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Minimum wage winners and losers far from certain

Of all the socio-economic policy issues discussed in the small business context, minimum wages are among the most emotive. It is not hard to see why. Standards of living are important benchmarks and the sense of ‘value’ is a deeply engrained economic concept.

When it comes to ‘value’, though, wages and how they progress are not as tied to the skills and characteristics of individuals, but to the value of the work they actually perform. The distinction is important when trying to understand and apply a minimum wage floor.

Principally, the higher the output of a worker, the higher their wage. A look at wage patterns in the economy bears this out—minimum wage earners only represent a fraction of employees (1 in 15 by Statistics Canada estimates), and most of those are new entrants
just beginning to pick up skills and experience— typically from middle-income households. Tracking studies also show that Canadians in low-wage categories at some point are highly likely to move up the income ladder over time—suggesting that the prospect of people being trapped in low wage occupations over the long term is not the norm.

There is some evidence from US studies that raising minimum wages can reduce poverty incidence by a ‘moderate’ degree, but even they suggest direct employment tax credit work incentives and active policies on skills are far more effective at achieving this policy goal. Moreover, there is little confidence that the relationship is positive forever—there likely exists a ‘sweet spot’ where higher minimum wages no longer have any net effects on poverty.

As for the common assertion that higher minimum wages are stimulative to the economy as a whole, there is no substantive evidence—especially in times of slack. The most likely effect is to redistribute activity from low-skill to higher-skill labour.

Just as minimum wage is a poor correlation to poverty, raising it significantly is a poor solution. Often left out of the debate is how minimum wage legislation cannot control for the number of hours of work offered by employers. Paraphrasing labour economist Morley Gunderson, he said poverty is caused by lack of hours of work, not by lack of dollars per hour. Again, strong evidence from Canadian studies shows that young workers bear the brunt of the offsetting impacts; for every 10 per cent increase in minimum wages, there is likely a decline of 3 to 6 per cent in employment.

A look back at 40 years of data in Ontario, for example, shows a pretty clear visual relationship between legislated minimum wage levels and employment rates among young workers (see Figure 1). It is hard to imagine that job prospects for new entrants would not start drying up if announced minimum wage rates sharply rise in 2018 and 2019.

Evidence for older workers is more muted by comparison, leading some to say that minimum wage legislation has no significant net impact on the economy. But it does change job dynamics by both reducing the incidence of layoffs and the incidence of hiring. Jobs may become easier to hold, but they are harder to get as a result, lengthening bouts of unemployment. Even so, however, the negative effects on employment grow progressively larger when minimum wages grow faster than average wage levels.

Employment, however, is a pretty clunky measure of work activity. The effects are probably greater on hours of work—which unfortunately are not measured as comprehensively by Statistics Canada.

Despite how this issue is presented to the public, all this evidence infers that minimum wages are not really an employee versus employer issue at all, but employee versus employee—with employers caught in the middle. Employers will have the pain of having to juggle their business structures and strategies with each change in legislated rates, but they will generally react over time by lessening reliance on new or unskilled labour. That businesses will immediately switch to robots for these tasks is a tad overblown, but with a compressed pay grid, the benefits to relying on more experienced (and productive) labour will be amplified.

Minimum wages are not just a small business phenomenon; large businesses also have employees earning the minimum. However, small firms tend to be the point of entry for many young people getting their first taste of the work world. These stepping-stone jobs provide valuable life experience far beyond the simple dollars earned per hour. Pricing this kind of experience out of the picture creates a hurdle that is much more difficult to overcome.

The issue is a lot more pointed at the small end of the business size scale also because, unlike in large enterprises, it is business owners’ personal earnings that absorb much of the variability in operating cash flow. Indeed, statistics show owners’ hourly compensation is much more likely to be at (or below) minimum wage levels than employees’—even to the point that employers are more likely to be in lowincome households.

In a nutshell, although higher minimum wages sound like a good policy, the net direct impact on people’s earnings is illusory. The approach can’t get around the basic truth that any wage cannot sustainably exceed the value of the work being done.

Ted Mallett, Vice-president and Chief Economist
416-222-8022 : [email protected] : @cfibeconomics

June 1, 2017

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