"Minimum-wage research (…) is
not just a technical quarrel over
the sign and magnitude of
wage-elasticity coefficients; it is the latest chapter in a
longstanding methodological dispute over whether and in what
domains neoclassical price theory can be said to properly apply"
(Kaufman, 2010; pp. 429).
Introduction
The minimum wage (MW) is one of the most important, and
studied, labor market institutions in labor economics. Its
importance rests on its capability for affecting the labor demand
because introduces additional rigidities in the labor market in
order (1) to get distributive objectives trying to face
concentration trends of the labor demand and/or trying to improve
the poorest employees" situation (Freeman, 1996; Kaufman, 2010;
Gorostiaga et.al, 2007); and (2) solving information problems in
the market given the difficulty to measure the marginal
productivity of the workers.
Nonetheless, most of researches in developed countries,
where the markets are usually more competitive than developing or
undeveloped countries, aim that a MW policy could affect
negatively the employment level. However, such a conclusion is
far of being unanimously accepted in labor economics and many
studies are arising in the contrary. Consequently, the objective
of this paper is analyzing the effects of the MW on the
unemployment rates in light of theoretical frameworks and
available evidence. Given the widely variety of variables
concerned across the several studies, a classification of the
evidence obtained in relation to MWs" impact is done. Then, an
analysis over the particular Chilean case is done.
Economic theory
There are two economic theories predicting the
relationship between MW and employment rate, each operating in
different market structures. The first one aims that if a MW is
introduced into a competitive labor market, the workers get
higher pay but the unemployment rate will rise because a higher
labor supply (Ni et.al, 2011; Baker et.al, 2002; Gorostiaga
et.al, 2007; Montenegro et.al, 2003). In such a market structure
the firms would be obligated to pay over the labor marginal
productivity. The theory also predicts that there would be
effects over wage dispersion which could become lower (Dolton
et.al, 2010). .
The second theory is operating in a monopsony market,
where one firm is able to fix the salary for the workers and they
do not have any chance for getting another better job in a
particular market (Baker et.al, 2002; Gorostiaga et.al, 2007;
Montenegro et.al, 2003). The firms set the wage of equilibrium
where marginal cost is equal to marginal revenue. According to Ni
et.al. (2011), "if a MW is promulgated lower than the equilibrium
result in a perfect competitive market, it will raise average
labor costs, reduce marginal costs, increase wage rates, and
promote the employment level" (pp. 20).
For time series, the most typical econometric model
assumed is (Boeri et.al. 2008):
where E is the ratio employment to population, X is
trend of economic cycle and MW is the minimum wage level.
Usually, MW is obtained from Kaitz index which is related to
youthful salaries and other lower salaries. The index is defined
as:
Where fit is the share of youthful employment
in the market i in the year t, mt is
the MW on year t, wit is the average wage in
the market i in the year t and cit is
the share of workers covered by MW in the market i in
the year t.
Evidence
Nonetheless, even though a negative effect of the MW on
the employment level is expected for competitive markets, there
is some important evidence in contrary (Kaufman, 2010; Ni et.al,
2011; Williams, 2001). In light of the evidence accumulated on
the last forty years, we know that such a relationship depends on
many other factors, for instance, reinforce institutions"
strength, size of the informal labor markets and different
impacts over several levels of qualification. In consequence, it
is useful to analyze the evidence obtained for classifying the
most important variables related to MWs" impact on the
unemployment.
a) Labor market structure: According to Kaufman
(2010) and Ni et.al. (2011), if the employment effect of a MW
increase is negative, the conventional interpretation is that the
evidence supports the competitive model; if it is approximately
zero or even positive, then the evidence is taken to be
consistent with a monopsony model. Such a description trends to
be confirmed by the evidence in the case of monopsonies, but is
not definitive in the case of competitive markets.
For competitive labor markets, a MW is supposed to
decrease the employment level because the rigidity of the
salaries (Ni et.al, 2011; Williams, 2001), which is a
neoclassical point of view (Kaufman, 2010). In this sense, and
linked with labor supply side, the main problem is the high cost
associated to changing the job, which has a negative effect over
the adjustment of the salary market (Dalton, 2010). However, a
considerable amount of research undertook in competitive labor
markets has not found such a relationship. According to Kaufman
(2010), the neoclassical position was strongly challenged in the
1990s by research on the "new economics" of the MW, for instance,
Card and Krueger (1994) who found evidence supporting a positive
effect of the MW over the employment level for fast-food
restaurants in New Yersey and Pensilvannia.
b) Age groups and other worker groups"
segmentation: Likely the most important consensus reached is
related to segment the labor force according to age groups. The
most research agree that there would be a negative impact over
the employment level afterward a MW increase for youngest workers
(Dalton, 2010; Williams, 2001) and unskilled workers (Dalton,
2010, Pedace et.al, 2011; Sabia et.al, 2010). However, these
results should be taken carefully because low wage industries are
more competitive than high wage industries (Kaufman, 2010), it
means, the negative impact again could be more related to market
structure instead workers segment. In contrary, Card and Krueger
(1994, 1995) found a positive relationship for youngest and
unskilled workers in competitive industries. Gavrel et.al (2010)
explains these results for saying that the introduction of the
minimum wage necessarily reduces the employers' selectivity,
which by definition is lower in unskilled workers, and therefore
tends to shorten the average duration of job
vacancies.
