Does a Minimum Wage Help Workers?
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- Authors: PIYAPORN SODSRIWIBOON, GABRIEL SROUR
- Published: March 1, 2019
Overview
- Authors: PIYAPORN SODSRIWIBOON (senior economist, IMF’s Asia and Pacific Department) and GABRIEL SROUR (senior economist, IMF’s African Department).
- Publication: F&D Magazine, March 2019.
- Core question: Does a minimum wage help workers? The explainer discusses why an overly generous wage may prompt employers to cut jobs.
- Context: Almost every country has a minimum wage; details vary (examples in the source: France fixes a universal minimum across the economy, New Zealand and South Africa differentiate between sectors and types of workers). Typically set by government and revised periodically in consultation with business and labor organizations.
Impact on welfare
- Key mechanisms that can blunt or negate intended gains:
- Employers may not comply with the minimum wage law; if no one actually receives the minimum, the law is irrelevant.
- In countries with large shadow economies, employers often give under-the-table wage supplements (“envelope payments”) to evade taxes or benefit costs; an increase in the minimum wage can lead employers to reduce envelope payments, leaving overall compensation unchanged.
- Employers might underreport hours worked, leaving total pay unchanged, or not report employment at all to evade the law.
- Even when regulations are respected, additional earnings may face heavy social security and labor taxes, reducing the impact on take-home pay.
- Employers may offset higher minimum wages by reducing benefits or hours or laying off workers to cut costs.
Impact on employment
- Central debate: whether increases in the minimum wage reduce employment.
- Theoretical outcomes:
- In competitive markets, an enforced minimum wage above prevailing levels can cause layoffs as firms unwilling to pay the higher wage reduce employment.
- In noncompetitive (monopsony-like) labor markets, a minimum wage can raise incomes without reducing employment and may even raise employment by attracting more workers.
- Empirical evidence summarized:
- Research spanning several decades is mixed: some studies find significant benefits, others find harm, and many are inconclusive.
- There is a growing consensus that when the minimum wage is set at a moderate level, the impact on employment is modestly negative.
- Recent research generally concludes that the change in employment caused by an increase in the minimum wage is close to zero, although more vulnerable groups, such as low-skilled and young workers, may be hurt.
- Plausible reasons for modest employment effects:
- At moderate levels, minimum wages account for only a small share of an employer’s total costs, so firms can absorb increases by reducing nonwage costs, raising prices, boosting productivity, or accepting lower profits.
Impact on inequality
- Purpose: Minimum wages aim to boost incomes of those at the bottom and reduce inequality/promote social inclusiveness.
- Empirical findings:
- Minimum wage hikes tend to narrow wage disparities, but only as part of a broader policy effort toward significant poverty alleviation.
- Limitations and risks:
- Minimum wages set too high can cause significant job losses and produce perverse distributional effects; as low-income earners lose jobs, inequality can widen.
- Minimum wage increases can compress the wage structure and pump up overall wages, leaving income disparity unchanged because firms want more productive workers to be better compensated.
What is the appropriate level?
- Evidence on the optimal level is limited.
- Studies that touch on the question suggest an ideal level somewhere between 25 and 50 percent of the average wage.
- Policy guidance from the analysis:
- Minimum wage policies should be calibrated to keep overall wage growth in line with productivity gains.
- The process of setting minimum wages should be depoliticized and delegated to independent experts.
From IMF Finance & Development Magazine, March 2019.
Content in this bundle
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- Does a Minimum Wage Help Workers?
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