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The economics behind the ‘living wage’ debate


Conor Yung

By

March 19th, 2018


Australia has joined the global political trend towards greater wage regulation, with a recent campaign from the ACTU calling for a ‘living wage’. However, examining the predicted effects of such a change would reveal it to be based on misguided beliefs. Conor Yung explains.


Debate concerning whether Australia’s minimum wage should become a ‘living wage’ has been sparked by a campaign from the Australian Council of Trade Unions (ACTU).[1] This has been led by the belief that the current minimum wage is not enough for workers to sustain a healthy living standard. The transition to a living wage has been more advanced in other regions of the world, with several US municipalities moving beyond the conventional minimum wage.

The push for a living wage has followed recent reports on wage stagnation. Historically, wages have had a linear relationship with economic growth. As the economy grew, workers’ labour became increasingly important to service the increases in demand, which generally resulted in higher wages. However, that trend has dissipated in Western economies due to globalisation. Labour demand, or the number of low-paying jobs, has decreased despite continued growth. The accessibility of cheap labour overseas and technological advances have provided a more cost-efficient alternative to employing human labour.[2]

 

What is a ‘living wage’?

The concepts of minimum wage and living wage are similar, in that both impose a price floor in the labour market, or a minimum cost of labour. However, whilst a minimum wage simply institutes a price at which companies must (legally) pay their employees, a living wage is far more ambitious. A living wage seeks to institute a wage that can provide for the basic needs for a 40-hour worker. The exact calculation of the living wage is a subject of mass debate; the current campaign by the ACTU proposes pegging the minimum wage to 60 percent of the median wage.[3]

 

Factors for consideration

The determination of a universal, optimal living wage is complicated by variants in the size of peoples’ families. Certain family structures, in particular single-income families, require a higher wage to stay out of poverty. The University of New South Wales Social Policy Research Centre (SPRC) conducted a report into the minimum income required by varying sizes of families, and it found that a single adult requires A$597 (before tax) a week to obtain a healthy living standard.[4] However, the national minimum wage is currently set at A$695 per week for a full-time worker. While that rate of earnings is inadequate to support a typical single-income family, the SPRC’s analysis suggests that a single worker already earns more than enough to obtain a healthy living standard.

Another factor is the effect an increase in the minimum wage would have on the price of labour. Like any product, the price of labour is deduced through the forces of supply and demand; a worker’s wage is simply what an employer is prepared to pay them, in competition with other employers. A living wage would simply act as a price floor, distorting this exchange by artificially increasing the cost of labour beyond its market value. As a result, employers may look to manage their labour costs by employing less people.

Increased wages may also have an adverse effect on price levels. Minimum wage rises increase the money supply of consumers, and if they are not matched by output growth, then inflation will occur because the demand for goods outpaces supply. The higher disposable income of workers causes an increase in consumption, which in turn leads to higher employment and higher prices in order to compensate for the increases in demand. This may lead to a further increase in wages, as lower unemployment increases labour demand, giving workers more bargaining power.[5] This is often the precedent for what is known as the ‘wage-price spiral’,[6] in which an increase in wages leads to perpetual inflation. Thus, workers’ real wages may not increase with a minimum wage rise due to the effect of inflation on one’s purchasing power.[7]

 

Research

Research has examined what is known as the ‘employment elasticity’, the change in employment associated with any given change in wages.[8] It has suggested that living wages are detrimental to employment in the labour market, due to their distorting effect on the price of labour.[9][10][11]

Studies have looked at the relation between increases in the minimum wage and the subsequent increase in unemployment, and found that a 10% increase in the minimum wage had caused a 1-3% increase in unemployment, which is more pronounced amongst young workers.[12] Thus, contrary to popular belief, an increase in the minimum wage would have a more deleterious effect on less-skilled workers in the labour market. There is also evidence that exposure to a high minimum wage has long-run effects of decreasing earnings later in life, due to having less training earlier in life.[13][14]

On the upside, other studies have found that workers are more committed to their job when working for a higher wage. They have also found increased productivity amongst the workers that are employed. Specifically, data collected from the city of Hamilton, Ontario indicates that there exists an increase in worker commitment and worker productivity, for those earning between CAD$15.95-$19.99 and those earning CAD$10.25 per hour.[15] Although this does not account for the broader economic effects on employment, the study shows that there are social benefits to those receiving the previous minimum wage rate.

 

The ACTU campaign to promote a ‘living wage’ needs to take into account the variants in family size and the broader economic impact of such policy. Research into the living wage has largely focused on its effect on employment and worker productivity. Whilst the ‘living wage’ proposal would likely give rise to increased worker commitment and productivity for those in the labour market, this would be at the expense of worker employment. Consequently, this would likely lead to a short term increase in consumption by those receiving the increase; however, the broader economic impact would be negative, due to its effect on prices and employment.

 

[1] Karp, P 2017, ‘Unions seek dramatic pay increases to ensure minimum ‘living wage”, The Guardian.

[2] Economist, T 2015, ‘When what comes down doesn’t go up’, <https://www.economist.com/news/briefing/21650086-salaries-rich-countries-are-stagnating-even-growth-returns-and-politicians-are-paying>.

[3] Karp, P 2018, ‘Labor considering options to peg minimum wage to median income’, The Guardian, <https://www.theguardian.com/business/2018/jan/31/labor-considering-options-to-peg-minimum-wage-to-median-income>.

[4] Greber, J 2018, ‘Half of Bill Shorten’s minimum wage workers are in top 50pc’, The Australian Financial Review, <http://www.afr.com/news/economy/half-of-bill-shortens-minimum-wage-workers-are-in-top-20pc-20180207-h0vdlf>.

[5] Blanchard, OJ 1986, ‘The wage price spiral’, The Quarterly Journal of Economics, vol. 101, no. 3, pp. 543-65.

[6] Investopedia ‘Price-Wage Spiral’, <https://www.investopedia.com/terms/w/wage-price-spiral.asp>.

[7] Blanchard, OJ 1986, ‘The wage price spiral’, The Quarterly Journal of Economics, vol. 101, no. 3, pp. 543-65.

[8] Economist, T 2017, ‘Economists argue about minimum wage’, <https://www.economist.com/news/finance-and-economics/21724802-two-studies-their-impact-seattle-reach-opposite-conclusions-economists-argue>.

[9] Brown, C, Gilroy, C & Kohen, A 1982, ‘The effect of the minimum wage on employment and unemployment’, Journal of Economic Literature, vol. 20, no. 2, pp. 487-528.

[10] Neumark, D & Nizalova, O 2007, ‘Minimum wage effects in the longer run’, Journal of Human resources, vol. 42, no. 2, pp. 435-52.

[11] Neumark, D & Wascher, W 1995, ‘Reconciling the Evidence of Employment Effects of Minimum Wages: A Review of Our Research Findings’.

[12] Tolley, G & Bernstein, P 1999, ‘Economic Analysis of a Living Wage Ordinance’.

[13] Ibid

[14] Neumark, D & Nizalova, O 2007, ‘Minimum wage effects in the longer run’, Journal of Human resources, vol. 42, no. 2, pp. 435-52.

[15] Zeng, Z & Honig, B 2017, ‘A study of living wage effects on employees’ performance‐related attitudes and behaviour’, Canadian Journal of Administrative Sciences/Revue Canadienne des Sciences de l’Administration, vol. 34, no. 1, pp. 19-32.

Image: M.o.B 68

 

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

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