Sunday, January 17, 2010

Ruminations On The Minimum Wage

And so it begins. From The Star:

"The Government wants to study the minimum wage mechanism so that workers are better paid in line with efforts to transit to a high-income economy...Human Resources Minister Datuk Dr S. Subramaniam said his ministry was looking at various ways practised worldwide to determine one that suits the country best...This is also aimed at reducing the dependence on foreign workers as attractive wages will lure locals to take up jobs they previously shy away from."

...and a sensible rebuttal:

"A minimum wage will not contribute to the development of a high-income economy, says an academic from the National University of Singapore...'Instead, a high-income economy is driven by technology and key competitive industries, and maintained through a stable human capital,' said Assoc Prof Shandre M. Thangavelu, who is with the university’s Economics Department...'The more developed human capital is, the higher wages can go, in line with increased productivity,' he added."

There is an extensive literature on the impact of a minimum wage, but the aggregate impact is in theory is pretty unambiguous. Since a minimum wage effectively puts a floor on wages above the market clearing wage, then assuming "normal" demand and supply curves for labour, labour demand should fall while labour supply should increase - in short, unemployment. A more nuanced view is that since a minimum wage is effectively only operative in the low-cost labour market, then unemployment should only rise in the low-wage labour sector, as this paper finds for the US and France (abstract):

"We use longitudinal individual wage and employment data for young people in France and the United States to investigate the effect of intertemporal changes in an individual's status vis-...-vis [sic] the real minimum wage on employment transition rates. We find that movements in both French and American real minimum wages are associated with relatively important employment effects in general, and very strong effects on workers employed at the minimum wage. In the French case, albeit imprecisely estimated, a 1% increase in the real minimum wage decreases the employment probability of a young man currently employed at the minimum wage by 2.5%. In the United States, a decrease in the real minimum of 1% increases the probability that a young man employed at the minimum wage came from nonemployment by 2.2%. These effects get worse with age in the United States, and are mitigated by eligibility for special employment promotion contracts in France."

Malaysia is an interesting case, as the low wage sector is dominated by foreign nationals. Implementing a minimum wage should indeed lower demand for foreign labour, but it doesn't follow that these jobs would then go to locals. Some portion of these jobs will just disappear, from businesses already on the margin. Nor will it necessarily improve the situation with respect to illegals, as the higher wage floor means Malaysia becomes even more attractive as an employer. Taken together, the impact on average incomes is therefore a balance between the increase in incomes against the loss of employment, and are likely to cancel each other out. That means a minimum wage should not be used as part of a Malaysian strategy to become a high-income country.

A further effect is that a minimum wage is also effectively a tax on businesses, as this paper shows (abstract):

"Although there is a large literature on the economic effects of minimum wages on labour market outcomes (especially employment), there is much less evidence on their impact on firm performance. In this paper we consider a very under-studied area - the impact of minimum wages on firm profitability. The analysis exploits the changes induced by the introduction of a national minimum wage to the UK labour market in 1999, using pre-policy information on the distribution of wages to construct treatment and comparison groups and implement a difference in differences approach. We report evidence showing that firm profitability was significantly reduced (and wages significantly raised) by the minimum wage introduction. This emerges from separate analyses of two distinct types of firm level panel data (one on firms in a very low wage sector, UK residential care homes, and a second on firms across all sectors). We find that net entry rates have fallen, but that the changes in exit and entry rates are statistically insignificant."

I'll go one further - a minimum wage is also effectively a tax on the higher income brackets. As a minimum wage is  a rise in input costs, there's an incentive for businesses to pass on these costs to consumers. Insofar as we're talking about low-wage export industries, that's not necessarily a problem for consumers although there would be a negative effect on Malaysia's export competitiveness. However, this will also have an effect on local businesses - the price you pay for teh tarik is going to go up as well.

One of the characteristics of high-income economies is also their high-cost structure (I've covered this before in a few posts, this one for instance). So implementing a minimum wage is like creating a high income economy - but without the high income. The only substantive argument in favour of a minimum wage is for income redistribution, as this paper suggests (abstract):

"This paper provides a theoretical analysis of optimal minimum wage policy in a perfectly competitive labor market. We show that a binding minimum wage -- while leading to unemployment -- is nevertheless desirable if the government values redistribution toward low wage workers and if unemployment induced by the minimum wage hits the lowest surplus workers first. This result remains true in the presence of optimal nonlinear taxes and transfers. In that context, a minimum wage effectively rations the low skilled labor that is subsidized by the optimal tax/transfer system, and improves upon the second-best tax/transfer optimum. When labor supply responses are along the extensive margin, a minimum wage and low skill work subsidies are complementary policies; therefore, the co-existence of a minimum wage with a positive tax rate for low skill work is always (second-best) Pareto inefficient. We derive formulas for the optimal minimum wage (with and without optimal taxes) as a function of labor supply and demand elasticities and the redistributive tastes of the government. We also present some illustrative numerical simulations."

On that basis a minimum wage, especially one high enough over the market-clearing level to actually have an effective impact on real low wage incomes, is one way to mitigate the effects of a high cost structure on the lower income group in a high-income economy. A minimum wage should be used as an adjunct to a high income strategy, not as an enabling mechanism. 

It's not necessarily a bad idea, but let's call it as it is. Like the talk about appreciating the Ringgit to raise domestic income levels, we might be putting the cart before the horse again.

1 comment:

  1. hishamh

    "So implementing a minimum wage is like creating a high income economy - but without the high income"

    well said..

    more like a mahal someone who comes back one in a while to KL..I already feel that its becoming a pretty mahal economy with a lot of value destroyer in the system...when in actuality very little value is created in the economy itself.....macam economy cukup2 makan aje