Unemployment Rates

Make no mistake, higher minimum wages have unintended consequences

Comment

The recent decision by the Australian Fair Work Commission (FWC) to increase the federal minimum wage by 5.2% and 4.6% for granted minimum wages was higher than expected.

Usually, the FWC strikes a balance between the demands of unions and employer groups. But this year there is no doubt that the commission has sided with the unions and the new Labor government.

Australians could be forgiven for assuming that higher minimum wages will prevent a reduction in the real wage in light of rising inflation.

But that’s not the way to go to raise wages. Instead, the unintended consequences will likely be higher inflation and rising unemployment.

First, the effects of the minimum wage on employment are one of the most studied topics in economics. In the Australian context, we can look at the empirical studies of Labor’s own minister, Andrew Leigh.

Despite its obvious relevance, there is a clear reason why Labor will not mention its own minister’s study. This goes against their arguments for a big increase in the minimum wage.

Cost of higher minimum wages

Leigh, a Harvard Ph.D. and former professor at the Australian National University, found an employment elasticity with respect to the minimum wage of -0.29. In other words, for the Australian workforce as a whole, a 1% increase in the minimum wage will cost jobs following a 0.29% reduction in labor demand.

Against the backdrop of an Australian workforce of 13 million, a 5.2% increase in the minimum wage will mean the loss of over 200,000 jobs.

The results are even more striking for young people. Leigh found that every one percent increase in the minimum wage could result in a one percent drop in youth employment.

The youth unemployment rate is double that of the rest of the working population. There is nothing natural about this sobering statistic. When the government dictates a wage floor above market value, it takes away the first rung of the employment ladder for young people trying to enter the workforce. This often puts them in a bind: if they can’t find a job, they can’t learn the skills that would make them employable. Thus begins a cycle of perennial unemployment.

A waitress delivers cutlery at a cafe in Mosman on January 3, 2021 in Sydney, Australia. (Jenny Evans/Getty Images)

There is no doubt about the trade-off between minimum wage and employment. This makes sense based on economic principles, and a solid body of evidence backs it up.

Those on the left, especially unions, will often tout a famous 1990s article by David Card and Alan Krueger as proof that higher minimum wages don’t cost jobs (pdf).

What they fail to mention is that by using more reliable payroll data instead of the survey data originally used, the results show that higher minimum wages actually lead to a significant reduction in employment. .

Inflamed inflation

Although the effects of the minimum wage on employment will always be questioned, the inflationary effects have become a greater concern due to the current economic situation.

Andrew McKellar, chief executive of the Australian Chamber of Commerce and Industry, pointed out that the new pay rise would add an additional $7.9 billion ($5.5 billion) in additional costs to businesses, which would hit their bottom line or would be passed on to consumers, fueling inflation.

The inevitable pain that will come with the Reserve Bank of Australia raising interest rates to historic lows to curb inflation will only be amplified by a higher minimum wage.

In my home state of Western Australia (WA), we have two separate industrial relations systems; the national and state system. The WA Industrial Relations Commission raised the state minimum wage even higher to 5.25%, further widening the gap between the state minimum wage and the federal minimum wage.

Why is this such a concern in particular?

This is because WA’s minimum wage only applies to particular businesses, namely those of sole proprietorships and partnerships. Therefore, as the Chief Economist of the WA Chamber of Commerce and Industry, Aaron Morey, has rightly pointed out, “it further disadvantages smaller businesses in WA, which are governed by the relationship system outdated industries in WA, compared to the majority of companies covered by the national system”. So much for supporting our small businesses.

Does Labor Care About Job Losses

Proponents of a higher minimum wage have succeeded. The Labor government got what it wanted from the Fair Work Commission. And no doubt, they are satisfied with a quick political victory. But it seems that no one in Labor cares about the jobs that will be lost in this way. Or the serious inflationary concerns that are accelerating.

Artificially steering wages is no substitute for reforms aimed at improving productivity. It’s the best – and frankly – the only effective way to help workers.

Even in the words of liberal economist Paul Krugman: “Productivity isn’t everything, but in the long run it’s almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to increase its output per worker.

This means cutting the corporate tax rate to incentivize business investment, reforming other parts of our archaic industrial relations system and cutting red tape to ease the regulatory burden and encourage innovation, especially for small businesses and startups.

The opinions expressed in this article are the opinions of the author and do not necessarily reflect the opinions of The Epoch Times.

Sebastien Tofts

Follow

Sebastian Tofts as a research assistant at Curtin University, Australia.