Minimum Wages and their Alternatives: A Critical Assessment

Abstract

Do minimum wages reduce in-work poverty and wage inequality? Or can alternative policies do better? Germany suffers from high unemployment among low-skilled workers and rising wage dispersion at the lower end of the wage distribution. We analyse the impact on employment, wage inequality, public expenditure, and incomes of poor households of three different policy options currently being discussed in Germany: a statutory minimum wage, a combination of minimum wages and wage subsidies, and pure wage subsidies to low-paid workers. In doing so, we distinguish between perfectly competitive and monopsonistic labour markets. We find that a minimum wage of EUR 7.50 would cost between 410,000 and 840,000 low-paid jobs, increasing the fiscal burden, while only moderately raising the income of poor households. With pure wage subsidies, the government can always ensure more favourable employment effects. Combining a minimum wage with a wage subsidy turns out to be extremely costly and inferior to wage subsidies in all respects.

Notes

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See eg D. Acemoglu, ‘Technical Change, Inequality and the Labor Market’, Journal of Economic Literature 40 (2002), pp.7–72.

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D. Acemoglu, ‘Cross-Country Inequality Trends’, Economic Journal 113 (2003), pp.F121–49; C. Dustmann, J. Lundstek and U. Schönberg, ‘Revisiting the German Wage Structure’, Quarterly Journal of Economics 124 (2009), pp.843–81.

L. McCall, ‘Explaining Levels of Within-Group Wage Inequality in U.S. Labor Markets’, Demography 37 (2000), pp.415–30.

G. Bosch and C. Weinkopf (eds), Low-wage Work in Germany (New York: Russell Sage Foundation: New York, 2008); W. Eichhorst and P. Marx, ‘Reforming German Labor Market Institutions: A Dual Path to Flexibility’, Journal of European Social Policy 21 (2011), pp.73–87.

Most economic schools are skeptical about the justification of minimum wages as an instrument of labour market regulation. For example, the German ordoliberal school, which is more favourable to certain kinds of state regulation than classical laissez-faire liberalism, proclaims that the state should create, preserve and manage a regulative framework in which competition, low inflation and high employment can be maintained. The market economy is seen as a tool to create sufficient means for an effective social policy. In designing a social order, however, the state must not intervene in the market process of price determination. While some redistribution of incomes is justified to maintain public support for the market economy in a democracy, direct intervention in specific market, such as setting a minimum wage, is not (W. Eucken, Grundsätze der Wirtschaftspolitik, Tübingen: Mohr Siebeck 1952). In the (New-)Keynesian tradition, active state interventions are justified to stabilise fluctuations in aggregate demand. The main reason for the state to intervene is that wage and price rigidities inhibit markets from clearing quickly through price adjustments. Instead of justifying the existence of minimum wages, this theoretical tradition sees nominal wage rigidity, generated not least by minimum wages, as the reason for further state intervention (H. Dixon, ‘New Keynesian Macroeconomics’, in S. Durlauf and L. Blume (eds), The New Palgrave Dictionary of Economics, 2nd edn, Basingstoke: Palgrave Macmillan, 2008).

D. Neumark and W. Wascher (Minimum Wages, Cambridge, MA: MIT Press, 2008) provide a comprehensive review of empirical studies on the employment effects of minimum wages for the US and other countries. The vast majority of studies finds that minimum wages have negative employment effects, especially if the focus is on the least skilled groups in the labour market.

J. Ragnitz and M. Thum, ‘The Empirical Relevance of Minimum Wages for the Low-Wage Sector in Germany’, CESifo Forum 2/2007, pp.35–7.

R. Bachmann, T. K. Bauer, J. Kluve, S. Schaffner, and C. M. Schmidt, Mindestlöhne in Deutschland. Beschäftigungswirkung und fiskalische Effekte (Essen: RWI Materialien 43/2008).

T. K. Bauer, J. Kluve, S. Schaffner, and C. M. Schmidt, ‘Fiscal Effects of Minimum Wages: An Analysis for Germany’, German Economic Review 10 (2009), pp.224–42.

