Does minimum wage rise lead to job losses?

The minimum wage is set to go up to $20 an hour from April. As usual, this has created divisions between progressives, in favour, and conservatives, who fear large-scale job losses. But evidence suggests minimum wage increases do not lead to large-scale job losses as is presumed by the right says Professor Ananish Chaudhuri.

Minimum wage increases are often designed to keep pace with inflation. As long as minimum wages are adjusted to keep up with the cost of living, it seems only fair to do so. This is particularly so given the consumer price index, the general measure of the cost of living, does not include things such as house prices and most likely underestimates how much the cost of living has changed. 

The proposed minimum wage is nearly three-quarters of New Zealand's median wage, which puts the current wage ahead of recent increases in the cost of living. But given the minimum wage is adjusted only periodically, unless there are further increases in the minimum wage in the near future, the cost of living increases will soon catch up.

Why don't we then keep increasing the minimum wage? Where does it end? Wages are a crucial part of determining prices. Beyond a point, pushing the minimum wage further will certainly lead to inflation and the aggregate job losses will not be worth any additional gains. There is no indication we are there yet.

Why don't we let the market decide? Here, proponents appeal to what is known as marginal productivity theory where workers are paid what they are worth to the business. The problem is, measuring this is not easy.

Furthermore, as Thomas Piketty points out in his book Capital in the 21st Century, since around 1980s the Anglo-Saxon countries (USA, UK, Canada, Australia and New Zealand) have introduced so-called "super-managers", whose enormous compensation packets are hardly commensurate with any measure of their marginal productivity.

Often such high salaries are excused by appealing to tournament theory - to attract highly talented people, make the prize (executive compensation) very large. However, the evidence shows little correlation between executive compensation and company performance.

Furthermore, European companies that eschewed this star-system do not seem to be suffering any adverse business outcomes.

It seems specious to argue salaries for workers at the bottom should be solely determined by their marginal productivity while those of managers have no connection with market forces.

The playing field is hardly level and it is tenuous to argue that these wages are being set by market forces.

But will raising the minimum wage not lead to job losses? Yes, but this answer is based on what is typically known as a partial equilibrium analysis of markets. Bear in mind this additional wage will be spent within the community. For example, some cafes may lay off wait-staff who may then need to find a job at The Warehouse. Evidence suggests minimum wage increases may lead to job displacement, but not a lot of job losses.

Small businesses that find this wage increase onerous should be able to make adjustments to the hours of work to balance out the increased pay for each of those hours.

The timing and the sensitivity of demand for workers to changes in wages matter too. Raising minimum wages in the midst of an economic downturn may not be the best idea.

During booms, the labour market is "tight" with lots of employers looking for workers. This works in two ways. First, when the minimum wage is raised, even if it leads to a lower demand for workers as a whole, typically the additional gains of those who retain their jobs exceeds the losses of those who lose their jobs. But during booms, the latter find it easier to find alternative employment.

But during downturns, when business are not looking to expand, finding alternative employment is not as easy. Also, in such situations, the market is "loose", with demand for workers highly sensitive to wages.

What often gets lost in debates is the illusory nature of wages and prices. For instance, if a loaf of white bread costs $2 and a baker makes $16 an hour then the hourly wage is worth eight loaves of bread. If the wage is increased to $20 and the price of a loaf goes up $2.50, the wage is still worth eight loaves of bread.

Raising the minimum wage is a way of bettering lives; lowering prices can be equally effective. Much evidence suggests many sectors of the New Zealand economy such as groceries lack competition. Reining in the market power of these businesses may well lead to lower prices and be an equally effective way of making things better off for those on the lower-income rungs.

Ananish Chaudhuri is Professor of Behavioural and Experimental Economics at the University of Auckland Business School and the author of Behavioural Economics and Experiments.

This article reflects the opinion of the author and not necessarily the views of the University of Auckland.

Used with permission from the New Zealand Herald, Ananish Chaudhuri: Does minimum wage rise lead to job losses? 7 January, 2021.

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