Minimum wage proves a blunt instrument

IN a recent research report, my colleagues Rachel Ong and Richard Seymour of the Centre for Labour Market Research, and I investigated aspects of the lives of people living on the federal minimum wage.

Following some media coverage of our findings, and a particularly harsh rebuke from Carolyn Smith of the Liquor Hospitality and Miscellaneous Union, I would like to clarify the purpose of that research and our findings.

The report was prepared for a research forum held by the Australian Fair Pay Commission. Most economists, though not all, accept that raising minimum wages results in employers offering fewer jobs and hence in lower employment. Previous research into minimum wages has concentrated on estimating the size of this effect.

Instead, we focused on the qualitative side of the trade-off. If an increase in the minimum wage does lead to some jobs being lost, how does the quality of life in unemployment compare to life on the minimum wage? Surely the commission should take this into account in setting minimum wages.

Using data from the Household, Income and Labour Dynamics in Australia survey, we compared a range of measures of wellbeing for the unemployed and for workers earning the federal minimum wage or below. We also included two other groups: medium wage earners who earned above minimum wages but below the top 25 per cent of wages; and high wage earners, who were defined as the top 25 per cent of earners.

The most important finding is that, by every measure investigated, people in unemployment are significantly worse off than people working in minimum wage jobs. The unemployed have worse health, lower life satisfaction, live in poorer households, experience substantially greater incidences of financial stress, and have poorer housing status.

The finding that most concerned Ms Smith was that there was no difference in the average reported levels of life satisfaction between minimum wage workers and those on medium wages. She described the results as 'nonsense' and claims that no other studies have found this result.

This is patently false. Ever since economists started working with measures of subjective wellbeing, such as life satisfaction or happiness, the weak link between income and subjective wellbeing in advanced economies has posed a major challenge to the profession.

After all, it is inconsistent with utility theory upon which the micro-foundations of economics are built, and questions governments' pursuit of economic growth as the principal objective of macro-economic policy.

So many studies have produced precisely the same result that a large literature now exists trying to account for it. Perhaps the most common explanation is that people's expectations rapidly adjust to their higher incomes, such that any increase in satisfaction quickly dissipates.

Our analysis suggests another reason why minimum wage workers in Australia are not so unhappy. By and large, minimum wage workers do not live in poor households.

Using a well-known measure of 'equivalised' household income, which adjusts household income for the number of adults and children living in the household, we divided the sample into income deciles.

More than half of all minimum wage workers actually live in households in the fourth, fifth and sixth deciles, right in the middle of the income distribution, and a further quarter live in higher income households.

Few live in households in the poorest 10th.

The reason for this is that households in which there are no working adults dominated the bottom deciles of the household income distribution. These include the unemployed, pensioners and many sole parents.

An important implication of this is that increasing the minimum wage will do little to address poverty or income inequality.

It will help many people who live in households in the middle of the income distribution, and a significant number who live in higher income households, but will help few from the poorest households.

These are the main reasons behind our conclusion that, in setting minimum wages, "the commission should be extremely wary of the potential impact of higher minimum wages on employment".

First, if an increase in the minimum wage results in people being unemployed rather than employed, then a very substantial loss of welfare is imposed on those individuals.

The loss of welfare associated with unemployment extends well beyond the financial impact, affecting people's self-esteem, mental health and too often impacting negatively upon the wider family.

Compared to this, the positive impact of higher wages for those who remain in minimum wage jobs will be very small. Second, increasing the minimum wage is a very blunt way of addressing poverty and income inequality. To the extent that it creates unemployment, it may even exacerbate it.

Ms Smith says it is all about being paid fairly for the work you do. That may be so. All we are saying is that in determining what is 'fair', the commission should consider the plight of those who are deprived of the opportunity for employment and of making a go of their lives.

It is the absence of work that really drives poverty and inequality in opportunity in Australia rather than the low wages of those in employment.

n Dr Michael Dockery is an associate professor at Curtin Business School.