. Rather they can occur in more subtle forms such as reduced new hiring of such workers and the installation of more automated equipment or processes that use fewer low-wage workers. Low maintenance buildings can substitute for custodial and maintenance services; retailers can use automated inventory systems and self-service checkouts; “disposable” consumer goods can substitute for repairs (it is cheaper to buy a new toaster likely made by low-wage foreign workers than to repair a broken one); and imports from low-wage countries and “offshore outsourcing” can substitute for domestic production. These effects are likely to occur slowly over time, which is one of the reasons why it is difficult to detect the effects of minimum wages.

The empirical evidence on the employment effect of minimum wages is mixed and controversial. Until the 1990s there was a general consensus amongst economists that minimum wage increases had a negative effect on the employment of teens and youths. The US evidence, where the majority of the studies have been conducted, tended to find that a 10% increase in the minimum wage would likely lead to a 1% to 3% reduction in employment of younger workers. That “consensus” was shattered by the work of some prominent and respected economists, especially David Card and Alan Krueger. They essentially found no adverse employment effect. This work has been challenged by other prominent and respected economists, especially David Neumark and William Wascher, whose work tended to find adverse employment effects often larger than the former consensus range. Recent studies have continued to yield conflicting results.

Interestingly, the Canadian evidence tends to more uniformly find adverse employment effects that are even higher than the old “consensus range.” The recent Canadian evidence generally finds that a 10 percent increase in the minimum wage reduces the employment of teens by 3 to 6 percent and slightly less for young adults. This is the case with four recent studies I have conducted with different colleagues and using different data sets and methodologies.

Who would not want there to be a minimum wage?
Businesses, and especially small business, generally oppose minimum wages because of the cost implications and the fact that they may find it more difficult to substitute capital or other inputs for low-wage labour. Some large businesses, however, have supported minimum wage increases likely because they pay above the minimum wage and want to reduce competition from their competitors who otherwise would pay below the minimum wage. Many economists oppose minimum wages because they can reduce employment opportunities — better to have a low-wage job than no job. As indicated, however, economists are somewhat divided on the issue.

How does the minimum wage relate to the poverty line? Aren’t people making the minimum wage also, in reality, officially “poor”?
There is more of a consensus amongst economists that, media portrayals notwithstanding, minimum wages are at best an exceedingly blunt instrument for dealing with poverty and may ultimately be harmful.

This is so for a variety of reasons. Many in poverty do not work or work only few hours, and many earn above the minimum wage. Poverty is related to family income relative to family need, while minimum wages are paid to individuals irrespective of their family situation or need. Minimum wages tend to affect teens and youth as well as multiple earners who live in middle and higher income households. Minimum wage jobs are often temporary stepping-stones held by youths who will not be in a state of long-run poverty and stuck in such jobs. Reductions in the employment opportunities for youths can lead to longer-run permanent scarring effects especially in times when youths are having difficulty finding jobs. They can encourage youths to drop out of school and queue for the jobs that now pay a higher minimum wage and this could exacerbate their poverty position in the long run. 

Minimum wages can inhibit workers from accepting lower wage jobs in return for the training and work experience that could improve their earnings in the future.  Minimum wages also place the onus on a small subset of employers to deal with a legitimate social issue the costs of which should be shared by society in general.

Increasing the amount of the minimum wage has been in the news recently, both in Canada and the US.  Why are there calls for an increase now?
Until recently, minimum wages have fallen behind inflation (so that their real value has declined) and they have fallen behind wage increases in general. As such, there is some pressure to restore their relative position. Also, the growing wage inequality that has occurred has drawn attention to those at the bottom of the wage distribution and there is some evidence that the erosion of the real value of the minimum wage has fostered some of the growth in wage inequality. The decline of unions in many countries has also fostered a search for other institutional arrangements to protect the unprotected. It is even possible that some employers are accepting minimum wages as a substitute for union organizing in lower-wage sectors such as the service sector (the “lesser of two evils” in their minds.)

The fact that economic research has not yielded a consensus in this area and there is credible research by reputable economists arguing that minimum wages do not have adverse employment effects makes it easier for politicians to cite this evidence as supporting something that tends to be politically popular. And minimum wages tend to have popular appeal. This is so in part because the wage increase is visible and tangible, while the adverse effects such as slower employment growth are less visible and can occur in very subtle fashions. 

Minimum wages may be good politics even if bad economics.

What is the focus of your research in this area?
I have published four studies on the impact of minimum wages in Canada. The studies have been published in different journals and have involved different combinations of co-authors (Mike Campolieti from U of T and three former graduate students from our program; Chris Riddell at Cornell; Byron Lee at Renmin Business School in Beijing and Tony Fang at Monash University in Australia). They have involved different data sets and different econometric methodologies. All find that minimum wages have an adverse employment effect on teens and to a lesser extent youths such that a minimum wage increase of 10% leads to a reduction in the employment of teens and youths of about 3% to 6%. This does not mean that minimum wages are undesirable; but it does highlight that there is a trade-off between higher wages and reduced employment opportunities.

I have also published two papers and am working on two more on minimum wages in China with a former student from our program, Jing Wang, who now teaches at York University. In China we find smaller and sometimes no effects of minimum wages on employment. This could reflect a number of possibilities: poor enforcement; or the fact that wages are increasing so fast in that country that the minimum wage is a non-binding constraint; or the possibility that employers are reducing the non-wage components of compensation such as meal allowances or break times.  These are issues we are investigating further.

Paul Fraumeni is a writer with the office of the vice-president, Research and Innovation