K.-U. Müller and V. Steiner, ‘Mindestlöhne kosten Arbeitsplätze: Jobverluste vor allem bei Geringverdienern’, DIW Wochenbericht Nr. 30 (2008), pp.418–23; K.-U. Müller and V. Steiner, Would a Legal Minimum Wage Reduce Poverty? A Microsimulation sSudy for Germany, DIW Discussion Paper No. 791 (2008).

D. Card and A. B. Krueger, Myth and Measurement: The New Economics of the Minimum Wage (Princeton, NJ: Princeton University Press, 1995); A. Manning, Monopsony in Motion. Imperfect Competition in Labor Markets (Princeton, NJ: Princeton University Press, 2003); M. König and J. Möller, ‘Impacts of Minimum Wages – A Micro Data Analysis for the German Construction Sector’, International Journal of Manpower 30 (2009), pp.716–41.

For a detailed description of the GSOEP, see G. Wagner, J. Frick, and J. Schupp, ‘The German Socio-Economic Panel Study (SOEP) – Scope Evolution and Enhancements’, Schmollers Jahrbuch 127 (2007), pp.13969.

J. Gernandt and F. Pfeiffer, ‘Rising Wage Inequality in Germany’, Jahrbücher für Nationalökonomie und Statistik 227 (2007), pp.358–80; Dustmann et al., ‘Revisiting the German Wage Structure’.

Dustmann et al., ‘Revisiting the German Wage Structure’.

For an overview, see H.-W. Sinn, C. Holzner, W. Meister, W. Ochel, M. Werding, Redesigning the Welfare State. Germany's Current Agenda for an Activating Social Assistance (Cheltenham: Edward Elgar, 2006).

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K. Brenke and K. Zimmermann, ‘Reformagenda 2010 – Strukturreformen für Wachstum und Beschäftigung’, DIW Wochenbericht Nr. 11/2008, pp.117–24.

Statistik der Bundesagentur für Arbeit, http://statistik.arbeitsagentur.de

This may be explained by the fact that many people report very low life satisfaction when unemployed – even when one controls for income losses. For Germany, Knabe and Rätzel (A. Knabe and S. Rätzel, ‘Quantifying the Psychological Costs of Unemployment: The Role of Permanent Income’, Applied Economics, first published on 23 August 2010 [iFirst]) found that for a male employee the additional psychological loss is as large as the former net income and therefore higher than the actual loss of income. For female employees, the additional loss is about 60 per cent of the former income.

Gernandt and Pfeiffer, ‘Rising Wage Inequality in Germany’.

Acemoglu, ‘Cross-Country Inequality Trends’; Dustmann et al., ‘Revisiting the German Wage Structure’.

A. Kettner and M. Rebien, Hartz-IV-Reform. Impulse für den Arbeitsmarkt (Nürnberg: IAB-Kurzbericht 19/2007).

Cf. Bundesministerium für Arbeit und Soziales: Die 10 wichtigsten Fragen und Antworten zum Mindestlohn, 2008, http://194.145.122.101/sites/generator/25932/property=pdf/faq.pdf

B. Rürup, ‘Für einen moderaten allgemeinen Mindestlohn’, Ifo Schnelldienst 61 (2008), pp.5–7; Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung (2008): Widerstreitende Interessen - Ungenutzte Chancen, Jahresgutachten 2006/2007 (Stuttgart: Metzler-Poeschler, 2008); P. Bofinger, M. Dietz, S. Genders and U. Walwei, Vorrang für das reguläre Beschäftigungsverhältnis: Ein Konzept für Existenzsichernde Beschäftigung im Niedriglohnbereich (Gutachten für das Sächsische Ministerium für Wirtschaft und Arbeit, Dresden 2006); König and Möller, ‘Impacts of Minimum Wages’.

Information about the campaign activities of minimum-wage supporters can be found on the trade union federation's website: www.mindestlohn.de

For a detailed description of the simulations, see A. Knabe and R. Schöb, ‘Minimum Wage Incidence: The Case for Germany’, Finanzarchiv/Public Finance Analysis 65(2009), pp. 403–41.

