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Phil O'Reilly

The cruel dark side of the minimum wage

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One of the tenets of economics is that an increase in the price of something causes less of it to be purchased. It’s a tenet that’s central to the minimum wage debate. The danger for those on the minimum wage is that they can be priced out of the market if the level of the minimum wage gets out of kilter with their level of productivity.

This danger has increased over recent years with successive increases in the level of the minimum wage. This is unfortunate given that the minimum wage was instituted with the noblest of intentions.

At the end of the nineteenth century New Zealand was one of the first countries in the world to introduce a base level below which pay rates were not permitted to fall. It was doubtless one of the reasons for our early reputation as a compassionate and progressive country. But now it’s apparent that the minimum wage is more likely to undermine job opportunities than create them.

Now it would be more compassionate to adopt different methods to help low-skilled workers improve their income levels. The obvious way is to increase skills, rather than arbitrarily increasing income levels without reference to skills.

Our need for more and better skills is manifest. In survey after survey conducted by Business NZ in recent years the overwhelming difficulty cited by employers has been their inability to source relevant and adequate skilled labour.

It’s wrong to have this huge unmet need while paying for an incomes policy that bears no relation to skills. Meanwhile, the minimum wage now appears to set the floor for collective bargaining. Where there was once a considerable gap between the lowest collective agreement rate and the minimum wage, today the difference is much smaller.

Another recent change is the virtual disappearance of the youth rate, its application limited to those in training and to roughly the first 3 months of a 16 or 17-year old ‘new entrant’s’ employment.The youth rate in its previous form – applying to all 16- and 17-year olds – was an aspect of the minimum wage policy that did at least have some logic. But getting rid of (most) youth rates – while retaining the minimum wage overall – makes it comparatively harder for young people to get their first job.

This is borne out by OECD research that indicates a 10% increase in the minimum wage leads to a 3% increase in youth unemployment. This should be a concern for us, as youth unemployment in New Zealand is around four times higher than overall unemployment.

Getting rid of youth rates affects firms’ internal relativities, since an arbitrary increase in pay for those on the first rung of the employment ladder has a knock-on effect raising other wages, with inflationary effects overall. And removing youth rates for most, while retaining them for trainees, is a disincentive for young people to undergo training.

People don’t stay on youth rates for long. The evidence is that as they pick up skills, they move quickly into normal pay bands. Youth rates are therefore similar to a probationary period at the beginning of employment – they are useful in allowing an employer and employee to try each other out with not too much risk to either party, potentially providing a basis for a strong future employment relationship.

However the shape of our minimum wage policy has now been changed to a largely general benefit, while still subject to regular upwards revisions. And now we are at the time of the year when the Government decides whether or not to further increase the minimum wage.

What factors should be brought to bear on its decision?

The most salient one is that if the cost of employing low-productivity workers rises, fewer will be employed. Employers are more likely to look for employees with higher productivity potential than to take on workers in need of greater help or supervision, and in the light of the current economic downturn this effect will be exacerbated.

A factor that should not be entertained is the

recent suggestion of indexing minimum wage increases to the Consumers Price Index.Indexing any wages at all to inflation is a bad idea: wages should be allowed to reflect the productivity and value of the job performed and should not be artificially linked to external forces.Indexing the minimum wage to the CPI would be worse still – artificially linking external forces to a wage formula that is itself artificial.

As with many feel-good ideas, raising the minimum wage may seem to be a good thing. But it has what commentators have called a ‘cruel dark side’, reducing employment opportunities for those with the fewest skills. Minimum wage laws guarantee minimum wages, but cannot guarantee what New Zealand needs more urgently: skills, productivity and jobs.