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Rationales for Minimum Wage Legislation

The various rationales for minimum wage legislation will be outlined and critically assessed. The intent is not to indicate the appropriateness or inappropriateness of a rationale, but rather to highlight the various trade-offs that are involved and the requirements for minimum wages to achieve these stated purposes. At this stage, the various rationales will simply be summarized. Later, theoretical considerations and empirical evidence will be brought to bear on the extent to which minimum wages achieve some of these goals.

Alleviating Poverty

Alleviating poverty tends to be the most important objective advanced for minimum wage legislation. At first glance, the connection seems obvious. If the person remains employed then raising wages increases annual earnings which can contribute to a reduction in poverty. The advantages of minimum wages as an anti-poverty device include:

They enable recipients to “earn” their income which is generally regarded as preferable (by both recipients and “payers”) to receiving income in the form of a transfer payment.
They bolster the labour market as a first line of defence against poverty.
Minimum wages may provide an attractive and more dignified alternative to social assistance or other income support programs.

The disadvantage of minimum wages as an anti-poverty device are generally associated with the fact that they are at best an exceedingly blunt instrument for dealing with poverty, and may actually have a perverse effect, exacerbating poverty.

If the person loses their job or is offered fewer hours of work because of the minimum wage, then the minimum wage can contribute to, rather than alleviate, poverty.
Poverty is related to family income relative to family need, while minimum wages are paid to individuals irrespective of their family situation or need. In that vein, minimum wages are not well targeted towards the poverty population, many of whom are not able to work in the first place.
As an anti-poverty device, minimum wages would also be poorly targeted even to the working poor since they also affect the earnings of youths and multiple earners in wealthier families.
Minimum wages affect only small portions of the population, most of whom are youths who are still within their family and temporarily in minimum wage jobs.
Minimum wages are an exceedingly blunt instrument for curbing poverty because even if the person were in poverty and remained employed, the earnings increase would not likely do much to close the poverty gap.
Some jobs are low-wage because they provide training or experience that can be valuable for subsequent wage growth that can facilitate a move out of poverty. If this training or experience is no longer possible (i.e., it is “priced out of the market”) then this could exacerbate poverty in the long-run.
Pricing such jobs out of the market because they cannot be done at a low wage, can lead to their being done at a zero wage as in the case of volunteer work or unpaid internships that are often done for the value of the experience. There is some irony to the fact that low-wage jobs are illegal, but jobs at zero wages can be encouraged for social reasons.
Using minimum wages to curb poverty places the onus on employers to deal with a social issue the costs of which should be shared by society in general. If a person is paid $6.00 per hour and society deems that they should be paid $8.00 per hour for social reasons, then it would seem appropriate for that difference to be paid out of general tax revenues perhaps in the form of a wage subsidy, rather than imposed on a particular employer.

Reduce Wage Inequality

Somewhat related to the objective of reducing poverty, minimum wages are also sometimes regarded as a policy instrument for reducing wage inequality (theory and evidence discussed subsequently). Such wage inequality has increased in recent years, largely reflecting the impact of technological change that has reduced the employment prospects of the less skilled, while increasing those of the more skilled. Other contributing factors include industrial restructuring from manufacturing to services (both low-end personal services and high-end business and financial services) as well as trade liberalisation where import competition has been strongest at the low end of the wage spectrum.

Place a Floor on Market Transactions

Minimum wages are sometimes justified on the ground of placing a floor below which labour market transactions are not allowed to occur. The rationale for this is usually couched in vague terms such as “people ought not to have to work at wages below the floor” irrespective of their productivity or the fact that the floor may mean that they cannot work at all. In that vein, minimum wages are simply a form of price fixing. Such price fixing occurs in other areas such as the requirement to pay “fair wages” in government contracts or “living wages” often in public sector jobs.

Eliminate Low Wage Jobs and Encourage Employers to Move up the Value-Added Chain

While the potential adverse employment effect of minimum wages is generally regarded as a negative consequence, there is a perspective that regards the elimination of such jobs as a positive consequence. Presumably, the rationale is that it puts pressure on employers to move up the value-added chain and create only higher-wage jobs. Minimum wages may also create pressures for employers to train their now higher priced labour so that their productivity now matches their higher pay, again enhancing productivity. Without such pressures, employers would gear their production processes to the availability of low-wage labour, with a low-wage labour market being a self-perpetuating equilibrium. Even if people are displaced into unemployment by minimum wages, this puts pressure on governments to develop training and other programs to move them into the higher-wage jobs.

