The wider implications of minimum wage

Illustration: Figtree Design

Minimum wages are a multifaceted issue where well-meaning legislation can bring about converse effects. Who benefits in the long run and how such practices will alter employment policies are some questions to ponder. PEM takes you through many of the aspects that need thinking through.

By Chan Huan Chiang

MTUC’s lobby on minimum wages
On June 30, 2011, the National Wage Consultative Council Act 2011 was passed after four hours of debate. It replaces the Wages Council Act 1947 and will assess wage levels by sectors, types and regions in preparation for a national minimum wage policy by the end of the year. The council will have 23 members with five representatives each from unions, professional bodies and employers. Five seats have also been reserved for public sector representatives. The bill that was tabled proposed that the chairperson, deputy and a minimum of five members must be appointed from among persons who are not public officials, employers or trade union members.[1]

A minimum wage policy is not the same as a minimum wage law and therefore not exactly what had been hoped for. The Malaysian Trade Union Congress (MTUC) has lobbied for a minimum wage since 1996, arguing that purchasing power has fallen, trailing farther and farther behind current wage rates.[2] Its survey found large disparities across companies and from region to region even among those in the same industry. In 2007, in response to a marked upward salary revision for government servants, the MTUC organised a nationwide picket and sent a memorandum to then Prime Minister Abdullah Ahmad Badawi for a minimum RM900 monthly salary plus RM300 cost of living allowance wage law aimed at increasing household income, ensuring the nation’s economic growth and reducing dependence on foreign labour.

The concept of “living wage” was also introduced by the MTUC, listing items that wages must be able to provide: nutrition, housing, children’s education, clothing, healthcare, transport, social security, recreation and social cultural needs. The minimum wage is designated as an international labour standard by the International Labor Organization (ILO) in the form of a “safety net” to secure workers a reasonable
standard of life. More than a hundred countries have some form of minimum wage set either as one nationwide base rate or variable base rates according to sector, occupation type and region, and either regulated by law or through collective bargaining to achieve a better distribution between employer profits and worker incomes.

In Malaysia, the 1947 Wages Council Act does have provisions for gazettes by the Human Resource
Ministry. Minimum wages by tripartite committees, comprising government, employers and employees, have been set for special categories and sectors: hotel workers in 1967, stevedores as well as shop assistants in 1970, cinema workers in 1972 and more recently for private security guards in 2010.[3]

More than 60 years of research on the economics of the minimum wage
There are more than 60 years worth of academic research on the implications to the economy when setting
minimum wages. Foremost is how much more unemployment will occur as fewer workers are hired when wages rise to match decreasing demand for labour against its supply. In 1946, George Stigler critiqued on the 1938 Fair Labor Standards Act aimed at bringing about working conditions sufficient for minimum living standards for health, efficiency and general wellbeing of workers without reducing employment or earnings. Inflation had rendered wage levels insufficient and people were crying out for even higher legal
minimums. He posed two basic questions: will a wage law reduce poverty and are there better alternatives?

His answers were no, and yes, because poverty is caused by many factors that have to be tackled and not just by wage levels alone.[4] For example, in the US, the Earned Income Tax Credit or EITC is a tax credit (i.e. negative tax) given for each dollar earned below a prescribed annual income. Despite this, the Fair Labor Standards Act in the US has been amended dozens of times, each time raising minimum wages in an attempt to catch up with inflation.

Some critical points that Prof Stigler argued in his 1946 paper included the fall in employment, and therefore incomes, may outweigh the total wage increase, leading to reduced overall earnings. Second, some types of businesses may be excluded and those who lose their jobs in the included business will compete for jobs in the excluded business, accepting even lower wages. The minimum wage law in this case actually causes workers to earn less. Third, those who lose their jobs may come from poorer families, even though the minimum wage law is meant to help them. Finally, a legislated minimum wage (in Malaysia, amounting to RM10,000 fine per worker for noncompliance) prevents those willing to work for less to get jobs even when there are employers willing to hire them but will be forbidden from doing so.

Since then, other studies have made more arguments against a minimum wage law. Inflation will go up as businesses pass on the added cost to consumers. It adversely affects some businesses more but these may be the ones that are important to the economy. Minimum wage may lead to lower productivity because even lazy workers enjoy a decent salary for little work. Minimum wages might also increase school dropouts because working becomes attractive relative to schooling. Businesses will have the incentive to automate and become
less dependent on workers, leading to reduced employment. Businesses might also reduce fringe benefits for the staff to off set increased labour costs.

Many of these conjectures, although well argued as Stigler did in 1946, had mostly not been verified with empirical data until 1995 when David Card and Alan B. Krueger published Myth and Measurement: The New Economics of the Minimum Wage. Their survey showed that rising minimum wage led to more employment in certain sectors. The impact of minimum wages on unemployment was minimal or nonexistent.[5] Such a finding struck at the very heart of demand and supply in microeconomic theory but a study by Arindrajit Dube, William Lester and Michael Reich from University of California Berkeley published in 2010 also found that higher minimum wages did not destroy low paying jobs.[6]

A few other studies produced mixed results, making the link between minimum wages and employment inconclusive. One possible explanation may be that minimum wages might have been set close to the equilibrium and thus employment numbers tend to stabilise rather than cause widespread changes by way of people being hired or fi red when wages rose.

Regardless of the theoretical and empirical controversy over findings of minimum wage research, the fact is that workers are generally paid an amount close to their marginal productivities which vary from worker to worker and from job to job. Fixing wage at a particular level means forcing employers to match it with the same level of productivity. Th is is good if the same worker can be trained, becomes productive and then enjoys bett er incomes. However, it is a bad thing if the worker is instead displaced by a more skilful person who is not from the poverty group.

Some economists, however, argue differently. When the economy is buoyant, businesses want to expand but this would increase demand for workers that will push wages upwards. Existing businesses become less profitable and will be reluctant to expand. Setting a legal minimum wage means that businesses have to pay higher wages anyway so business expansion can go ahead without conflict and create more jobs. There will also be potential indirect effects, i.e. minimum wages narrow the income gap, boost consumption and stimulate economic growth.