What Are the Effects of Higher Minimum Wages?

TSURU Kotaro
Program Director and Faculty Fellow, RIETI

In a bid to address the problem of the working poor and rectify the situation where the amount of minimum wages falls below that of livelihood protection benefits, efforts have been made to raise regional minimum wages since 2007. In particular, the previous government led by the Democratic Party of Japan (DPJ) made it a goal to raise the average minimum hourly wage nationally to 1,000 yen. On the other hand, in the course of its campaign for the latest House of Representatives elections, the Japan Restoration Party called for reforming the minimum wage system into a more market-oriented one. In what follows, I would like to introduce relevant research findings in recent years and their implications to consider minimum wage policy following the recent change of government.

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Minimum Wages, written by David Neumark, professor at the University of California, Irvine, and William L. Wascher, deputy director at the U.S. Federal Reserve Board (FRB), is probably the most comprehensive and currently available survey of literature on the impact of minimum wages in both theoretical and empirical aspects.

The most controversial issue in discussing the right or wrong of minimum wage policy is its impact on employment. As a general rule, higher wages lead to lower employment in a perfectly competitive market. However, in the case of an employers' market, where companies have the power to control wages, both the wage and employment levels are kept lower than expected in a perfectly competitive market. In such a situation, there is room to expect an increase in sales that more than offsets an increase resulting from a minimum wage hike, and companies may increase employment even in the event of a minimum wage hike. Indeed, it is theoretically possible that a wage increase does not lead to a decrease in employment as it provides workers greater motivation to work and, combined with more skill-developing opportunities, leads to higher productivity.

Based on their comprehensive review of a large volume of empirical evidence from studies mainly conducted in the United States, Neumark et al. pointed out that minimum wages reduce employment opportunities for low-skilled workers, and their adverse effects are more conspicuous on those directly affected by changes in the minimum wages. An overwhelming majority of the research papers reviewed showed that minimum wages have negative effects on employment with only a handful pointing to positive effects. They emphasized that this tendency is even clearer when it is based only on what they view as the most compelling evidence.

Following their survey, active research efforts have been made in the United States, using new methods and different sets of data. As minimum wages are set not only by the federal government but also by many state governments, some researchers focus on county-level data in order to exclude the effects of state-specific factors. For instance, in his 2009 paper, Jeffrey P. Thompson, currently an economist at the FRB, evaluated the effects of minimum wages on teenage employment at the county level. Although the effects are small and insignificant in terms of the average across counties, he pointed out that a considerably large negative impact was observed in counties where the minimum wage was likely binding.

Meanwhile, a 2010 paper coauthored by Arindrajit Dube, assistant professor at the University of Massachusetts, Amherst; T. William Lester, assistant professor at the University of North Carolina, Chapel Hill; and Michael Reich, professor at the University of California, Berkeley, compared contiguous county-pairs straddling state borders and found no adverse effects of minimum wages on employment. As such, the effects of minimum wages on employment remain disputable.

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However, continuing the dispute focusing solely on whether or not minimum wages have negative effects on employment is unproductive because even in a perfectly competitive market, a rise in the minimum wage would cause substitution effects at various levels, which in turn create winners and losers. For instance, while a rise in the minimum wage leads to a decrease in demand for the least-skilled workers, demand for more skilled workers is expected to increase as their wages become cheaper in relative terms. This would put those companies and industries with a large proportion of minimum wage employees (primarily small and medium enterprises) at a relative disadvantage. On the other hand, major companies or industries hiring a large number of high-skilled workers and offering above minimum wages to low-skilled workers would find themselves at a relative advantage and might increase employment. In the case of the U.S. fast food industry that has a large number of low-income customers, a rise in minimum wages means an increase in the purchasing power of its customers, which may result in an increase in employment.

In addition to those effects on employment, we also need to consider how minimum wages affect the distribution of income, corporate profits, and prices as well as what impact they will have on human capital over a long term horizon. Even in cases where no employment impact is observed, the impact of a minimum wage hike will be felt in the form of reduced working hours or lower corporate profits unless there is a sufficient increase in the labor productivity. And even if companies manage to pass on their higher costs into the prices of their goods or services, consumers are to bear the burden. In other words, there is no free lunch and someone has to pay the cost.

