Financial Times: The real minimum wage and poverty reduction

China Labour Bulletin is quoted in the following article. Copyright remains with the original publisher.

Feb 03, 2015

By Rodrigo Zeidan, Fundação Dom Cabral

The debate over the minimum wage in the US is an interesting one. Wages have been falling in real terms for the last 30 years but there is strong resistance to any kind of increase in the federal minimum wage. The social contract in the US calls for a flexible labour market, and market efficiency trumps equality considerations. Not even Nobel Laureates can influence the debate. But there are lessons to be learned from the strong real growth minimum wage policies in two of the Bric countries, Brazil and China.

In Brazil, the minimum wage increased 3.18 a year per cent between 2000 and 2014; in China, it grew at 8 per cent a year, for the average city, during the last 10 years. It is expected to grow 13 per cent a year under China’s current Five-Year-Plan (2011-15), according to the China Labour Bulletin.

There is an interesting paradox in Brazil and China. While the pace of economic growth is expected to slow, both countries have robust labour markets and falling poverty. Some of this is the result of structural policies that target real minimum wage growth.

I usually give a simple task to my students or executives when teaching corporate finance or microeconomics: calculate the minimum efficient scale of a new business, guesstimating its main operating costs. In Denmark, the social contract for fair wages is so strong that students usually estimate significantly higher wages than the minimum wage even for low-skilled labour, arguing that high wages would attract more productive workers. The rationale is diametrically opposite in Brazil and China, where most students, even senior executives, simply assign the minimum wage for the majority of workers and try to minimize the salaries of managers and other personnel.

That is why the minimum wage matters: in many emerging markets, the social contract implies that business owners disregard the possibility of performance-related pay, bonuses, or any form of redistributive policy that would allegedly result in reduced productivity. Meanwhile, unless the minimum wage is set high above the rate for low-skilled labour productivity, it should have no impact on employment.

We know that raising the minimum wage has been an important and overlooked structural policy that had a significant impact on poverty reduction in Brazil and China. Usually, minimum wage policies are viewed throughout a simple dichotomy: higher wages result in lower employment. However, there is scant if any evidence of this, and it would be true only for efficient and fully-functioning labour markets, the kind one can perhaps imagine in some developed countries. For developing countries, minimum wages have a real impact on poverty, even when we consider formal vs informal markets.

Here is what the evidence on the relationship between minimum wage, poverty and unemployment shows us:

  • Raising the minimum wage affects formal and informal workers alike: in fact, informal workers – workers without social security contribution – experienced significant wage increases when the minimum wage was raised even while formal workers did not (Khamis, 2013).
  • The necessary conditions for a pass-through effect of rising minimum wages on income and not unemployment are: low real minimum wages, a buyer’s labour market, and enforcement capabilities (Ni et al., 2011).
  • Minimum wages have significant impact on general wages, but almost no discernible impact on jobs (Schmit, 2013). Evidence from the UK shows that there is some profitability reduction for firms, but no effect on firm exits (Draca et al., 2011).

The minimum wage is a powerful redistributive tool (Freeman, 1996). In Brazil, 30 to 45 per cent of the reduction in income inequality is due to minimum wage growth – although some of the effect is due to the indexation of public pensions to the minimum wage (Gasparini and Lustig, 2011). In China, there is even a productivity boost, with Poncet et al. (2014) finding that minimum wage growth increases the productivity of surviving firms and allows more productive firms to replace the least productive ones, even though it may have an adverse effect in some regions (Fang and Lin, 2013).

There seems to be a case for a prescriptive policy of minimum wage growth as long as the job market is robust. There also seems to be an optimal level of development at which minimum wage growth is an optimal policy – when countries are moving towards middle-income status and the redistributive effect trumps possible effects on unemployment and competitiveness. And too much of it would surely magnify the costs of such a policy, but the idea of doubling the minimum wage in some sectors in India seems a plausible course of action.

Cheap labour in Brazil and China is at its end, most of it due to minimum wage growth. We also have much less poverty because of it. Other emerging markets should follow suit.

Rodrigo Zeidan is associate professor of finance & economics at the Fundação Dom Cabral and visiting associate professor at NYU Shanghai.

References

Freeman, R. B. (1996). The minimum wage as a redistributive tool. The Economic Journal, 106 (436): 639-649.
Draca, M., Machin, S. and Van Reenen, J. (2011). Minimum wages and firm profitability. American Economic Journal: Applied Economics, 3(1): 129-51.
Gasparini, L., and Lustig, N. (2011). The rise and fall of income inequality in Latin America. In Ocampo, J. A. and Ros, J. (Eds.), The Oxford Handbook of Latin American Economics, 691-714.
Ni, J., Wang, G., and Yao, X. (2011). Impact of minimum wages on employment. Chinese Economy, 44(1): 18-38.
Khamis, M. (2013). Does the minimum wage have a higher impact on the informal than on the formal labour market? Evidence from quasi-experiments. Applied Economics, 45(4): 477-495.
Schmitt, J. (2013). Why does the minimum wage have no discernible effect on employment? CEPR Reports and Issue Briefs, 2013-04.
Poncet, S., Mayneris, F., and Zhang, T. (2014). The cleansing effect of minimum wage: Minimum wage rules, firm dynamics and aggregate productivity in China. CEPII Working Paper, 2014-16.
Fang, T., and Lin, C. (2013). Minimum wages and employment in China. IZA Discussion Paper, No 7813.

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