Lowering unemployment by hiking minimum wage

The author is Associate Chair and Director of Graduate Studies Program, Department of Economics, Ateneo De Manila University.

For most economists, the idea of increasing the minimum wage is taboo.
Raise the idea and one instantly gets tagged for being a leftist.
Mention the thought and everybody jumps on one for defying the law of
supply and demand. Tinker with it and one supposedly endangers the
health of the economy by increasing the rate of unemployment.

The reason is simple. Get rid of the minimum wage, and supply and
demand will take care of itself. In due time, the labor market settles
at equilibrium. The number of laborers who desire to work (labor
supply) equals the number of employment opportunities (labor demand).
Thus, everybody gets employed.

On the other hand, raise the minimum wage and the cost of labor
increases. As a result, companies are less willing and able to hire
more. And this increases the rate of unemployment. In fact, one may
even draw a simple supply and demand diagram to show the increase of
unemployment and what economists call the deadweight loss.

As in reality, a World Bank study indicates that a 10% increase of
minimum wage increases unemployment by 7%. Indeed, this agrees with the
supply and demand of labor markets. And this justifies most economists
view. Increasing the minimum wage is detrimental to the economy as it
raises unemployment.

To analyze further, suppose that the minimum wage is P100 and that the
unemployment rate is 9%. To simplify, suppose that there are 10,000
laborers. This means that 9% or 900 are unemployed, and 9,100 of them
earn minimum wage. From that, aggregate wage is P910,000. Suppose that
government raises wage by 10% to P110. This necessarily increases
unemployment by 7% from 900 to 963. This means that minimum wage
earners decrease from 9,100 to 9,037. From that, aggregate wage changes
from P910,000 to P994,070.

In other words, aggregate wage increases by P84,070. If there are 20
working days per month, this translates to P1,681,400 per month or
P20,176,800 per year. Without counting the 13th-month pay and the
multiplier effect, this is P20,176,800 per year for Megamall, Jollibee,
and Aling Nenes Sari-Sari Store to make. And this translates to more
jobs!

More so, raising the minimum wage improves general welfare. Carl
Shapiro and Joseph Stiglitz (1984) once proposed to improve welfare by
collecting a lump-sum tax or tax on income, then transfer revenue to
employees as a form of subsidy on wage. This way, demand for output
goods increase. Firms sales and then profit increase. They increase
output and therefore increase demand for labor. Ultimately, welfare
improves.

But this does not fundamentally differ from raising the minimum wage.
Both effectively take income from firms. Both essentially transfer
money from firms to workers. The only difference is that money goes
straight to workers.

In other words, it is more efficient. First, the money goes straight to
wage earners, instead of having the money passed through government
paperwork, bureaucracy and even corruption. Second, it is more
difficult not to pay. When a firm does not pay tax, the government
sues. When it does not pay the wage earner, the wage earner sues.
Because the money ultimately belongs to the wage earner, he or she is
more relentless to make the firm pay. Third, taxation has more legal
loopholes, and greater administrative costs. For minimum wage, once the
firm hires, they pay at least the minimum wage or they pay illegally;
and there are no ifs, ands or buts on that. And fourth, instead of the
government spending for projects that it thinks are socially equitable,
wage earners themselves – spend the money to where their satisfaction
(utility) is maximized.

More so, raising the minimum wage increases government’s revenue. As
stated, raising the minimum wage by 10% results to greater aggregate
wage. This means greater tax base for the government. Add the fact that
the Bureau of Internal Revenue (BIR) proportionately collects more tax
from wage than on corporate profit, revenue will even more likely
increase.

Nonetheless, increasing the minimum wage has other potential harms. For
one, doing so might increase inflation rate. Via Engels Law, minimum
wage earners proportionately spend more on necessities as food. Thus,
increasing the minimum wage increases wealth of wage earners, and this
increases demand especially on food items. As of February 2002, the
year-on-year inflation rate is approximately 3.4%, which is lowest in
recent history. Add the fact that this is mainly so because inflation
of food is approximately 1.5%. Then, increasing the minimum wage is not
likely to cause inflation.

We also know that industry sector is only 80% capacity utilized. Thus,
the increase in aggregate demand is not likely to push the industry
sector to its limit. Consequently, price in the industry sector is not
likely to increase.

Another argument that goes against raising the minimum wage is that it
may decrease investment. This goes for investors (foreign and domestic)
who want to set in this country to sell its products in the domestic
market, and those who want to export its products. For those who intend
to sell products in the domestic market, the cost of labor is offset by
added demand in the market. Thus, this type of investment is not likely
to be affected.

For investors who intend to export, China already offers extremely
lower wages to its laborers than we do. Thus, current foreign investors
would have already left long ago if only wage determines their
location. There is more than wage that investors consider before
investing; perhaps it is efficiency, due to efficiency wage models;
perhaps it is something else; but it is not only wage. In addition,
foreign investors usually pay greater than the minimum wage to begin
with. Thus, they are unlikely to be affected.

And finally and most importantly for politicians who claim to want to
alleviate poverty, raising the minimum wage is good politics. It
decreases labor unrest. And this leads to social benefit.

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