8/15/2017 Employment down, productivity up?

Buttonwood’s notebook

Minimum wages
Employment down, productivity up?

Most studies show a higher minimum wage leads to a fall in employment but the

potential gains in productivity are less examined

Buttonwood’s notebook Apr 1st 2016 | by Buttonwood

THE idea of a higher minimum wage (along with a citizen's income

(http://www.economist.com/news/finance-and-economics/21651897-replacing-

welfare-payments-basic-income-all-alluring) ) is getting more momentum, as

governments grapple with the rise in inequality over recent decades. Britain

introduces a "living wage"* of £7.20 an hour today (around $10.30) for those aged

over 25 while Democratic Presidential Candidate Bernie Sanders supports a rise in

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the minimum wage to $15 an hour (https:// berniesanders.com/issues/a-living-

wage/) , phased in over seven years (the federal minimum wage is currently $7.25

but many states have higher requirements). 

Economists have been grappling for decades with whether (and by how much) a

higher minimum wage affects employment. A paper by David Neumark

(http://wol.iza.org/articles/employment-effects-of-minimum-wages) of the

University of California (on the very useful IZA World of Labor's website)

summarizes the literature. Most studies show there is an impact with a 10% rise in

the minimum wage causing around a 2% drop in employment for affected workers

(normally the young and low-skilled).  This is not the same as saying that overall

employment will fall by the same amount. 

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The paper also shows that a higher

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James Damore tackling poverty as many hope. Low-wage

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workers don't all belong to low-income

A dodgy dam in Canada’s east families. Mr Neumark notes that, in 2008

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“ Only 12.7% of workers earning a wage of
THE ECONOMIST EXPLAINS
less than $7.25 an hour were in poor

See all updates households, while 44.6%—or nearly half,

most of whom were probably teenagers

or other secondary workers—were in households with incomes three times the

poverty line (or approximately $63,000 in 2008 for a family of four) or higher.

Thus, if the benefits of the minimum wage were spread equally across all

affected low-wage workers, only 12.7% of the benefits would go to poor

households, and nearly half would go to households in the top half of the

household income distribution.”

adding that

“ Another reason minimum wages may fail to help low-income families is that

many low income families have no workers. Of families whose head was below

age 65 in 2010, 52% of families below the poverty line had no labour income,

while only 6% of families above the poverty line had none.”

Still there are other potential impacts of higher minimum wages; one is higher

productivity (http://www.bloomberg.com/news/articles/2016-03-31/cameron-wage-

boost-set-to-spur-productivity-at-the-cost-of-jobs) . Some British companies that

voluntarily shifted to a higher living wage

(http://www.economist.com/news/ britain/21631137-more-companies-find-paying-

living-wage-makes-sense-honest-living) found that staff absenteeism and turnover

rates reduced, and productivity improved. It is hard to disentangle cause and effect

here; are better-paid staff better motivated or are employers forced to become more

efficient to absorb the cost of higher wages?

This issue is also very topical because of the apparent slowness of productivity

growth, despite the excitement over new technology

(http://www.economist.com/news/special-report/21621237-digital-revolution-has-

yet-fulfil-its-promise-higher-productivity-and-better) . One explanation could be

the sluggishness of wage growth; labour is so cheap that employers have less

incentive to replace it with capital. 

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Over time, one would expect higher productivity to lead to higher wages. Robert

Gordon's monumental economic history "The Rise and Fall of American Growth"

points out that the US experienced a "great leap forward" in productivity growth

between 1928 and 1950, despite the Great Depression. In the second half of this

period, there was a very big increase in real wages per hour. Some of this may be

down to a tendency to substitute capital for labour; some of it may be down to the

spread of earlier innovation such as the electrification of factories. Sheer necessity

forced American business to get more innovative during the Second World War to

churn out the armaments that America needed; those lessons were then carried

over into peacetime production. 

Mr Gordon concludes that

“ World War II saved the US economy from secular stagnation and a

hypothetical scenario of economic growth after 1939 that does not include the

war looks dismal at best”

Since we can hardly hope for a war, might there be other positive impacts? Higher

minimum wages could stimulate the economy and boost wages, for example. Or if

employers focus on high-skilled workers in the short term, that could boost

productivity and the economy in the long term, eventually providing jobs for the

low skilled. 

Alas, another paper on the IZA website (http://wol.iza.org/articles/do-minimum-

wages-stimulate-productivity-and-growth) , from Joseph Sabia of San Diego

University, is not encouraging on this score. He does find evidence that higher

minimum wages redistribute productivity from low-skilled to high-skilled jobs.

But

“ In studies of OECD countries, the literature provides relatively little evidence

that increases in minimum wages raise aggregate GDP. ”

However, Mr Sabia admits that

“ More sophisticated empirical evidence on the effects of minimum wages on

aggregate productivity is relatively new. This literature has faced a number of

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challenges, including: (i) how to measure overall and industry-specific

productivity; (ii) disentangling the effects of minimum wage increases from

other concurrently implemented economic policies or economic trends; and (iii)

accounting for spillover effects of the minimum wage on productivity in

“control” regions.”

It would be nice to think that a higher minimum wage had very positive

macroeconomic effects but the evidence to date isn't encouraging. Of course it is

good news for those workers who receive it, and the legislation may discourage the

"sweatshop" conditions still seen in developing countries. And it is understandable

that politicians are tempted by the idea; it is a policy with no revenue implications

for the government, just for the private sector.  Indeed, in the July 2015 Budget

(http://www.economist.com/news/ britain/21657412-george-osborne-well-way-

balancing-britains-books-now-he-hopes-reshape) , Britain's government used the

good news of a higher minimum wage to offset the bad news of benefit cuts. The

Institute for Fiscal Studies points out (http://www.ifs.org.uk/publications/7980)

that those who lose from the second won't necessarily gain from the first 

Our scenario suggests that only around 13% (£150 per year) of the losses due to

tax and benefit changes (£1,090 per year) of all working age households

currently entitled to benefits and tax credits – including non-working

households – will be offset by the NLW, on average.

When it comes to helping the poor, the issues are much more complex than simple

slogans might suggest. But this is the era of simple slogans.

* This is a renamed version of the minimum wage. Prior to the May 2015 election,

the Labour party was campaigning for a "living wage" and the Conservatives neatly

nicked their slogan

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