Monday, February 21, 2011

When Does A Minimum Wage Start Having Unemployment Effects?

According to Mike Moffat and Stephen Gordon, when it exceeds 40% of the average wage (excerpt):

Reconciling the Minimum Wage Literature

…There are dozens of studies that show increasing the minimum wage has an adverse effect on employment. However, Card and Kreuger (1993) and an excellent paper shared by Erin Weir, Dube, Lester, and Reich (2010) show that there is no reduction in employment when the minimum wage is raised. How can we possibly reconcile this?

There are a few ways. Back in 2006 Stephen Gordon wrote a blog piece When the minimum wage bites which looked at the work of Pierre Fortin (and others) and concluded:

“So what have we learned from all this?

  1. When minimum wages are 'low' - say, less than 40% of the average hourly wage - then moderate increases won't have a significant short-run effect on employment.
  2. When minimum wages are around 45% of the average, they significantly reduce employment.”

That is one explanation - that the studies that show no adverse effect had minimum wages below the 40% threshold. I believe there may be another explanation. In Three Changes Making It Difficult To Find a Low Skill Job I discuss the three substitutes for minimum wage labour:

  1. Find a technological solution. Rather than hiring another worker, is there a piece of equipment or machinery that will do the job, or make existing workers more productive so another person is not needed? The automated checkouts in grocery stores might be a good example, though I've often wondered how much labour they truly save.
  2. Outsource/offshore/subcontract. Instead of doing the work in-house, can we pay someone else to do it? Off-shoring has become easier than ever for even the smallest of businesses thanks to services such as eLance and Mechanical Turk.
  3. Do without. Instead of having 8 cash-registers open, can we get away with having only 7?

As you may know from my previous blog posts on the minimum wage, my own digging into this issue has led me to a similar conclusion as Stephen’s: that a minimum wage has little to no adverse effect if it is close to the wage that the labour market is freely offering. But here, he offers an easier threshold to look at – 40% of the average wage.

I honestly don’t know what the average wage rate in Malaysia is, though we’re pretty clear on the median wage which is around RM1,500 pcm. If that can be taken to be the crucial benchmark, then any minimum wage set above RM600 is going to cause job losses, or cause employers to seek the other alternatives that Mike talks about – invest in capital (if possible), outsourcing, and/or simply not hiring any new workers. The final alternative of course is that some businesses will simply shut up shop.

Which course will be followed will depend on the particulars of each industry and employer – technically, it would depend on the elasticity of substitution between capital and labour, and the wage price elasticity of labour itself. None of this is of course necessarily undesirable from a macro-perspective, as getting Malaysian businesses to be more capital-intensive/skill-intensive is part of the NEM/ETP goals.

But at this stage, we have to recognise that there will be a social cost involved in setting a minimum wage, and it seems likely that there will be losers in this process. That makes the provision of a social safety net and greater investment in reskilling/retraining programs a critical adjunct to any minimum wage proposal – it is better to be proactive than reactive here. Whether we will need to suffer a permanently higher long term unemployment rate is still to me unknown – job losses might concentrated among immigrant workers (i.e. the labour force might shrink in response) – but that too is something to worry about.


  1. Hisham,
    what is wage-led growth policy and profit-led growth policy?

    1. @anon

      I've never seen those terms used, but at a guess, it would be demand-side (wages) and supply side (profits) growth policies. The former looks at active demand management through the use of government spending; the latter involves increasing spending and the returns to investment by cutting corporate and personal income taxes.