The minimum wage: Making it pay

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Minimum wages are hotly debated as ways of improving equity and boosting the wages of lower skilled workers. All OECD countries apply some kind of wage floor. Do they achieve their goals?

When an employment search website was launched in Germany a few years ago, it caused a stir, not least because of its provocative title: Jobdumping.de. The idea was crudely simple, too. An employer posts a vacancy and the wage they are ready to pay. Job seekers make their bid, and the employer either hires the cheapest worker or bids up the wage to get the worker they want. The idea took off. Jobs were advertised and snapped up at low pay rates, including some, such as cleaning jobs, at well below the German average. This promoted exploitation at a time of high unemployment, some blogs cried, and broke strict labour agreements, others remarked.

Did it? Germany’s labour market is well-regulated, though it is one of nine OECD countries with no nationally applicable minimum wage. This group of countries, which also includes Austria, Italy and the Scandinavian countries, has traditionally relied on collective bargaining agreements to set wage floors, covering sectors and occupations which account for a very high proportion of the workforce. However, some workers are not covered by these collectively-negotiated wage minima and legislation has sometimes intervened. For example, it was partly to prevent unfair wage dumping from contractors using cheap labour, often from abroad, that Germany adopted a wage floor for the construction sector in 1997. Then in March 2007, lawmakers agreed to set a minimum wage floor for 850,000 cleaners, too.

Minimum wages are a long-standing tradition in many other OECD countries. A minimum wage was first introduced in New Zealand in 1894, and followed a few years later by Australia. The US federal minimum wage was passed into law in 1938. Japan and Korea now have minimum wages, while in Europe, so do France, Greece, Portugal, Spain, the Benelux countries and many countries in central and eastern Europe. Ireland and the UK (not for the first time) introduced national minimum wage systems in the 1990s.

Today 21 of the OECD’s 30 member countries have statutory minimum wages, and in just over half of these countries minimum wages have risen slightly faster than average wage levels in recent years. Only in the US have the real earnings of workers on the minimum wage dropped sharply in recent years, and there is strong pressure to raise them again.

What are the pros and cons of having a minimum wage? Wage floors dissuade employers from pocketing tax concessions aimed at improving take-home pay of low-wage workers or passing on any payroll taxes by lowering wages. They can improve equity by lifting the incomes of lower paid workers and encourage those on the edge of the labour market, such as the low-skilled, to hunt for a job. If set too low, they lose this usefulness. However, if set too high, minimum wages will stop employers from hiring lower skilled workers, and may end up protecting the “insiders” with the jobs.

For some firms, the cost of taking on extra staff, even at the minimum wage, can be a hurdle. In fact, social contributions and other payroll taxes add, on average, around 18% to the cost of employing minimum-wage workers. Most countries charge similar rates for minimum-wage labour and higher-earning employees, but preferential rates are found in Belgium, France, Hungary, Ireland and the UK.

If several countries with legal minimum wages have low unemployment rates, it is largely because the level is deliberately set so as not to constrain job growth. In the UK, a special commission has been quite effective to date in ensuring that the minimum wage keeps up with living costs and growth, while not rising too high.

On balance, the evidence shows that an appropriately-set minimum wage need not have large negative effects on job prospects, especially if wage floors are properly differentiated (e.g. lower rates for young workers) and non-wage labour costs are kept in check. But what about the goal of boosting incomes among lower paid workers? Do wage floors “make work pay”?

Consider gross earnings first. On average across 21 OECD countries, the gross earnings of a full-time minimum-wage earner came to nearly 38% of average wages, ranging from roughly 25% of the average in Korea and Mexico to more than 45% in Australia, France, Ireland, the Netherlands and New Zealand. Moreover, since 2000, gross minimum wages have grown by approximately 8.5% in real terms on average across the 21 countries.

How much of these increases go towards improving people’s net wages? A higher gross minimum wage may boost gross income, but what really matters is net take-home pay. This is the amount workers actually get into their pockets, and it depends on how tax and benefits apply to low-wage earners. Minimum-wage workers are paid the lowest wages but they still pay taxes. Add in social contributions and the overall burden on minimum-wage earners remains considerable, at between 15% and 28% in half of the countries. On average across the 21 countries, income taxes and social contributions reduce the take-home pay of full-time minimum-wage earners by just under 15%.

After adjusting for differences in prices across countries using purchasing power parities for 2006, this leaves a net income of about $4.50 per hour in the US and Japan. A full-time minimum-wage job pays most in some west European countries and in Australia, at a PPP equivalent of around $7.50 per hour.

The after-tax value of hourly minimum wages ranges from 27% of the net average wage in Korea, up to 60% in Ireland. In seven countries it is above 50%, and in another six below 40%, including in the US and Japan (see chart).

Some 10 countries have eased tax burdens on low incomes in recent years. Over the 2000-2006 period, the sharpest tax reductions for minimum-wage workers have been in Belgium, France, Ireland, the Netherlands and, in spite of a large increase in minimum-wage levels, in Hungary. Also, tax burdens of average wage earners have fallen less strongly than for minimum-wage earners.

In other words, raising minimum wages might lift labour costs, but not necessarily boost net incomes as much as they should. Policymakers may achieve more impact by improving disposable earnings via changes in the tax and benefit system. By blending such measures with appropriately-set minimum wages, work can be made to pay.

References

  • OECD (2007), Taxing Wages 2005/2006, special feature, “The Tax Treatment of Minimum Wages”, Paris.
  • OECD (2006), OECD Employment Outlook 2006: Boosting Jobs and Incomes, Paris.
  • OECD (2003), Employment Outlook 2003, “Making Work Pay, Making Work Possible”, Paris.
  • St. Martin, Anne and Peter Whiteford (2003), “More jobs and better pay”, OECD Observer No. 239, September, OECD, Paris.
OECD Observer No. 261 May 2007



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