Sometimes the argument is tied up in terms of foreign competition. That is, it is impossible to compete with the extreme low wages that exist in many developing countries; hence, it is better to eliminate such jobs domestically and focus on creating high-productivity, high-wage jobs. Forcing employers to invest in labour-saving technology may be essential in the long run to maintain competitiveness and hence create (or at least save) other jobs – any elimination of low-wage jobs being a regrettable by-product of this process.

Obviously, if the elimination of low-wage jobs were a costless process this would seem socially desirable. But the elimination of such jobs is costly to those who lose them, and it obviously imposes costs on employers who otherwise rely on low-wage, low-productivity labour. It is easy to say “better no-job than a low-wage job” if you are not the recipient of no job. As well, if training low-wage workers for higher wage jobs is socially desirable, this can be done without eliminating low-wage jobs – it is a matter of devoting resources to move minimum wage workers up the value added chain. Over, this argument of minimum wages ultimately enhancing productivity and competitiveness is difficult to assess theoretically or empirically.

Provide an Incentive to Leave Income Maintenance Programs

Minimum wage legislation is sometimes justified on the ground of providing an incentive to leave income maintenance programs like welfare. If the monetary returns to work are higher, then there obviously is an incentive to engage in labour market work as opposed to remaining on an income maintenance program. This obviously can be a saving to taxpayers. It is also likely to be preferred by transfer recipients, most of whom are likely to prefer work to welfare if the work pays sufficiently.

While this may occur in many circumstances, it is also likely to be the case that the elimination of many low-wage jobs can also reduce the opportunities to leave income maintenance programs for work. Such work requires that the jobs are available and it is not clear that fewer jobs (because some are eliminated because of the minimum wage, although the remaining ones are higher-paid) provide more alternatives to welfare than does more lower-wage jobs. Furthermore, if it is socially desirable to provide higher-wage jobs to induce people to voluntarily move out of income maintenance programs, then it would seem that the appropriate policy response is for governments to supplement the pay in otherwise low-wage jobs. This assumes, of course, that employers are paying low wages because the jobs are of low productivity, and that employers are thereby assuming the full labour cost associated with such work. In such circumstances, a government supported wage subsidy would mean that there would not be an adverse employment effect. It would also ensure that the burden is shared across society and not imposed on a small number of employers who are otherwise paying low wages because the workers simply have low productivity. The concern, however, is that employers may be paying low wages not because of low productivity, in which case a government wage subsidy effectively subsidizes their behaviour.

Increase Aggregate Demand and Generate Multiplier Effects

There is some intuitive appeal to the notion that minimum wages may raise aggregate demand in the economy by putting purchasing power in the hands of low income persons who are likely to spend rather than save. This is especially the case since minimum wage earners are likely to spend their income in their community to the benefit of the local economy, as opposed to spending on travel and foreign luxury goods. Such initial spending could have multiplier effects as it ripples through the system affecting the purchasing power and spending of others. As indicated by Whittingham (1970, p. 4-8) in documenting the early arguments advanced in favour of minimum wage legislation in Ontario when it was first applied in the 1920s:

“Side effects from setting [minimum wage] floors such as … placing a floor under purchasing power ... were used by the Board as selling points to gain support for its program.”

The operative phrase here is “selling points” since there is little contemporary credence placed by economists on such arguments. It is not clear how aggregate demand would be affected by minimum wages given that some would be unemployed with little or no purchasing power. Furthermore, if firms did not have to pay the higher wages presumably they would spend on other items like investment and this would increase aggregate demand and have multiplier effects. Much of the investment spending would also be in the local community. In dealing with aggregate effects it is always important to consider the counterfactual of what would occur in the absence of the event (e.g., the minimum wage increase). The counterfactual is seldom that nothing would occur.

Help Pay for Rising Tuition Fees

Raising minimum wages may be regarded as a policy that would help students pay for rising tuition fees. This could be especially important for those who are otherwise credit constrained and hence who would find it difficult to finance post-secondary education, perhaps because of their disadvantaged status. Since students are increasingly working while in school, higher minimum wages could possibly help in this regard.

