Richard Grant: Why a minimum wage doesn’t equal employment

One could argue it’s another classic capitalist versus socialist argument in confused South Africa – the case for a minimum wage. The capitalists arguing against it because it will hurt the bottom line and jobs, while the socialists argue for it because it will up living standards. And in the piece below Richard Grant argues against the use of a minimum wage to ease unemployment. The professor of finance and economics says those who attribute productivity gains to increases in a minimum wage, confuse the horse with the cart. He says it also has a negative impact on youth unemployment, as first starters find it more difficult to find a job, as experience doesn’t weigh up with the minimum salary. Not a good sign in a country that has a 54 percent youth unemployment rate. – Stuart Lowman

By Richard Grant*

South Africa began 2016 with an official unemployment rate of 26.7% in the first quarter. The expanded measure of unemployment – which includes working age people who have become “disillusioned” with their employment prospects and have dropped out of the labour force – was officially greater than 36%. This means that at least one third of the potential labour force is presently either unable or unwilling to engage in productive activities for pay – at least not in the documented economy. Why?

Richard Grant
Richard Grant

The Economic Freedom of the World (EFW) annual report for 2016, released in mid-September, shows that South Africa has continued to decline in economic freedom across all five major measured categories. SA declined in absolute terms to an overall rating of 6.64 (out of 10), compared to 6.74 the previous year. The relative decline is even more glaring. Of 159 countries rated this year, South Africa placed 105th, which is a severe drop from the previous year’s rank of 96th, and from 89th the year before that.

A surprisingly large number of politicians and academics have proposed the imposition of an effective national minimum wage in the expectation that it would increase incomes and promote economic growth. But the low rating in the EFW section on Labor Market Relations, and the high unemployment rate, should warn us against such poorly founded interventions.

A more sophisticated approach might recognise that to forbid the payment of any wage below the legal minimum would price some of the least productive workers out of the labour market. This would serve to restrict the supply of labour such that the marginal product of labour would rise to the level of the new wage floor, the minimum wage. With the assistance of government to eliminate the competition from lower-priced workers, those remaining workers who are sufficiently productive to keep their jobs will indeed enjoy the new higher wage.

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We cannot, however, be certain that most (or any) of the original low-paid workers will remain. As the wage rate is raised, new workers might enter or re-enter the labour force now that the higher wage makes it worth their while. These might be workers who previously did not need to work because they were perhaps retired or supported by relatives – or they might be workers from other occupations who prefer their new jobs but would not take them at the old lower wage. In either case, the new workers displace the original workers.

The union lobbyists would make the case that their less-skilled brethren deserve a “living wage” or that by increasing the minimum wage, the increased purchasing power would stimulate economic growth. Of course, the true, but unspoken, goal of the union lobbyists is to raise the minimum wage sufficiently so that the less-skilled workers can no longer compete for jobs by charging less than the skilled workers. This is just another technique for restricting the supply of labour in order to increase further, the already higher wages for a subset of skilled workers.

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A minimum wage discriminates against youth. Young people, entering the working world for the first time, have yet to learn the skills needed to earn higher wages. Entry-level jobs with low wages are the pathway for young people to gain skills and experience without which they are unlikely to be able to rise to the higher-paying jobs. This is why most countries that have minimum wages will have a separate, lower minimum for youth. Otherwise, they would be condemning many young people to unemployment and stunted career prospects. South Africa suffers a youth unemployment rate above 54%.

The imposition of a minimum wage does not suddenly impart new skills to low-wage workers. Although a wage increase can certainly improve morale, there is no assurance that workers will increase their productive skills any faster than they would have, or sufficiently to justify payment at the new minimum wage level. It is more likely that some percentage of the labour force will be displaced, and that they will take longer to achieve higher wage levels than they would have otherwise. Academic researchers might declare the percentage of displaced workers to be “small,” but to those who are displaced, and to their dependents, the impact is not insignificant. Everyone who would have interacted with them is affected.

Read also: Warren Buffett on income inequality – minimum wages no answer

A legislatively imposed minimum wage should not be confused with a wage increase that is voluntarily offered to workers by their employer. Academic researchers who attribute productivity gains to increases in a statutory minimum wage are generally confusing the cart with the horse. The statistics they study are generated by the actions of legislators who are eager to take credit for minimum wage increases but not foolish enough to impose the bold increases that would make the unemployment effects too large and too obvious.

  • Richard Grant is Professor of Finance & Economics, Lipscomb University, Nashville, Tennessee & Publications Editor, Free Market Foundation
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