Wednesday 25 March 2015

The Effects of Minimum Wage on Employment: A brief Analysis




 1.1 Introduction

The concept of the minimum wage remains a resounding mantra for workers, policy makers and even employers and it serves as a useful tool intended to achieve certain labour market outcomes. Saget (2006) defines the minimum wage as the minimum amount that must be paid to a significant component of workers inorder to meet the needs of  not only the workers but also their families, while considering the social and economic context of the country.

1.1 Theoretical Background

According to the neo-classical theory, the imposition of a minimum wage on a competitive labor market creates unemployment;  either because some workers are displaced from their jobs or because new workers enter the labor market hoping to find one of the high-paying ,but scarce, jobs (Borjas, 2013). Borjas (2013) further theorized that if the minimum wage is applied to a covered sector (for example the formal sector), displaced workers might move to the uncovered sector (informal sector); thus shifting labour supply and reducing the uncovered sector’s wage. The theory further propounds that firms usually respond to the  fixing of the minimum wage by reducing employment. since the minimim wage is usually set above the market equilibrium wage. 
Despite the aforementioned theoretical framework, Saget ( 2014) stated that empirical evidence from nine (9) countries established that,in 68 percent of the cases, the minumum wage had no effect on employment. This is because employers can adjust to these increases in labour cost imposed in the firm by the imposition of the minimum wage. This result is buttressed by Borjas (2013) who indicated that the cost of adusting labour downwards is usually higher than the cost of hiring.
The question then is how do employers adjust to the increase in cost as a consequence of the fixing of minimum wage?  Eyraud & Saget (2005) observed that an increase in the minimum wage could affect employment instantenously; but usually there is a tendency for the effect to be delayed, especially with small firms. Eyraud & Saget (2005) further stated that small firms are typically   hesitant to layoff workers in response to a rise in production costs (due to increase in minimum wage) since their productive capacity would suffer as a result. Addtionally, an increase in labour cost could result in employers defering the  creation of  new jobs or refraining from filling  posts left vacant by workers going into retirement. The overal effect of the minimum wage on employment is not instantaneous but delayed due to cost considerations by the firm (Borjas, 2013; Eyraud & Saget, 2005).
Another way. ,according to Eyraud & Saget (2005), is that employers tend to manipulate the hours worked by either adjusting it updwards or downwards; or alternatively by  changing shift or working days of employees as a substitute for retrenchment of workers . The first scenario was observed in a case study in Brazil where employers demanded longer working hours so as to make up  for the increase in the minimum wage (Eyraud & Saget, 2005; Lemos, 2003).

3.1 Traditional Time Series Estimation Method

Over time there has been basically two methods of estimation of the minimum wage, using labour supply and demand concept (Eyraud & Saget, 2005). The underlying hypothesis for the traditional model is that the employment rate is a function of the economic activity that determines the demand for labour, labour supply and the minimum wage. Saget (2014) observed that for a long period it was believed that a 10 percent rise in the minimum wage would lower teenage employment by one percent before new estimations were introduced. Eyraud & Saget (2005) and Brown, Gilroy, & Kohen (1982) realized that , in the United States, a 10 per cent increase in the minimum wage led to a reduction in adolescent employment by 1 to 3 per cent on average over the period 1954-80. However in a study by Rama (1996) in Indonesia, a 10 per cent increase in the minimum wage was estimated to rather reduce urban wage employment by less than a quarter of a percent.
These traditional time series measures as found out by Saget (2014) and Eyraud & Saget (2005) were frought with some weaknessness ranging from limitied exogenous factors in the estimation model; the complication due to stationarity, endogeneity, seasonal variations and insufficient dispersion in the minimum wage over time; as well as the lack of sensitivity of the fluctuations in economic activities and the specification of the econometric model.

3.2 New Time Series Method correcting for Non-stationarity and Seasonality

Of recent, a newer technique meant to reduce the negative impact on the minimum wage -employment model caused by seasonality and non-stationarity has been introduced. Though the new methods analyzed the same kinds of data and used the same estimation techniques as the old method, they are more precise in statistical terms. Bernstein & Schmitt  (1998) proved the effectiveness of this method by using the same data and models used in the earlier studies. They found out that effects on the employment rate that was previously attributed to explanatory variables such as the minimum wage were largely accounted for by seasonal variations and non-stationarity. The key finding of Bernstein & Schmitt (1998) was that a 10 per cent increase in the minimum wage is associated with no more than a 0.5 per cent fall in the employment rate of adolescents, a figure which is statistically insignificant.
Like the traditional method, Saget (2014) observed that the new approach did not reduce the problems of endogeneity, lagged effects of the minimum wage, heterogeneity within low wage workers, as well as the problem of indivudal panel data linked to selecting the appropriate control group to compare minimum wage workers with.
It is also relevant to analyse the effects of fixing minimum wage on employment. Saget (2014) concluded that the overall employment effects tends to be small or nil if the minimum wage is fixed to protect workers at the lower end of the wage distribution or if the minimum wage increases in line with consumer prices and considering growth, labour productivity, and wages. Nevertheless, marginal group of workers or those with low productivity could be negatively affected by the fixing of the minimum wage.

Saget (2008) observed that developing countries sometimes set their minimum wages either  too high or too low to serve as a meaningful constraint on employers. When the minimum wage is set too low, it is unlikely to be binding. This many result in the overall numbers of workers at or below the minimum wage to be few. Saget (2014) however suggested that low minimum wages should not be used as a tool to protect business already nearing mortality. It is was also suggested by Saget (2008) that countries should delink the minimum wage from social benefits,On the contrary, a high minimum wage is likely to be “binding”, but it could lead to high levels of non-compliance among employers; which could result in many workers receiving below the threshold (Saget 2008; Saget, 2006).



References

Bernstein, J., & Schmitt, J. (1998). Making work pay: The impact of the 1996-97 minimum wage increase. In F. Eyraud, & C. Saget, Fundamentals of Minimum Wage Fixing (p. 76). Geneva: International Labour Organization.
Borjas, G. J. (2013). Labor Economics. New York, New York, United States of America: McGraw-Hill.
Brown, C., Gilroy, C., & Kohen, A. (1982). Times-series evidence of the effect of the minimum wage on youth employment and unemployment. Journal if Human Resources, 18(1), 3-31.
Eyraud, F., & Saget, C. (2005). The fundamentals of of Minimum Wage Fixing. International Labour Organization. Geneva: International Labour Organization.
ILO. (1970). Minimum Wage Fixing Convention, 1970 (No. 131). Convention concerning Minimum Wage Fixing, with Special Reference to Developing Countries (p. 1). Geneva: International Labour Organization. Retrieved March 6, 2015, from http://www.ilo.org/dyn/normlex/en/
Lemos, S. (2003). A menu of minimum wage variablesfor evaluating emplqyment effects:. 3, 2. London: University College London.
Rama, M. (1996). The consequences of doubling the minimum wage: The case of Indonesia. In F. Eyraud, & C. Saget, Fundamentals of Minimum Wage Fixing (p. 73). Geneva: International Labour Organization.
Saget, C. (2006). Fixing Minimum Wage in Developing Countries: Common Failures and Remedies. Jakarta: International Labour Organization.
Saget, C. (2008). Minimum Wage Levels in Developing Countries: Common failures and remedies. International Labour Review, 147, pp. 25, 34-41.
Saget, C. (2014, March). Presentation on "Minimum Wage effect on Employment and Inequality". Slide 7-18. Turin, Italy: ITC-ILO.


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