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Archived - Minimum Wages in canada : theory, evidence and policy

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Theoretically Expected Impact Of Minimum Wages

Minimum wage legislation can have an impact on various dimensions of labour market behaviour[1]. The dimensions examined here include employment, hours of work, earnings, wage inequality, income distribution, labour force participation, unemployment, fringe benefits and working conditions, training, spillover effects on other wages, and aggregate wages. In this section, the expected effect is outlined based on basic principles of economics.

Employment

By far the most studied aspect of minimum wage legislation is its impact on employment. The static, partial equilibrium impact of minimum wages is straightforward. Minimum wage increases should unambiguously reduce employment since the substitution and scale effects work in the same direction. That is, the minimum wage increase should induce firms to substitute away from the higher priced labour that receives the minimum wage increase, and into using more of other inputs including capital and even higher priced labour that does not receive the minimum wage increase. In the short-run such substitution may be difficult, but in the long-run it can occur in subtle fashions especially as firms alter their technology and processes of production. For example: self-service gasoline stations with credit card payment systems can substitute for low-wage attendants who pump gas; buildings can be designed to require low maintenance as a substitute for custodial and maintenance services; discount retailers (e.g., Costco and Home Depot) that utilise automated inventory and self-service systems can substitute for more personalised retailing; pre-packaged foods can substitute for food preparation; disposable food containers can substitute for dishwashing; and almost “disposable” consumer goods can substitute for repairs (it is generally cheaper to buy a new toaster, likely made with low-wage foreign labour, than to try to repair a broken one).

In addition to this substitution effect, wage increases induce a scale or output effect as firms pass part of the cost increase to consumers who reduce their purchases of the more expensive goods or services. This in turn reduces the firm’s derived demand for the higher priced labour as well as all other complementary inputs. In the extreme, the cost increase could force some firms out of business, perhaps shifting some of their lost production offshore, thereby eliminating those jobs as well as the use of complementary inputs including other workers.

In a dynamic growing economy, these adverse employment effects would be manifest in the slower growth of employment of minimum wage jobs rather than layoffs or terminations of persons at the minimum wage. This is likely one of the reasons that minimum wage effects are so difficult to observe.

The magnitude of this adverse employment effect depends upon the elasticity of demand for labour with respect to the minimum wage increase. That elasticity is likely to be large, and hence the adverse employment effect substantial, if:

1. There are many good substitute inputs for those affected by the minimum wage increase
2. There are many good substitute goods and services for those produced by the minimum wage labour so that consumers will substitute away such goods when their price increases
3. Minimum wage labour costs are a substantial portion of the costs of producing the product or service
4. The substitute inputs are in elastic supply such that their use will not be choked off by their price increasing as the demand for such substitutes increase as they are used in place of minimum wage labour.

In general, most of these factors are such that the demand for minimum wage labour is likely to be fairly elastic, and hence the adverse employment effect large, especially in the longer run. For example, minimum wage labour is unlikely to possess scarce talents that make it such that other inputs cannot be substituted for minimum wage labour, especially in the longer run when employers have had the opportunity to alter their production process. Similarly, the products and services produced by minimum wage labour (e.g., textiles, personal services) are likely to be sensitive to price increases, especially given the availability of low-cost imports (in essence making low-wage labour in other countries a substitute for minimum wage labour in Canada). Even in the case of non-tradable personal services (e.g., restaurants, custodial and maintenance) there is generally considerable sensitivity to the prices that are charged in part because of intense competition as well as alternatives through subcontracting. Many minimum wage jobs are also in labour intensive industries where labour costs are a substantial component of total costs. Also, the substitute inputs (e.g., basic capital equipment and other labour) are likely to be fairly readily available in elastic supply

While minimum wage legislation should have an unambiguously negative effect on the demand for workers affected by the minimum wage, it can have an ambiguous effect on the demand for other workers who are not at the minimum wage. The substitution effect away from workers at the minimum wage should increase the demand for workers who are substituted for minimum wage labour. If minimum wages disproportionately affect teenagers, for example, this could mean an increase in the demand for youths (age 20-24) to the extent that they tend to be paid slightly above the minimum wage and are a good substitute for teenage labour. In contrast, if the employment of persons at the minimum wage fall then this means a reduction in the demand for other inputs (including workers) who are complements to workers at the minimum wage. Similarly, the output reduction emanating from the minimum wage increase (in the extreme, the firm going out of business) means a reduction in all inputs including other workers at the firm. For these reasons, the demand for non-minimum wage labour is affected in an ambiguous fashion by minimum wage increases; their employment could increase or decrease as a result of minimum wage changes.

Hours

While the employment response of minimum wage receives by far the most attention, employers can also adjust the hours of work of those affected by the minimum wage increase. The decision as to whether to adjust hours or employment generally depends on the quasi-fixed costs associated with hiring, training and terminating employees. If such costs are high, then firms are more likely to adjust the hours of existing employees so as not to incur the fixed costs if they terminate existing employees and may have to subsequently rehire them or hire and train new employees.

In general, such fixed costs are not regarded as substantial for less skilled employees at the minimum wage. Training is often minimal, as is recruiting and hiring costs, at least compared to more skilled employees who embody considerable human capital. For this reason, firms are just as likely to reduce the employment of minimum wage workers as they are to reduce their hours, in contrast to skilled employees where they may reduce their hours so as not to lose them (and the quasi-fixed hiring and training costs they embody).

This does suggest, however, that the employment response of minimum wage increases may understate the total reduction in labour demand to include hours reductions. In essence, if any hours reductions were converted to full-time equivalents, the employment response would be larger.

Labour Force Participation

Minimum wages could reduce labour force participation (i.e., the decision to enter the labour force and work or look for work) because the adverse employment effect would discourage people from entering the labour market given that fewer jobs are available – a form of the “discouraged worker” effect. Alternatively stated, those who cannot get a job because the minimum wage has “priced them out of the market” may leave the labour force altogether and engage in non-labour force activities. For younger people this could mean school, for older persons it could be retirement, and for others it may be household activities.

Working in the other direction, if a family member loses their job because of the minimum wage, other family members may enter the labour market and work or look for work –a form of the “added worker” effect. As well, given the higher wage in the minimum wage jobs more persons may engage in “wait unemployment” – remaining in the labour force in the hope of getting the more coveted job.

Unemployment

Minimum wages can increase unemployment to the extent that there is an adverse employment effect and the person remains in the labour force looking for work. This may exacerbated by the “added worker” effect if other family members also enter and look for work to offset the decline in family income associated with the job loss. It may be further exacerbated by the possibility that those who are looking for work may engage in longer “wait unemployment” given the higher-wage jobs. Working in the other direction, the fewer number of jobs that exist because they are priced out of the market by the minimum wage may lead some to leave the labour force altogether and engage in other activities such as school, retirement or household work. To the extent that there is substantial labour force withdrawal, then the rise in unemployment would be much smaller than the decrease in employment.

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Date Modified:

2011-11-22