Raising Minimum Wages Would Deprive the Youth of Employment Opportunities

Faculty Fellow, RIETI

Following the 2007 amendment to the Minimum Wage Act, regional minimum wage rates have been consistently on the rise across Japan. The average minimum hourly wage rate increased from 668 yen in 2005 to 737 yen in 2011, rising approximately 10% over the years. The government's intention is to address the problem of the working poor by raising minimum wages. However, concerns are being raised over the potential negative impact of higher minimum wages on the employment of low-skilled workers, particularly, teenage workers who are presumably inexperienced and unskilled. In an attempt to verify the relevance of these concerns, Yuko Mori, researcher at the Japan Society for the Promotion of Science, and I examined the impact of higher minimum wages on the employment rate of men and women aged 16-19 using data from 2007-2010. We reported our findings at the recent RIETI Workshop on Minimum Wage Reform.

Higher minimum wages mean lower employment rates for teenagers

Our analysis found that a 10% hike in the regional minimum wages would lower the employment rate of men and women aged 16-19 by a minimum of 5.3 percentage points. This is a significant figure considering the fact that their average employment rate during the period 2006-2010 was about 17%.

The relationship between the degree of increase in the minimum wage rates and changes in the employment rate for men and women in their teens is shown in the graph below:

Changes in minimum wages and those in employment rates in 2007-2010Changes in minimum wages and those in employment rates in 2007-2010

The horizontal axis represents the differences in the natural logarithmic values of minimum wage rates between 2007 and 2010. A value of approximately 0.1 on the axis, corresponding to Tokyo and Kanagawa, means that the minimum wages in these two prefectures were raised by approximately 10% over the three-year period. The greater minimum wage hikes in Tokyo and Kanagawa relative to other prefectures are due to institutional factors. The new Minimum Wage Act as amended and enacted in 2007 calls for rectifying the situation where the amount of minimum wages falls below that of livelihood protection benefits. Since livelihood protection includes housing assistance, it thus reflects housing costs that vary significantly across regions. Therefore, in regions where housing costs are higher, the reverse gap between minimum wages and livelihood protection benefits was larger, requiring a greater hike to rectify the situation. Besides Tokyo and Kanagawa, some other prefectures show a relatively large hike in minimum wage rates. Prior to the law revision, the reversal between minimum wages and livelihood protection benefits had been conspicuous in these prefectures.

The vertical axis measures percentage point changes in the employment rate for men and women aged 16-19 between 2007 and 2010. The graph shows that the employment rate dropped by approximately five percentage points for those in Tokyo and Kanagawa. We can also see that the degree by which the minimum wage was raised and the degree of changes in the employment rate for men and women of this particular age group, measured along the horizontal and vertical axes respectively, were generally in an inverse relationship.

The period 2007-2010 witnessed the occurrence of the global financial crisis that had a significant negative impact on the labor market, and the magnitude of the impact might have been different across regions. Thus, we conducted analysis after controlling for the impact of business fluctuations, using the unemployment rate of men aged 30-59?which is not directly affected by an increase in minimum wage rates but reflects the overall condition of the labor market?as the indicator of the business cycle. As aforementioned, our analysis found that the employment rate of men and women aged 16-19 would decrease by a minimum of 5.3 percentage points when minimum wages are raised by 10%. We also controlled for regional differences in school enrollment rates for those aged 16-19, but there was no significant change in the findings.

Japan should introduce refundable tax credits

Attention must be drawn to the fact that addressing the problem of the working poor by means of raising minimum wages comes at the cost of depriving men and women in their teens of employment opportunities. The Japanese government suggests the need to raise minimum wages by pointing out that the nation's minimum-to-average wage ratio is low relative to other member countries of the Organisation for Economic Co-operation and Development (OECD). However, we must not forget that many OECD countries?most conspicuously advanced economies in Europe?are facing the serious problem of youth unemployment. In order to solve this problem, the OECD calls on the governments of countries concerned to "ensure that minimum wages are not set at levels that discourage employers from hiring inexperienced and low-skilled young people" (in its news released published ahead of the Group of 20 Labor and Employment Ministers' Meeting held in Mexico in May 2012). Japan must listen to this call.

Of course, teenage men and women are not alone in being affected by changes in minimum wages. There must be some workers who retain their work and have their wages increased as a result of a minimum wage hike. And if they are members of poor households, raising minimum wages can serve as an effective poverty reduction measure. However, in order to draw a conclusion on that possibility, it is necessary to conduct further empirical analysis rather than simply discussing the possibility.

When we warn against raising minimum wages, many people may think that we are trying to negate the need for measures to help the working poor. But that would be a total misunderstanding. The question is what approach to take to help them. One way to provide effective wage subsidies to workers in poor households is to offer refundable tax credits. The United States and the United Kingdom have a system to provide such credits, and both are beginning to see some positive results. In a nutshell, a refundable tax credit system is to subsidize wages for workers in poor households at the cost of other taxpayers. Being subsidies for wages, i.e., compensation for work, refundable tax credits does not create a disincentive for work, a typical side effect of livelihood protection benefits. However, Japan must clear a series of tough hurdles to pave the way for introducing the system. Specifically, it needs to secure necessary financial resources, introduce taxpayer identification numbers, and reform the tax system in such a way to designate household income as the basis for taxation and tax credits. Furthermore, attention must be paid to the possibility that the introduction of the tax credit system or wage subsidies may increase the supply of the low-skilled workforce and lead to declines in overall wage levels. Even though the tax credit system involves all of these difficulties, solving the problem of the working poor, which is a national issue, solely by raising minimum wages or at the cost of employers is not a viable option, given the expected side effects discussed above. Although it has a long way to go, Japan must face squarely and address the problem of the working poor by introducing the tax credit system.

October 9, 2012

October 9, 2012