What can labor ministers in the developing world learn from the heated debate on minimum wages that Seattle’s dramatic reforms reignited? The answer may be confusion. After more than 6,000 scientific articles, the discussion on the costs and benefits of raising minimum wages is still one of those unresolved million-dollar questions: Many economists claim that it is a very effective way to guarantee decent jobs for workers and to reduce inequality, but other economists and policymakers seem convinced that it would do just the opposite. The recent experiment in Seattle, unfortunately, adds little clarity.
In 2014, Seattle became one of the first large cities in the US to increase the minimum wage to $15, up from $9.47. This increase is currently being phased-in over time. No rise that dramatic had been pushed through in the US before. So, economists salivate at the chance to understand the impacts of this hike in wages on jobs and earnings. Some results are in: a recent study found much larger negative impacts than previous analyses of the effects of minimum wages: the salary bump to $13 in 2016 hurt low-paid workers the most. It reduced hours worked in low-wage jobs by around 9 percent, while hourly wages in these same jobs increased by 3 percent.
To estimate these impacts, the authors used a rich and confidential dataset with detailed information on earnings and hours of work. They also compared the labor market outcomes of Seattle against those of neighboring areas, using these outside areas as a control group. The methodology of this study, however, was questioned by some experts. Skeptics argue that, since the study compares Seattle against cities that did not experience such booming labor market, it fails to isolate the impact of the minimum wage adjustment. Because when businesses struggle to find workers during a boom, they tend to offer higher salaries and low-skilled workers may be replaced by high-skilled ones. Other critics point out that the study did not consider that many low-wage workers could have switched to self-employment, and not to unemployment.
Countries and cities around the world have experienced dramatic changes in the minimum wage for decades. And most of the studies that attempted to measure the effects of the minimum wage on employment found small or insignificant impacts. There are also no firm conclusions that higher minimum wages create incentives for businesses to hire workers informally (that is, to pay them “under the table” and avoid social security contributions).
Beyond this empirical evidence, economic theory provides guidelines on how to set up the level of the minimum wage. To put it in simple terms, setting the minimum wage to a level higher than the productivity of a worker would make it prohibitive for firms to stay in business. Shutting the doors to business is counterproductive in the fight against inequality and improved earnings.
In developing countries with low enforcement capacity, setting the minimum wage above the productivity of workers may not force businesses out of business, but could create incentives for firms to evade minimum wage legislation and hire workers informally. Going from formal to informal employment would hurt workers as they lose access to unemployment and health insurance. Their employment becomes more tenuous and prospects more difficult.
While there is no fixed formula to establish the level of the minimum wage, the recent World Bank report “Balancing Regulations to Promote Jobs” offers some guidelines. Minimum wages around the world are most frequently set at around 40 percent of mean salaries, with large differences across countries (see figure below). But the appropriate level depends on a host of country-specific factors, such as labor market conditions and variations in worker productivity across occupations.
Sleepless in Seattle
The controversy behind the impacts of higher minimum wages will leave economists and policymakers tossing and turning for years to come. According to Seattle’s phase-in plan, the $15 minimum wage will be binding for all large employers by early 2018. While we do not know when the assessment of the full-rollout of this policy will be released, the anticipation generated by the recently released study will sure make it a blockbuster.
Regardless of the results of such assessment, maybe another million-dollar question should be posed: Is raising the minimum wage the best policy to create decent jobs and reduce inequality? There may be other ways to do this.
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