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The Unintended Consequences of Increases in the Minimum Wage

Ximena Del Carpio's picture

Most countries around the world have some form of minimum wages. Policymakers have often argued that raising the minimum wage increases the income of low-income workers, and therefore can be used as a tool to reduce poverty and inequality. Some policymakers also argue that wage increases can improve workers’ productivity (Levine, 1992; Raff and Summers, 1987) because they lead to increases in work effort, reductions in job turnover and more on-the-job training (Katz, 1987). However, several studies find that increases in minimum wages without commensurate increases in labor productivity could lead to job losses in the formal sector. The main reason provided for this argument is that poor workers—the people expected to benefit from the policy—are more likely to be pushed out of formal employment because they often have limited skills and low productivity, and thus tend to be among the first to be laid off when minimum wages increase.

In a joint paper with Ha Nguyen and Choon Wang, we use Indonesian firm census data (the Industry Survey, which covers firms with more than 20 workers) to examine directly the employment impact of minimum wage changes for manufacturing firms in Indonesia. Previous evaluations in Indonesia looked at the impact on production workers (e.g. Alatas and Cameron, 2008); however, the employment effects on non-production workers have been largely ignored in previous research. Our paper takes a step further by also focusing on non-production workers in the sector, and on workers with different education levels and gender.

There is a perception that non-production workers are unaffected because they are typically high-skilled workers such as managers and researchers, who are less susceptible to changes in minimum wages. However, the analysis shows that in Indonesia (and probably in most developing countries), a large proportion of non-production workers are low-skilled workers performing menial tasks in factories such as cleaners, drivers, guards, and supporting tasks for production workers. Indeed, we find that the negative impact of minimum wages on non-production worker employment is more pronounced than that on production worker employment, especially in small firms. Although non-production workers account for a smaller fraction of the manufacturing labor force, they do account for a much larger fraction in the services sector (and hence in the entire economy), thus making the findings from this paper very relevant to the economy as a whole.

We also look at employment changes by workers’ level of education and gender to identify the groups that are most severely affected, and to see if firms substitute low-skilled, less-educated workers with skilled, more-educated workers. This issue is of utmost importance, especially when policymakers make increases in wage levels with the objective of reducing poverty through wages. We find that workers with low levels of education in small firms are the hardest hit, especially if they are female. Workers with a high school education or above do not seem adversely affected.

In the paper we offer potential reasons why minimum wage hikes affect non-production workers and women more than men. In the case of non-production workers, low skilled non-production workers perform support tasks in the manufacturing process, making their role less critical to the bottom line of the factory and more at risk when minimum wages are raised. One potential reason why low-skilled women workers in the sector are more vulnerable to wage hikes than men is that employers take into account costs associated with benefits they are legally obligated to provide them (e.g. maternity and family leave, maternity insurance coverage) and the costs they incur replacing them during their longer work absences (Ruhm, 1998).

A key lesson from the paper is that having an adequately skilled workforce can prevent job losses. More highly skilled workers (with a high school education and above) are not affected by wage hikes. The underlying problem is that in the case of low-skilled (or unskilled) workers, higher minimum wage levels likely exceed their level of productivity. Thus, increases in the minimum wage mean that small companies, which are those that employ these workers most often and have low capital intensity, have to lay off non-essential workers (or even recruit informal ones) to avoid going out of business. Lastly, our analysis also shows that there does not seem to be a substitution of less educated workers by better educated ones; instead, low skilled workers are simply laid off by their employers.

References:

Alatas, V. and Cameron, L. (2008), ―The Impact of Minimum wages on Employment in a Low Income Country: A Quasi-Natural Experiment in Indonesia, Industrial and Labor Relations Review, Vol. 61, No. 2, pp. 201-223.

Hausmann, R., L. D. Tyson, S. Zahidi, (2010). "The Global Gender Gap Report 2010". World Economic Forum, Geneva, Switzerland.

Katz, L. (1987). ―Efficiency wage theories: a partial evaluation. In NBER Macroeconomics Annual (ed. S. Fischer). Cambridge, MA: MIT Press.

Levine, D. (1992). ―Can Wage Increases Pay for Themselves? Tests with a Productive Function. Economic Journal, 102 (414). Pp:1102-1115.

Raff, D., and L. Summers. (1987). ―Did Henry Ford Pay Efficiency Wages?‖ Journal of Labor Economics, 5 (4). S57-S86.

Ruhm, Christopher. (1998). ―The Economic Consequences of Parental Leave Mandates: Lessons from Europe. Quarterly Journal of Economics 113 (1): 285-317.