This, of course, must be traded off against the possibility that some may not be able to get jobs because of the higher minimum wage. As well, higher minimum wages may entice some to leave school to look for the higher paying jobs. Furthermore, there is no reason tuition fees should be singled out as a merited expenditure item any more than, say, the basic necessities of food, shelter and clothing. Policies to assist in meeting tuition fees are likely best dealt with more directly through such means as scholarships, loans and financial aid.

Protect the Unprotected

Historically, minimum wages were instituted to “protect the unprotected” – namely women and youths. As indicated by Whittingham (1970, p. 4-8) minimum wages were introduced in the 1920s:

“To protect the physical, moral and intellectual well-being of female workers … by ensuring that single female workers would be paid a living wage, thereby protecting those unorganised workers who had little bargaining power ...
…
In 1937 … the authority to set legal minimum wages was extended to male employees, a reflection of concern over cut-throat competition and the related socially undesirable impact on wages that occurred during the depression of the 1930s. However … while the principle of a minimum wage for male employees was accepted in 1937, with one minor exception floor rates for male workers was not ordered until 1963, twenty-six years after the enabling legislation was passed …

A more modern day rationale would include protecting others who have little individual bargaining power or collective bargaining power against employers (and the modern day rationale would not likely deem women in need of categorical “protection”).

It is possible that benevolent employers may willingly accept the legislative constraints of minimum wages (as well as other employment standards) providing that it is uniformly and fairly applied to all. In effect, it provides a level playing field and inhibits what some may regard as “unfair” competition based on low-wages. It gets employers around the “prisoner’s dilemma” problem of having to pay low wages to compete with their competitors who pay low wages. All may agree not to compete on that bases by agreeing to all be bound by legislative constraints that inhibit them from paying low wages.

Of course, if the low wages reflected low productivity, then this would not be “unfair” competition. As well, rallying cries against “unfair” competition usually result from their being any competition. Also, the prisoner’s dilemma rationale of all agreeing not to compete on the bases of very low wages is not relevant to a global market place where it is not possible to enforce such co-operative behaviour.

Protect the Already Protected from Low-Wage Competition

A more cynical version of the protection rationale is that minimum wages are not designed to help those who receive the minimum wage, but rather to protect the already protected higher-wage groups who otherwise would be subject to competition from low-wage labour. This is an interpretation often given to the historical rationale to protect women and youths – that is, the real rationale was to protect males from competition from lower-wage women and youths. Unions can also benefit from reduced competition from low-wage labour. The same can apply to higher-wage employers for whom minimum wage legislation would not be a binding constraint, although it could be a binding constraint on their low-wage competitors.

It is often emphasized in economics that those who are regulated tend to “capture” the regulatory process to further their own ends, often under the guise of lofty social goals. This is especially the case when incumbent employers want to deter new firms from entering the market and competing on the basis of lower costs and hence prices. One way to do this is by extending, to potential new entrants, the costly regulations that the incumbent employers already meet – such incumbent employers have revealed that they can already meet those costs since they are surviving in the market under such costs. By extending them through laws and regulations they ensure that new entrants also have to meet those higher costs.

Reduce Nee

d for Unions A related cynical interpretation of the “real” rationale for labour standards legislation, including minimum wages, is to potentially reduce the demand for unions. If the “state” can provide the protection, there may be less need for individuals to look to unions to provide such protection. For some employers, employment standards laws may be the “lesser of two evils.” They generally impose costs, but involve less of a loss of control than can be the case under unionisation. In a game - theoretic context, labour standards laws can be a form of collective pre-commitment whereby employers as a group agree to be mutually bound by such laws. The laws are costly, but less costly than the alternative of, say, unionisation. Having laws that are uniformly mandated on all employers can get around the prisoner’s dilemma problem that each employer would have an incentive to defect if adherence to such employment standards to deter unionisation relied on voluntary co-operation.

For this reason unions often opposed labour standards laws when first introduced. The fact that unions almost invariably support them now, however, suggests that this rationale as being a possible substitute for unions is offset by the fact that they tend to help unions by reducing competition from low-wage labour that could otherwise be a substitute for unions.

Provide a Model to be Emulated by Others

A rationale for minimum wage legislation that may be particularly relevant to the federal jurisdiction is to provide a model to be emulated by other jurisdictions. This is particularly the case since, as discussed subsequently, workers in the federal jurisdiction tend not to work in jobs that are affected by minimum wages at least at conventional levels. As well, the federal jurisdiction may be closely watched as a possible leader in “progressive” initiatives, setting the cue for others to follow. The federal minimum wage may thereby be a pattern setting norm to be emulated by other jurisdictions.

