Raising low wages is not good welfare

Des Moore disputes the idea that a minimum wage protects the less well-off

AFR 9 May 02

The Australian Industrial Relations Commission will this morning hand down a decision in its Safety Net Review. The ACTU has claimed for a 6 per cent increase in the base minimum wage rate to $11.54 an hour and the counter-claim by the Federal Government and some business organizations was for a 2.4 per cent increase. The betting is that the Commission will come down somewhere in between.

But this time wasting process should be abandoned in the interests of the unemployed, particularly the low-skilled. It only continues because of the misguided perceptions that a "moderate" minimum wage is the basic protector of living standards of low wage earners and achieves this without adverse effects on employment.

In reality, the minimum wage is a highly ineffective protector because wages provide only a mere 8 per cent of average incomes of households in the lowest income group. While it is not the most desirable social situation for social security to provide 70 per cent, it shows that the main protector at the bottom end is social security, not the wage system.

With more than half of low wage earners in the top half of household incomes, raising the minimum is also a highly inefficient welfare measure. Indeed, it runs counter to welfare objectives because it increases the inequality of incomes.

Both welfare and economic objectives are also undermined if the minimum wage keeps people out of employment. This is a very high probability, particularly in Australia where the minimum is a relatively high 58 per cent of the median wage compared with around 40 per cent in lower unemployment countries such as the US and UK. Indeed, our minimum wage greatly increases the difficulty of obtaining jobs for the 60 per cent of

our unemployed in the unskilled and inexperienced category (not to mention the many unskilled not officially unemployed but who also want work).

True, US economists Card and Krueger (C&K) have claimed that a "moderate" minimum wage will have zero or even positive effects on employment. However, as revealed in the two surveys in the Commonwealth’s submission on the minimum wage claims, 11 out of 14 minimum wage studies on US employment outcomes and 17 out of 25 using other data find significant negative employment effects. Even the multi-influenced OECD has acknowledged that the C&K claim is "highly controversial and may reflect the fact that the federal minimum wage in the United States is relatively low".

Most importantly, although not mentioned in the Commonwealth submission, detailed analyses by Professor Richard Burkhauser of Cornell University (with colleagues) suggest there are serious flaws in the C&K research. They identify major problems with data reliability, with analytical limitations from the coverage of only a single industry or short time periods, and even with basic defects in econometric models. Burkhauser is one of many well-qualified US labour economists continuing to support the conventional view that minimum wages reduce employment and he has made submissions to that effect to the US Congress and the UK Low Pay Commission.

[NOTE: This para was deleted from the published article. Doubts about C&K’s claim are reinforced once the main theoretical basis is understood, viz that the imposition of a minimum wage leads to higher employment if firms have previously been exercising a monopsonistic power allowing wages to be paid at rates below what they could afford profitably. While this is valid as a theory, it is very unlikely to have wide application in

practice. C& K’s own acknowledgement that "if the minimum wage is raised too much we will see job losses" adds to the likelihood of adverse employment effects in our high minimum wage environment.]

Employment is best encouraged by allowing wages to be market-determined and living standards of low-wage earners are best protected through the social security system. Political opposition to abolition of the minimum wage might be overcome by offering

social security assistance additional to the (single person’s) unemployment benefit of $9,000 a year, a marked contrast with the much higher minimum wage of around $21,000. If linked directly to work, such additional assistance would encourage employment as well as protecting those in low-income households who earned less than the current minimum in a deregulated wage system.

Such an approach may be the only way of obtaining the political agreement to the deregulation of the labour market that is an essential pre-condition to securing substantial increases in employment of the many unskilled deprived of the opportunity to

contribute to their own and the nation’s advancement. But what an opportunity for moving the reform agenda forward — an offer of higher employment, lower unemployment and protection of low wage earners!

Des Moore is Director, Institute for Private Enterprise. Further analysis is contained in the paper on "Minimum Wages: Employment and Welfare Effects, or Why Card and Krueger were Wrong" presented to the recent HR Nicholls conference and available on the web site of both the IPE and that society.