Figures for the UK and France are for 2007 and for the Netherlands for 2005 (Eurostat, Minimum Wages, http://epp.eurostat.ec.europa.eu/portal/page?pageid=1996,45323734&_dad=portal&_schema=PORTAL&screen=welcomeref&open=/labour/earn/earn_minw&language=de&product=EU_MASTER_labour_market&root=EU_MASTER_labour_market&scrollto=0; 2008).

Ragnitz and Thum, ‘The Empirical Relevance of Minimum Wages for the Low-wage Sector in Germany’.

Our results closely correspond to those by Bauer et al. (T. K. Bauer, J. Kluve, S. Schaffner, and C. M. Schmidt, ‘Fiscal Effects of Minimum Wages: An Analysis for Germany’) who find that a minimum wage of EUR 7.50 would destroy the jobs of 626,000 western German and 235,000 eastern German workers.

Card and Krueger, ‘Myth and Measurement’, p.373; for an extensive treatment, see Manning, ‘Monopsony in Motion’.

See eg Manning, ‘Monopsony in Motion’.

Card and Krueger, ‘Myth and Measurement’.

Bundesministerium für Arbeit und Soziales, Lebenslagen in Deutschland. Der 3. Armuts- und Reichtumsbericht der Bundesregierung, Berlin 2008.

For our calculations, we assume that all full-time and part-time employees who are laid off will receive UB I. If they received supplementary UB II even before becoming unemployed, they will receive the full UB II amount without any deductions. Persons formerly employed in a mini job who received supplementary UB II will continue to receive UB II; all other workers will not receive any public transfers when becoming unemployed. Other factor incomes are taxed at an average tax rate of 30 per cent.

See F. Kramarz and T. Philippon, ‘The Impact of Differential Payroll Tax Subsidies on Minimum Wage Employment’, Journal of Public Economics, 82 (2001), pp.115–46; G. Laroque and B. Salanié, ‘Une Décomposition du Non-Emploi en France’, Economie et Statistique Nr. 331 (2000), pp.47–66; G. Laroque and B. Salanié, ‘Labour Market Institutions and Employment in France’, Journal of Applied Econometrics 17 (2002), pp.2548.

P. Mühlau and W. Salverda, ‘Employment and Earnings Effects of Low-wage Subsidies: The Case of SPAK in the Netherlands’, in W. Salverda, C. Lucifora and B. Nolan (eds), Policy Measures for Low-Wage Employment in Europe (Cheltenham: Edgar Elgar 2000), pp.67–92; R. de Mooij, Reinventing the Welfare State (The Hague: CPB Netherlands Bureau for Economic Policy Analysis, 2006).

I. Marx, ‘Job Subsidies and Cuts in Employers’ Social Security Contributions: The Verdict of Empirical Evaluation Studies', International Labour Review 140 (2001), pp.69–85.

For further details, see H. Sterdyniak (2007), Low-skilled Jobs: The French Strategy (Documents de Travail de l'OFCE 2007-15, OFCE, 2007).

Laroque and Salanié, ‘Labour Market Institutions and Employment in France’.

H.-W. Sinn et al., ‘Redesigning the Welfare State’; H.-W. Sinn, C. Holzner, W. Meister, W. Ochel, and M. Werding, ‘Die zentralen Elemente der Aktivierenden Sozialhilfe’, ifo Schnelldienst 60 (2007), pp.48–53.

See Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung, Widerstreitende Interessen – Ungenutzte Chancen, Jahresgutachten 2006/2007 (Stuttgart: Metzler-Poeschler 2006); Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung, Arbeitslosengeld II reformieren: Ein zielgerichtetes Kombilohnmodell (Wiesbaden 2006).

R. Schöb and J. Weimann, Arbeit ist machbar – Die Magdeburger Alternative: Eine sanfte Therapie für Deutschland (Dößel: Janos Stekovics, 5. Auflage 2006); A. Knabe, R. Schöb and J. Weimann, ‘Marginal Employment Subsidization: A New Concept and a Reappraisal’, Kyklos 50 (2006), pp.557–78.

For a formal analysis see Knabe, Schöb and Weimann, ‘Marginal Employment Subsidization’; A. Knabe and R. Schöb, ‘Subsidizing Extra Jobs: Promoting Employment by Taming the Unions’, CESifo Working Paper No. 2130, October 2007.