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Social Justice and the Economics of the Minimum Wage

There has been ample media coverage of the well-deserved award of the Nobel Prize in Economics to Canadian David Card, in part for his work on the impacts of the minimum wage. As Andrew Coyne noted in the Globe and Mail, however, Card's work requires interpretation.

Card studied the impacts on employment of a small minimum wage increase in New Jersey in 1992 compared to adjacent Pennsylvania which did not raise its comparable low minimum wage. The key finding was that there was no negative impact on minimum wage jobs in New Jersey, contrary to the mainstream economic orthodoxy of the day.

Many subsequent studies have confirmed that modest increases in the minimum wage from low levels indeed have little or no impact on jobs. The most plausible explanation is that, left to their own devices, employers set the wage at too low a level. A wage increase can pay for itself by reducing very high turnover in low-paid jobs and associated recruitment and training costs.

Further, employers can respond to a minimum wage increase by accepting a somewhat lower profit margin, or by raising prices, rather than by cutting jobs.

Some thirty years after Card's study, economists take a much more nuanced view of minimum wages.

It has come to be recognized that higher minimum wages can be a significant tool to raise productivity, defined as the value of output per hour worked. Higher productivity can justify higher wages, increasing the quality of jobs.

Imagine you are in a minimum wage job paying $10 per hour and that you work 30 hours per week, earning a total of $300. If the minimum wage is hiked by $1 per hour, your earnings would rise to $330.

Suppose the employer responds by investing in new machinery and training to raise output per hour, and cuts hours from 30 to 28. In that case, the worker still gets a pay increase, from $300 to $308, and gains two hours of time to work elsewhere.

At the economy-wide level, higher productivity can mean fewer low-wage jobs without causing high unemployment.

In the Scandinavian countries, about 10% of all workers are in low-paid jobs, defined as earning less than two-thirds of the national median wage, compared to 20% in Canada. Unions and labour market policies such as high minimum wages can set a high wage floor without raising unemployment. Workers in low-wage sectors like fast food and hotels earn much more per hour than in Canada.

Our goal should be decent wages for all workers. The way to get there is to push for higher productivity in low-wage sectors by raising wages while maintaining full employment. That is precisely the formula pioneered by Sweden which remains relevant today.