In summary, the evidence trends to confirm that youngest
and/or unskilled workers not only would suffer an increase in
their unemployment level but also the unemployment duration would
be longer (Pedace et.al, 2011; Williams, 2001). If we associate
such a segments with poorer population, the results suggest that
raising the "minimum wage continues to be an inadequate way to
help the working poor" (Sabia et.al, 2010; pp. 592).
c) Enforcement and compliance strength: According
to Squire et.al. (2011), for identifying between developed and
developing countries a useful differentiation related to strength
of institutional variables is obtained. The degree of compliance,
enforcement, penalties for non-compliance, and existence of
uncovered sectors (often called informal labor market) are issues
much more likely to be weaker in developing countries, affecting
the real impact of minimum wages (Boeri et.al, 2008). It has been
detected, for instance, that modest penalties for paying wages
below the MW do not permit to trust in results showing positive
or null effect on unemployment (Boeri et.al, 2008; Squire et.al,
2011).
Distance from the average wage: For analyzing the
outcomes obtained by Card and Krueger in 1994, Freeman (1996)
explains them as a result of the lower level of the MWs in the
nineties, which were frozen in US during the eighties because the
high inflation. This assumption provided a new line of discussion
about the MWs in terms of the level, measuring their impact
related to how far (or close) is regarding average wage. If this
gap is significantly high for unskilled workers, a lighthouse
effect could occur giving information to the employers about
real state of salary-floors which is a saving in information
costs. Gavrel et.al (2010) offer an alternative explanation for
saying that a MW will have a negative impact on the employment
level depending on how lower is regarding average wage. In his
viewpoint, two effects happen at the same time when a MW is
introduced: a job creation reduction and an increase in job
search intensity. If there is a lower MW, the second effect
dominates the first one. On the contrary, for high values of the
MW, the reduction in the creation of jobs leads to an employment
cut.
Short, medium and long run: In his research,
Dalton (2010) claims against the excessive attention paid for the
most researches about the MWs" impact in the short run for the
UK, arguing "since in the short run the costs of adjusting inputs
tend to be high, the response of employment to MW increases might
not be immediate" (pp. 525). Gavrel (2010) explains the results
obtained by Card and Krueger (1995) for introducing a distinction
between short and long term, saying that in the short term a
minimum wage increase will raise employment by shortening the
expected duration of vacancies. There is not a significant amount
of research doing the distinction between short, medium and long
term, nonetheless, the available evidence aims that a MW does not
affect the unemployment on the long term (Dalton,
2010).
The minimum wage
performance in Chile
There is not a significant amount of research analyzing
the MW impact on the unemployment in Chile. However, the
available evidence tends to confirm the main trends shown in our
theoretical framework. Montenegro et.al. (2003), for instance,
taking advantage of the unusual variance in labor market policies
in Chile, concluded that minimum wages reduce the employment
rates of youth and the unskilled at the benefit of older and
skilled workers. It is important to note that most of research
done in Chile has run cross-sectional models using data obtained
from the University of Chile"s household surveys, which monitors
the employment-unemployment status in the metropolitan area (40,1
% of population in 2009) four times a year since 1956.
Figure 1
Evolution of real wages per month (in
GB£ of December 2010)
Source: National Institute of
Statistics (INE), Chile
Chile is a developing country where labor market
regulations prescribe high severance payments and minimum wage.
Given this condition, the first antecedent we need to consider in
order to analyze the impact of MW on unemployment is related to
enforcement and compliance levels and size of the informal labor
market. In this sense, both Bravo et.al. (1997) and Montenegro
et.al. (2003) highlights the high enforcement and compliance
levels of Chile in comparison to other developing countries. Even
though the Chilean levels were located under developed countries
during the nineties, there was no reason of thinking about a
distorted MW impact on unemployment (Bravo et.al. 1997).
Unfortunately, there are not cross-countries comparisons of
enforcement and compliance levels for period
2000-2010.
In terms of the ratio of minimum wage to average wage,
in Chile we find an increase over the last ten years, overtaking
40% in 2001 which is considered the limit between a low and high
impact of MW on distributive level and potentially unemployment
(Dickens et.al. 1999).
Figure 2
Ratio of minimum wage to average
wage.
Source: National
Institute of Statistics (INE), Chile
Following the assumptions developed by Dickens et.al.
(1999), it is possible to say that a potential effect of MW on
unemployment will be higher on unskilled workers given the ratio
of MW and average wage according to level of qualification. As we
can see in Figure 3, the less skilled workers group shows a
higher ratio (over 60% in the last years) in comparison with
professionals and semi skilled groups.
Table 1
Ratio of minimum wage to average wage for
level of qualification
This trend supports the results obtained by Montenegro
et.al. (2003) and the general assumptions analyzed by classifying
the evidence for several segments, though regression models are
needed in order to confirm the trend.
Figure 3
Ratio of minimum wage to average wage for
level of qualification.
Source: National
Institute of Statistics (INE), Chile
Conclusion
There is not conclusive evidence about the real impact
of MW on unemployment. However, for identifying and classifying
the evidence obtained related to the most important variables
affecting this relationship a clearer sight is obtained. In this
sense, there is considerable evidence supporting the higher
probability for the employment level in youngest and unskilled
workers as being negatively affected by MWs. This evidence
permits to forecast a higher impact for this group in the Chilean
case, given the ratios of MW to average wage. In the same path,
there would be some evidence in order to confirm the importance
of the ratio of MW to average wage as a determinant of MW impact.
By the other hand, in light of the international evidence and the
Chilean case, the competitive model theory (it would have a
negative impact on employment) tends to be ambiguous, though
stronger in the cases where the enforcement and compliance levels
are enough in order to avoid larger uncovered social groups, for
instance, a lower informal labor market. Finally, this work
conclude the necessity for undertaking more empirical research
about the MW impact on unemployment level in the Chilean case
through more sophisticated regression models.
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Autor:
Rodrigo Valdivia Lefort
PAPER DUE FOR COURSE OF WRITING ECONOMIC
REPORTS
MASTER OF SCIENCES IN BUSINESS
ECONOMICS
KINGSTON UNIVERSITY OF LONDON
MARCH 2011