Friday, November 26, 2010

The proposed reduction in the National Minimum Wage

The government has proposed reducing the national minimum wage (NMW)by €1 per hour (see discussion pp35-36 of the National Plan). This has generated a lot of comment in the media and the blogosphere. Here is my reaction.

While economics is often castigated for what it doesn’t know, it is generally accepted that the demand for labour does slope down and the supply slopes up. This means that a minimum wage above the equilibrium will increase unemployment. There are circumstances in which this does not happen (labour market monopsony) but I think the presumption should be that these are the exception in the absence of evidence to the contrary. Unfortunately, as with so many other things, we have no real evidence for Ireland. The international evidence, of which there is a lot, is mixed but one has to question how relevant much of it is to the current Irish situation anyway.

For reasons I don’t entirely understand, discussion about the minimum wage evoke visceral and often incoherent responses- see the rants on the “Irish Economy” blog of late. Even amongst the more coherent, dogma seems to lie close to the surface: those who question the merit of a NMW or advocate its reduction are accused of some ideological bias. Note that only other people suffer from ideological bias, not oneself. Clearly Vincent Browne, the Labour Party and the trades union leadership are above having any ideology. I think the probability of there being a reasoned public debate on the subject is precisely 0. Those who argue against the present proposal (& similar policies) are often motivated by a genuine concern for the less well-off, something which is to be applauded. But, in my view, they do not seem to be able to grasp that a NMW can actually help condemn someone to unemployment.

So will the policy matter? It is hard to say: like most things “it depends”. It depends on how it is implemented. The newspapers today suggest that it will only apply to new hires. This is not mentioned in the plan. If this is the policy it is both stupid and cynical. One would not expect many new hires in the present market so why bother? It looks like a cosmetic nod to the outside world – who are funding us- with a broad wink to the domestic world “Ah, we’re not really reducing it, lads”. Nobody is fooled by this. Do we really want international observers to think that we are not serious about getting our economy going again? According to one report the leader of the Green Party is trying to distance the government (& presumably himself) from the policy by claiming that Commissioner Olli Rehn required it (shades of "An older boy made me do it, sir"). There is also the possibility, if the policy applies to new hires only, that firms react to it by letting workers go simply so they can hire others at the lower wage.

The interaction between the NMW and other policies (Martin Ryan touched on this in comments below) is central. One has to compare the rate with the alternative, one element of which is the level of unemployment benefit. It is important remember that replacement rates are complex because of various social welfare entitlements (including medical cards) that the unemployed may receive. So there are policy complementarities that need to be worked out. If replacement rates remain high – as they are for some in the population- then any positive employment effects will be attenuated. Another detail is what happens to the various sectoral arrangements where a lot of the low paid workers actually are.

My guess is, the government is right to do what they are doing (assuming they are serious about it), it might do some good, is very unlikely to do much harm but the devil is in the details.


Martin Ryan said...

Thanks for contributing such a detailed analysis on this topic Kevin; I am in agreement with your commentary.

One point I want to highlight is the popular criticism of the NMW reduction related to consumption-demand and living standards (I don't agree with this criticism in light of the massive unemployment problem in Ireland at present). It was expressed recently by TASC, as follows:

"TASC is especially concerned at the proposal to reduce the Minimum Wage by €1 an hour. In research published earlier this year, and presented to the Joint Oireachtas Committee on Enterprise, Trade and Innovation, TASC argued that reducing the minimum wage will have little impact on competitiveness but will reduce aggregate demand in the economy – which in turn will result in job

TASC has long argued that the incomes of those at the lower and middle end of the income
distribution should be protected – not just on equality grounds, but also for economic reasons.
Middle and lower income earners are more likely to spend all or most of their incomes, thus
providing much-needed demand in the economy."

TASC Comment on the NMW Reduction

Obviously such a statement draws on many ideas, such as the effects of NMW reduction in general equilibrium, and the interaction with marginal propensity to consume. Bearing in mind the policy-goal of internal devaluation would also be salient here I imagine. I was just wondering if you had any comment on the TASC argument Kevin?

Anonymous said...

I'm in support of a high minimum wage, but concede that a higher minimum wage could have the effect of increasing unemployment. My response to that is, basically, when wages get low enough, one may as well not even have a job. I personally, at least, would rather be unemployed and receive welfare than work for poverty wages.

Jason Loughrey said...

I actually agree with Kevin and Martin on this one. The minimum wage can be a bulwark against discriminatory practices. But I think that it is also wrong to deny someone labour that they are freely willing to participate in at €7.65 per hour. It is really a very complex area as Kevin suggests and welfare is not just determined by wages. I think that we should all take a look at the paper by Whelan and Maitre entitled "Protecting the Vulnerable: Poverty and Social Exclusion in Ireland as the Economic Crisis Emerged". The economically vulnerable are not just those people living on the minimum wage. In any case the politicians should lead by example and impose a wage cut upon themselves first before embarking on this policy. Given that the empirical evidence is not very strong on the minimum wage, the political economy is crucial. For me the aggregate demand argument does not seal the issue by any means.