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Whether it is because globalisation is gaining momentum, or because a finance crisis looms, or because companies make good profits or the EU is being enlarged, unions and a certain shade of politician always find bullet-proof reasons to plea for the establishment of minimum wages, ideally across the entire economy. In principle, minimum wages sound okay. People should be able to live in dignity with the wages they earn from their labour, shouldn’t they? Job beginners should not be exploited by paying them paltry hourly rates and so on. How could anyone be against that? Well, it so happens that, in order for anyone to earn a wage, minimum or not, you first need a job. And, in the real world, minimum wages are not exactly job creating machines. Quite the contrary, they are pretty efficient job destroyers, particularly at the level of those who most need it, the low-earners. A timely new study by CESifo researchers Andreas Knabe and Ronnie Schöb shows with solid data why this is so, and what would happen if Germany should yield to the call for establishing minimum wages. Using data from the German Socio-Economic Panel, they examined how a minimum wage affects employment, wage inequality, public expenditures, and aggregate income in the low-wage sector. As the authors point out, every citizen in Germany is entitled to basic income support when in need and, after having exhausted all other available options, the German social system today still prevents those in employment from drifting off into poverty. A minimum wage, they stress, is thus not needed to fight poverty. If, nonetheless, one wants to raise the income and employment chances of the working poor, a minimum wage appears to be an ill-designed policy. A minimum wage of EUR 7.50 per hour will only have a small positive effect on the aggregate income of the affected households, but would cause 840,000 job losses. Not only that: the authors’ calculations show also that the income losses of those people who lose their jobs exceed the income gains of those remaining in employment and, since higher wages for some workers come at the cost of job and income losses for others, inequality among the low-paid increases. Messrs. Knabe and Schöb put it in no uncertain terms: “The minimum wage makes the groups most in need worse off”. What about statutory minimum wages as a way to reduce public expenditures? While a minimum wage would decrease the supplementary unemployment payments for the employed workers, it would force the government to spend more funds on additional unemployment benefits, due to the increased number of job losses. These additional expenditures outweigh, to the tune of about EUR 4 billion per year, the savings in transfers to those still employed. A tempting way out of the conundrum would be to introduce a minimum wage as a redistributive tool but to supplement the measure with a wage subsidy aimed at neutralising the adverse employment effects, akin to what the French have done. But in the German case the sums do not add up: At a statutory minimum wage of EUR 7.50, public spending would shoot up by EUR 15.6 billion per year while generating only EUR 5.1 billion in additional income per year for the affected households. This approach turns out to create windfall gains for employers and employees who are not in need and earn an hourly wage above the minimum wage. This, again, translates into an increase in the inequality index. So, what to do? How to create jobs and, at the same time, make sure that those in employment take home acceptable salaries? The authors posit a sensible proposal: a wage subsidy scheme that reduces the social security contribution for low-income groups. This reduction could be applied either at the employee or the employer side. Due to the different amount of time both variants would take to increase firms' demand for labor, the employee side being the slowest, the best option appears to be to apply this subsidy to the employer side. In the long run, their calculations show that if the subsidy ultimately falls on the employer, a wage subsidy that is as costly as a statutory minimum wage of EUR 7.50 would allow for the creation of around 800,000 new jobs and raise the income of the affected households by almost EUR 4 billion per year. If the subsidy eventually falls on the employee, there are no positive employment effects, while income effects are similar in magnitude to the other case. But, as the authors warn, the additional income in this case would accrue only to incumbent workers. Whatever the case, the author’s data show clearly that a minimum wage is an inferior policy to wage subsidies. By spending the same amount of money directly on wage subsidies that it would have to spend indirectly to finance the cost of minimum wages through higher expenditures on unemployment and welfare benefits, the government would achieve more favourable employment and income effects with wage subsidies than with minimum wages. But, how to sell this to the dyed-in-the-wool advocates of minimum wages? Well, make them understand that the important thing is not what wage minimum employers are forced to fork out, but how much each worker takes home at the end of the month—and whether he or she has a wage to take home at all. The Ifo Institute has long advocated this path in what it has labelled “Activating Social Assistance”. Click on the links below to learn more.
Andreas Knabe and Ronnie Schöb: Minimum Wage Incidence: The Case for Germany, CESifo Working Paper No. 2432 |
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Note: This text is the responsibility of the writer (Julio C. Saavedra) and does not necessarily reflect the opinion of either the CESifo Working Paper author(s) cited or of the CESifo Group Munich. Copyright © CESifo GmbH 2004-2008. All rights reserved. |