The case of the United Kingdom provides interesting insight. The traditional sector-by-sector minimum wage system was abolished in 1993, and then, after an interval of several years, the current national minimum wage system was introduced in 1999. In the meantime, a series of empirical studies have been carried out to analyze the effects of minimum wages on employment. Partly because of a moderate rise in minimum wages, researchers have come to a fairly common understanding that minimum wages have no clear impact on employment.

Meanwhile, Mirko Draca, assistant professor at the University of Warwick, Stephen Machin, professor at University College London, and John Van Reenen, professor at the London School of Economics, showed in their 2011 paper that profitability dropped more sharply in low wage companies than in other companies. Also, a 2009 paper by Jonathan Wadsworth, professor at Royal Holloway, University of London, showed that a hike in the prices of consumer services was greater than that in overall consumer prices. As such, a rise in minimum wages had a clear impact on corporate profits and prices.

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In Japan, how much progress has been made so far in the empirical analysis of the effects of minimum wages? A 2009 paper by Daiji Kawaguchi, associate professor at Hitotsubashi University, and Yuko Mori, research fellow at the Japan Society for the Promotion of Science (JSPC), can be cited as an international-class study that analyzed workers susceptible to minimum wages using a large volume of data. Using data through 2002, they showed that a rise in minimum wages had an adverse impact on the employment of male teenagers and middle-aged, married women.

However, as an upward trend in minimum wages became conspicuous from 2007 onward, the need to examine data in and after 2007 has been pointed out. Against this backdrop, Kawaguchi and Mori conducted an analysis using data through 2010 as part of a RIETI research project that I headed, whereby they showed that a 10% rise in minimum wages is expected to decrease the labor force participation ratio for young workers aged 16-19 (average 17%) by about five percentage points. A hike in minimum wages has an apparent adverse impact on employment in Japan when we focus on susceptible workers.

What are the implications for Japan's minimum wage policy? First, special attention must be paid to the types of workers who are easily affected by a rise in minimum wages. It is worth considering introducing age-differentiated minimum wages (setting a lower wage floor for youths rather than for workers of other age groups), such as those in some European countries. As a means to address the problems of income inequality and poverty, refundable tax credits may be a more desirable option. Some people are calling for a significant increase in minimum wages, pointing to the fact that Japan's minimum wage level, measured as a percentage of the average income, is one of the lowest among the member countries of the Organisation for Economic Co-operation and Development (OECD). However, this requires more careful discussion as Japan ranks roughly in the middle in terms of real minimum wage at purchasing power parity (PPP) (see Figure).

Figure: Real Hourly Minimum WageFigure: Real Hourly Minimum Wage

Second, we must be fully aware of how minimum wages affect businesses. As part of the aforementioned research project, RIETI Vice Chairman & Vice President Masayuki Morikawa reported that an increase in minimum wages has a negative impact on corporate profits. Third, there have been calls for making public policy more evidence-based, and this applies to minimum wage policy as well. In the United Kingdom, the Law Pay Commission (see the Keywords section), an independent body to advise the government on minimum wage policy, was established in conjunction with the introduction of the new, national minimum wage system, thereby enhancing the relevant research and analysis functions significantly. It is necessary to reorganize the central council on minimum wages in Japan (see the Keywords section) from the same viewpoint.

>> Original text in Japanese

* Translated by RIETI.


[Low Pay Commission (LPC) in the United Kingdom]

A government advisory body consisting of nine members drawing from employee, employer, and academic backgrounds, the LPC puts forward its recommendations on the minimum wage level and changes to the minimum wage system in the annual review of the national minimum wage. For this purpose, it conducts research, analyzes relevant data, commissions research projects, and carries out written and oral surveys of firms in low-wage sectors. Two of the three independent commissioners are scholars specializing in labor economics or labor-management relations, and they conduct surveys and research from an independent standpoint.

[Central council on minimum wages in Japan]

An advisory body for the minister of health, labour and welfare, the council sets a guideline for revising regional minimum wages. It is composed of members representing employees, employers, and public interests. As members representing the first two groups differ in their opinions, the council's guideline typically reflects the opinion of those representing public interests and hence is in a neutral position. Just like now-defunct wage councils in the United Kingdom, Japan's central council on minimum wages effectively serves as a bargaining table for labor-management negotiations with representatives of public interests playing a coordinating role.

January 22, 2013 Nihon Keizai Shimbun

February 25, 2013