Social Policy in Ontario

Boost the wage, help the worker

Posted on February 23, 2011 in Debates

Source: National Post — Authors: Jim Stanford

NationalPost.com – FullComment/Canada/Debate
February 22, 2011.   By Jim Stanford

Like most economics majors, I was taught early on at university that minimum wages mess up an otherwise efficient marketplace for labour. You see, there’s a demand curve for labour, and it slopes down. There’s a supply curve for labour, and it slopes up. The two lines cross in the middle, at the sweet spot where supply equals demand.

Now insert the minimum wage: a horizontal line, positioned above the cross. It’s plain as day. Too much supply, too little demand, too much unemployment. Well-meaning but foolish bureaucrats should leave the market alone to perform its autonomous, masterful balancing act.

The story is simple. It’s elegant. And it’s wrong. But you have to progress far beyond Economics 101 to find out why. And in the meantime, that simplistic supply-and-demand diagram gets deeply imprinted on too many impressionable minds.

No employer hires labour just for the sake of growing their workforce. So the fact that labour is cheaper, in and of itself, never guarantees that more people will be hired. Why do employers hire workers? To work: that is, to produce something. Employment is a derived demand, dependent on sales of whatever good or service workers produce. Their employment depends mostly on whether there’s enough demand for their output, so that their employers can profitably produce it. That, in turn, depends on a whole stable of economic variables, macro as well as micro — not least including whether working families have the purchasing power to buy back the stuff they produce.

So, contrary to Economics 101, there’s not really an independent demand curve for labour. And the supply for labour cannot be depicted simplistically, either. In fact, labour supply often declines as wages increase (since workers can then afford more leisure time). The two lines don’t reliably and stably cross. In fact, it’s not clear they cross at all: even where wages are unregulated, unemployment is a normal, permanent feature of the economy. Except under very unusual circumstances (such as the Second World War), labour supply never actually equals demand.

Nevertheless, that Economics 101 story was swallowed whole by a generation of economists, and minimum wages fell out of fashion. From the late 1970s to the mid 1990s, Canadian minimum wage levels (after inflation) declined by about one-third.

But then a new spate of research threw the conventional wisdom into question. U.S. economists David Card and Alan Kruger found no reliable empirical evidence that higher minimum wages produce unemployment. But they found several benefits of minimum wages, including a “trickle-up” effect (whereby many non-minimum-wage workers also got raises); reduced turnover; and higher productivity.

Indeed, in a more complete economic model, there are even circumstances in which higher minimum wages can lead to higher employment. If demand for goods and services is chronically weak, increasing purchasing power (by boosting wages) can kickstart demand and thereby increase job creation. Similarly, when powerful employers are in a position to influence wages (rather than accept a going rate), minimum wage laws eliminate the incentive for employers to artificially curtail hiring in order to suppress wages; the result is more employment, not less.

In practice, the effect of minimum wages on employment is probably a wash. Gradual increases in minimum wages, within reasonable bounds, have virtually no impact on employment at all, in either direction. So long as levels are set realistically relative to productivity and profitability, minimum wages can be increased with no measurable damage to employment.

Perhaps influenced by this recent sea-change in economists’ attitudes, policy makers in most provinces have begun to revitalize minimum wages. After years of stagnation, the real purchasing power of minimum wages has increased markedly since 2005, boosting incomes across the lower tiers of Canada’s labour market. With business profits simultaneously reaching their highest share ever of Canadian GDP, it could hardly be argued that these modest but important increases squeezed out private sector activity. On the other hand, those higher minimum wages contributed notably to the first real wage gains enjoyed by Canadian workers in a generation.

This successful policy trend should be continued. Minimum wages (now at or near $10 per hour in most provinces) should be increased gradually but steadily in the years to come.

National Post

Jim Stanford is an economist with the Canadian Auto Workers. This article is excerpted from What Determines Wages and Income Distribution, downloadable at Caw.ca.

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Tags: economy, ideology, standard of living

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