Increasing minimum wage to $20 an hour in April 2021

The minimum wage in New Zealand is set to go up to $20 per hour from April 2021. As usual, this has created divisions between the progressives, who are in favour and conservatives, who fear that this will lead to large scale job losses.

While there is conflicting evidence on this issue, the preponderance of evidence suggests that minimum wage increases do not lead to large scale job losses as is presumed by the right.

Below I discuss the typical questions that come up in this debate.

First, very often minimum wage increases are designed to keep pace with inflation. As long as minimum wages are adjusted to keep up with the cost of living it seems only fair to do so. This is particularly so given that the consumer price index, which is the general measure of the cost of living, does not include certain things, such as house prices and therefore most likely underestimates how much the cost of living has changed over the years.

The proposed minimum wage is nearly three-quarters of New Zealand median age, which puts the current wage ahead of recent increases in the cost of living.  But given that the minimum wage is adjusted only periodically, unless there are further upward revisions in the minimum wage in the near future, the cost of living increases will catch up to it soon. 

Second, why don’t we then keep increasing the minimum wage? Where does it end? Wages are a crucial part of determining prices. Beyond a point pushing the minimum wage further will certainly lead to inflation and the aggregate job losses will not be worth any additional gains. There is no indication that we are anywhere there yet.

Third, why don’t we let the market decide? Here, proponents are appealing to what is known as marginal productivity theory. Here, each worker is paid what he or she is worth to the business. But the problem is that measuring marginal productivity, and therefore how much each worker is worth to the business, is not easy.

Furthermore, as Thomas Piketty points out in his book “Capital in the 21st Century”, since around 1980s the Anglo-Saxon countries (USA, UK, Canada, Australia and New Zealand) have seen the emergence of “super-managers”, whose enormous compensation packets are hardly commensurate with any measure of their marginal productivity.

Often such high salaries are excused by appealing to tournament theory, which says that the way to attract highly talented people is to make the prize (executive compensation) very large. In this sense, these super managers are similar to sports stars or movie actors. The evidence does not bear this out since there is little correlation between executive compensation and firm performance.

Furthermore European companies that have eschewed this star-system do not seem to be suffering from any adverse business outcomes.

So, it seems specious to argue that salaries for workers at the bottom should be solely determined by their marginal productivity while those of managers have no connection with market forces.

The playing field is hardly level and it is tenuous to argue that these wages are being set by market forces.

But, will raising the minimum wage not lead to job losses? Yes, but this answer is based on what is typically known as a partial equilibrium analysis of markets. Bear in mind that those who get this additional wage will also spend that money within the community. So, yes, some cafes may lay off their wait-staff who may then need to find a job at the Warehouse. Evidence suggests that minimum wage increases may lead to job displacement but not a lot of job losses.

Small businesses that find this wage increase onerous should be able to make adjustments to the hours of work in order to balance out the increased pay for each of those hours.

The timing and the sensitivity of demand for workers to changes in wages matter too. Raising minimum wages in the midst of an economic downturn may not be the best idea.

During booms, the labour market is “tight” with lots of employers looking for workers. This works in two ways. First, when the minimum wage is raised, even if it leads to a lower demand for workers as a whole, typically the additional gains of those who retain their jobs exceeds the losses of those who lose their jobs. But during booms, the latter find it easier to find alternative employment.

But during downturns, when business are not looking to expand, finding alternative employment is not as easy. Also, in such situations, the market is “loose”, with demand for workers highly sensitive to wages

Finally, what often gets lost in such debates is the rather illusory nature of wages and prices. For instance, if a loaf of white bread costs $2 and I make $16 an hour then my hourly wage is worth 8 loaves of bread. It does not change anything if my wage is increased to $20 but the price of a loaf goes up $2.50. My wage is still worth 8 loaves of bread.

Raising the minimum wage is certainly a way of bettering lives, lowering prices can be equally effective. Much evidence suggests that many sectors of the New Zealand economy such as groceries are characterized by a lack of competition. Reining in the market power of these businesses may well lead to lower prices and be equally effective ways of making things better off for those of us on the lower rungs of the income distribution.