There is empirical evidence that minimum wage setting in Canada follows a “race to the middle” based on government’s responding to voters’ notions of fairness (Green and Harrison, 2005). That is, minimum wages are set by comparisons to the minimum wage in other jurisdictions as well as the median wage of other low-skilled workers so as not to appear to be unfair in their minimum wage setting process. Ideological pressures cause deviations from that pattern, with left-leaning governments tending to set relatively higher minimum wages and right-leaning ones setting lower ones (largely by not altering the minimum wage so that its real value gets eroded by inflation), although those deviations dissipate over time as governments change.

Whether the federal government does, or should, follow this process is an open question (dealt with in the conclusion of this paper). As indicated, it is more likely to be a beacon for norm setting and hence can deviate from the pattern of following others to the middle. That it should fulfil its role as a pattern setter assumes that the advantages of a higher minimum wage outweigh its disadvantages – an assumption that is extremely contested as documented subsequently. Furthermore, an argument can be made that it should not play the role of a leader putting political pressure on others to follow since the federal government does not likely bear the cost (in terms of possible lost jobs) from a higher minimum wage given that few workers in the federal jurisdiction are at the minimum wage. As such, it may be socially irresponsible to lead others into battle when it is at no risk. It is simply enhancing its image at the expense of others who may feel pressured to follow, but whose constituencies may bear the cost. In effect, it may simply be encouraging the “exporting” of jobs by pricing them out of the market, given global pressures.

Relevance of Rationales in Current Environment

Clearly, there are a variety of rationales for minimum wage legislation and they are not always mutually consistent (e.g., reduce low-wage non-union competition which should foster unionisation versus reduce the demand for unions by providing higher wages through legislative fiat). Whatever the rationales, there are reasons to believe that many of them are more relevant and others are less relevant in the new world of work of today compared to the former old world of work.

Minimum wages may be more relevant to curb the rising wage inequality, although this could also mean that the increasing number at the bottom of the wage distribution could have their employment opportunities adversely affected by minimum wages. Minimum wages also may be more relevant for encouraging people off of the rolls of welfare or other forms of income maintenance (assuming, again, that they obtain jobs) since increased emphasis is being placed on “workfare” or encouraging able-bodied person off the roles of welfare. As well, minimum wages may be regarded as increasingly relevant to assist the “working poor” whose wages otherwise are so low that they cannot earn a living wage. Minimum wages may be more relevant to eliminate low-wage jobs and encourage movement up the value-added chain, given the increased emphasis on competing on the bases of high value-added and high productivity for high-wage economies. They may be more relevant to protect the unprotected who have little individual or collective bargaining power, given the decline in unionization (slight in Canada, nevertheless a decline) as well as the likely decline in union bargaining power given the forces of global competition.

In contrast, minimum wages may be less relevant in the new compared to the old world of work for a number of reasons. Given the proliferation of multiple earners in the family (emanating from the increased labour force participation of women and youths working part-time while in school) the connection between an individual’s wage and family poverty is weakened even further. The growth of small business and non-standard employment means that minimum wage legislation may be more difficult to monitor given the nature of such jobs (although this is likely to be more true of other aspects of labour standards since minimum wages are relatively straightforward). There is concern, however, that regulations can have a disproportionately adverse effect on the small business sector given the small profit margins, and that this can jeopardise the new job creation that characterises that sector. In general, there is growing concern that increased regulation will deter new investment and the jobs associated with that investment given the increased mobility of financial and physical capital in the global economy. This could be of particular concern if federal minimum wage increases, which are not likely to be resisted in that sector given the fact that it is a non-binding constraint for most federal employers, played a leading-edge role putting political pressure on other jurisdictions to raise their minimum wages and this regulatory constraint affected employers in those jurisdictions.

Many of the dilemmas associated with minimum wage legislation arise because wages are an unusual “price” in that they are called upon to serve a variety of competing functions, not all of which are mutually compatible. From an economist’s perspective, wages are used to allocate labour to its most efficient use and to create the appropriate incentives with respect to labour supply (participation, hours of work) as well as human capital formation (education, training, mobility, job search). From a policy perspective, however, wages are also called upon to help alleviate poverty and to influence the distribution of income. They can also have an impact on aggregate unemployment as well as competitiveness. Not surprisingly, when a single instrument is called upon to serve so many functions, conflicts may arise.