Minimum wage – maximum unemployment?

Does the minimum wage bite the hand that it is intended to feed?


According to its supporters, the minimum wage – the lowest wage that employers can legally pay – protects workers who are too weak to negotiate a tolerable paycheck on their own with employers. Critics of a wage floor point out that a high wage may attract more workers than firms want to provide. In theory, in an unregulated labor market, this imbalance is temporary. Eventually, the excess workers – the unemployed – will offer to work at lower wages. This will force the market wage to fall until no excess labor remains. But if a law prevents the market wage from declining, then unemployment will persist. The minimum-wage law hurts the workers that it was ostensibly designed to protect.

Applied to Central Asia, this argument may have its flaws, both theoretical and empirical. It assumes that the labor market is competitive: Employers and employees are so numerous that no one of them can affect the market wage. This is determined instead by their collective decisions. In this setting, no employer can pay another worker less than she is worth, since she has lots of other opportunities. But as a former Soviet satellite, Kazakhstan still has many areas that are dominated by a single employer -- so-called “one-company towns,” which may have numbered in the dozens in mining, metallurgy and agriculture during the Nineties, noted two World Bank economists, Martin Rama and Kinnon Scott. Kazakhstan may have even more company towns than is typical in the Commonwealth of Independent States, because Soviet industrial subsidies per capita were larger here. The power of these companies over Kazakhstan’s labor market is suggested by a finding of Rama and Scott that wages rose when a large company moved into a small town and fell when it left.

Bad company

In company towns, given an unregulated labor market, the worker must either accept the employer’s pay offer or not work at all. Thus the employer may set the wage well below the worker’s value in production; to induce her to accept the offer, he needs only to leave her slightly better off than she would be when unemployed.

In addition, the boss may refuse to hire many worthy workers. The reason given by economic theory is that he usually pays the same wage to all workers of a given type (for example, all recent high-school graduates applying for jobs at his plant). To hire another worker, he must raise his pay offer, since she had refused a job at the earlier, lower wage. But if he raises pay for this worker, he must also do so for all of his other workers of the same type. The cost of doing so may exceed the value of the additional worker to the plant; and so he won’t offer to hire her.

In a company town, a minimum wage may raise the workers’ pay without threatening their jobs, since each employee would still add more value to the firm than she cost. Also, the boss may hire more workers, because he no longer perceives a large expense in raising their wage. He must pay the minimum wage (at least) to all workers, so he will hire anyone who is worth that wage.

A simple example may help clear up these ideas. Suppose that the employer dominates the local labor market. A worker now applies for a job. Suppose that she would be worth $10 an hour to the employer but would be willing to work for as little as $3. Then the boss will offer her only $3 and pocket $7 as profit. Now suppose that the government sets the minimum wage at $9. The boss would still hire the worker, since she more than pays her way: But his profit on her labor will drop to $1 ($10 minus $9). The other $6 of profit now go to the worker.

Real wage, real world

Empirically, the claim that the minimum wage creates unemployment is controversial. The most common conclusion is that the minimum wage increases unemployment, holding all else constant. But some statistical studies conclude that the minimum wage has no effect on unemployment – or may even reduce it. One reason may be that governments rarely adjust the minimum wage for inflation. As prices rise, the amount of goods will diminish that, say, a thousand tenge can purchase. If the government does not increase the number of tenge in the minimum wage, then eventually its real value may fall below that of the wage that would clear the labor market. In that case, the minimum wage has no effect on workers; it’s just a wage floor, and the market pay that they actually receive already exceeds it.

In December 2010, the government set the monthly minimum wage at 13,728 tenge (about $92 at the current exchange rate).  This is 2.5 times the “poverty line” (so called because a person making less than this is deemed by the government to be poor), according to the news source Interfax-Kazakhstan. The minimum wage is higher for manual laborers as well as workers in hazardous industries, noted analyst Kanat Berentaev; in that case, it may affect those markets more than others. The labor ministry has said it would increase the minimum wage by 2015 as it restructures the policy, reported neweurasia.net . Perhaps, as officials redesign the minimum wage, they may wish to analyze what, if anything, it has actually accomplished. – Leon Taylor, tayloralmaty@gmail.com


Good reading


Ronald G. Ehrenberg and Robert S. Smith. Modern labor economics: Theory and public policy. Ninth edition. Boston: Pearson Education. 2006. Surveys work on the minimum wage.

Robert H. Frank. Microeconomics and behavior. Third edition. McGraw-Hill. 1998. Discusses the effects of the minimum wage in a labor market dominated by one employer.

Kanat Berentaev. The strike of oil industry workers: analysis of reasons and ways of solving the situation (short thesis). Center for Analysis of Public Reforms. Online at algadvk.kz .

Martin Rama and Kinnon Scott. Labor earnings in one-company towns: Theory and evidence from Kazakhstan. The World Bank Economic Review 13:1, pages 185-209. January 1999. On line.




References



Interfax-Kazakhstan. Kazakh ministry of labor adjusts poverty line for Q1 2011. January 6, 2011. Online.

neweurasia.net . Minimum wages in Kazakhstan and abroad. January 5, 2010. Online.