"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.
References
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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