Weighing Trade-Offs of Higher Labor Costs

Daniel Hamermesh is a Professor of Economics at University of Texas at Austin, and Royal Holloway, University of London.

A major topic of debate right now in many industrial countries — like France, Germany, Switzerland, the United Kingdom, and the United States — is whether to raise or even just introduce minimum wages. Advocates cite the need for better working conditions, while critics worry that higher labor costs will raise unemployment and possibly deter growth as businesses retrench. Who's right? Or are both sides right? To learn more, the JKP spoke with Daniel Hamermesh — a Professor of Economics at University of Texas at Austin, and Royal Holloway, University of London — who recently examined how labor costs affect companies' demand for labor.

He says that studies show, as economists would expect, that higher labor costs (like minimum wages, overtime pay, and health benefits) reduce employment and/or the hours worked by individual employees — meaning that this loss must be traded off against the benefits that higher earnings might provide to specific groups of workers. Thus, the key question becomes by how much employment falls when labor costs increase. The best estimate going, Hamermesh says, is that a 10% increase in labor costs generally will lead to a 3% decrease in the number of employees (or to a 3% reduction in the hours they work, or to some combination of both) — hence the oft-cited "3 for 10" rule. As for the United States, he says, any losses from higher minimum wages shouldn't be very big because minimum wages are so low compared to most other industrial countries (see table).

For more on the topic, see Hamermesh's policy note "Do labor costs affect companies' demand for labor?" for IZA's World of Labor.

This post was first published on the Jobs Knowledge Platform.