Ethics@work: The minimum wage pendulum [pg. 17]

February 16, 2006 21:21

Raising minimum wage is an issue in the 2006 elections. Is it really an effective way to fight poverty?

taking cash out of wallet 88

paying money wallet 88. (photo credit: )

The 2006 election campaign may be remembered as the one that put the minimum wage on the map. Amir Peretz has promised to raise the statutory minimum wage, while other pols are urging better enforcement. There is much evidence that enforcement is spotty, and that hundreds of thousands of workers make less than the legal minimum wage in Israel. Professional opinion on the minimum wage has gone through some transformations - what I would call a pendulum. When I was in graduate school in the mid-1980s, the approach to the minimum wage was pretty much an orthodox, classical one: The minimum wage is like any other price floor; the effect is to raise the wages of a few workers while driving many others out of the market. The result for workers is that some gain a little while others lose a lot, which means that workers on the whole are probably no better off. The result for employers is unambiguously negative, since they are cut off from one source of valuable labor and their earnings will suffer. Consumers also lose, since reduced economic activity means goods are scarcer and more expensive. Since workers are also consumers, every sector loses out. I think it is safe to say that most of my colleagues believed that the minimum wage was a Trojan horse of the labor movement designed, not to help less-skilled workers, but on the contrary to price them out of the market and reduce a major source of competition to union labor. However, within a few years more studies were published which showed that the minimum wage did not always have the effects predicted by classical theory. For instance, reductions in employment are often found to be quite small. Furthermore, even if raising the minimum wage harms employment, it might still reduce poverty by giving more to the employed poor than it takes from the unemployed. This opened the door for an increase in the professional legitimacy of this policy instrument. Now the pendulum is swinging back; we have learned that the actual effects, while sometimes different than the predicted ones, are not necessarily any more salutary. My politically incorrect take on the current literature is as follows: According to our current and more enlightened understanding of the impact of minimum wage, this policy instrument is capable, under certain circumstances, of improving the lot of the poor. But in practice, it really doesn't. In fact, new research shows some previously unrecognized dangers. Let's look at some of the new ideas: How could a minimum wage help the poor? ANSWER 1: KEEP PEOPLE IN THE WORK FORCE. The traditional analysis objects that a minimum wage is really a kind of a subsidy provided to some low-wage workers. Subsidies are expensive and distort the market. But the fact is that poor people are already the beneficiaries of welfare benefits even if they don't work. So having a minimum wage could be the lesser of two evils; it could mean that at least some poor people attain a decent standard of living through wages, not through welfare payments. PROBLEM: Most people who receive the minimum wage are not poor. Lots of people who are out of work because of the minimum wage are poor. So the minimum wage is not a very cost-effective way of keeping people out of poverty. A lot of the benefit goes to people who aren't poor and a lot of poor people don't benefit. (In fact, they pay higher prices to subsidize the minimum wages of better-off workers.) A "negative income tax" scheme, which gives a wage boost only to the poor, is much more effective. ANSWER 2: IMPROVE SKILLS: When there is a minimum wage, there are only good jobs. So people who can't get good jobs can't get any jobs. This increases the incentive to obtain skills that enable workers to get quality jobs. PROBLEM: The opposite can also occur. When there is no minimum wage, only skilled jobs pay decent wages. So if you want decent wages you have to obtain skills. When there is a minimum wage, even low-skilled jobs pay a decent wage, so some people can get jobs with reasonable pay without skills. There is evidence that higher minimum wages can lead to an increased number of youngsters leaving school because work becomes an attractive option. This improves their short-term earnings prospects but seriously undermines their long-term earnings. Furthermore, lots of times a "low wage" is really a synonym for "on-the-job training." In return for work, an inexperienced employee gets a little money plus a little training, enabling him or her to get a better paying job in the future. When there is a minimum wage, there is more of a tendency to seek "disposable workers" who can do the job and earn their keep. There is little incentive to invest in them, both because employers can't afford it and also because since the minimum wage is attractive they can always get new workers to replace shirkers. Many decent jobs are available now for workers with "experience." But people starting out are unable to get any experience, because they don't have any. A lower minimum wage would provide a way for workers to get into the pipeline. So high minimum wages seem more likely to harm skill levels than to help them. ANSWER 3: MINIMUM WAGE IS HARMLESS. The big bad economists of yore predicted that minimum wages would have a profound impact on employment, but a number of studies showed that the impact was relatively minor. So even if the impact on poverty is small, it's a good tradeoff. PROBLEM: Most of these studies on the impact of the minimum wage come from the US, where the minimum wage is not much of a constraint. Today the minimum wage in the US is only about a third of median wages and is paid to only about two percent of wage earners. It's hardly surprising that fiddling with it has little impact. (Some states have much higher minimum wages than the Federal rate, but these tend to be high-income states like Alaska or Connecticut. The minimum wage is still a small fraction of the local median wage.) Compare this to Israel, where the minimum wage is fixed by statute at 47.5% of the average, and is paid to close to 30% of employees. The minimum wage in Israel, as a fraction of per capita income, is one of the highest in the world. Under these conditions, raising the effective minimum wage can be expected to have a major impact on employment. Research from Europe, where minimum wages are higher than in the US, tend to show greater negative impacts on employment, especially on part-time employment which is so crucial for younger workers and working mothers. The question of whether a minimum wage helps or hurts the poor is a practical question, not an ideological one. It depends a lot on how high the minimum wage is compared to average wages. If it is very low, the fraction of recipients who are poor is higher, and the employment effects of raising it are smaller. So there is a better chance to help the poor by raising the minimum wage. When the minimum wage is high, raising it is going to help more non-poor people and harm more poor people. I personally am skeptical about any benefits from a minimum wage, but I acknowledge that the verdict is still mixed and a moderate minimum wage could prove beneficial. But, at its current level in Israel, it is a drag on employment. A good compromise would be to lower the minimum wage somewhat and to enforce it more consistently. I'm convinced that raising the minimum wage now will be effective in helping middle class workers maintain their wage levels, at the expense of causing unemployment, hardship and dependency among the poorest and least-skilled workers. The writer is research director at the Business Ethics Center of Jerusalem (, an independent institute in The Jerusalem College of Technology. He is also a rabbi.

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