Sunday, 28 June 2015

Minimum wage and its cost to workers

I have argued in a previous blog that my hourly subsidy proposals should be much more effective at supporting the least economically fortunate than a generous minimum wage.

There are several reasons to prefer targeted earnings subsidies to the minimum wage as a means to increase the living standards of low earners, such as that high minimum wages will price some people out of the job market, make some products and services untenable, benefit low-wage workers from already wealthy families and that it will damage exports from the area and shift the economy to more service work instead.

I wanted to emphasise another important reason that minimum wages can take from the poor while giving to them. According to economic theory (though backed up by a lot of evidence), minimum wage increases will generally be passed on to consumers.

The important question is who will pay the cost of these price increases. If only the goods and services purchased by the economically fortunate increase in price then it is a highly redistributive policy.

On the other hand, if low earners will have to pay a lot more for the goods they buy then the policy simply takes with one hand while giving with another. This is particularly problematic where the minimum wage is having a lot of other impacts on the economy such as increasing involuntary unemployment for the worst off.

The literature on the subject seems to indicate that the latter is true, and that the minimum wage will increase prices substantially for the low workers. Examples are from the USA MaCurdy, 2015 as summarised in the WSJ; Hungary Harasztosi and Lindner, 2015; and the UK Wadsworth, 2010 (also cited in Aitken Dolton and Wadsworth, 2014).

Are there reasons to be sceptical of this argument that earning subsidies might be more effective than the minimum wage at improving the position of the least well off? Perhaps some will worry that the evidence comes from right-wing or mainstream economists. But is there any evidence to the contrary? I would be interested if anyone has any contrary evidence that they can share. 


Physiocrat said...

Where does tax incidence fit in to this analysis? Once the issue of passing-on of tax is raised, it gets difficult to maintain a grasp of what is really happening.

Wage subsidies are functionally equivalent to an increase in tax/NI thresholds, are they not? What is the difference?

dougbamford said...

Thanks for the comment. As is so often the case, incidence is the issue with the (in this case high) living wage proposals.

The problem is that stuff isn't getting cheaper but wages are going down or stagnating. You might think both issues result from a rising population on a planet with limited resources. Forcing companies to pay higher wages is one response to this, but must be careful about what will happen as a result.

The "incidence" of these policies will fall largely on the same people who we wish to help - the people at the bottom of the earning scale who will find themselves unemployed or at least paying more for stuff while with their newly increased income.

As for the difference between wage subsidies and increasing thresholds I suppose there is an analogy here, but the subsidy is specifically a payment to the individual taxpayer (or in this case tax recipient). Increasing the threshold will just take a group of people out of paying the tax in question.

I guess one response is that if the government is giving out money to workers it isn't going to be able to spend it on other things. My positions is that low-paid workers are the best people to give it to.

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