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Here’s what a truly fair minimum wage would look like: Mike Moffatt

How high is too high?

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How high should we set the minimum wage in Ontario? And what should determine how the minimum wage is increased?

The Ontario government has set up a Minimum Wage Advisory Panel, tasked with answering these questions. I applaud the government for this initiative, as the existing method of raising the minimum wage from time-to-time by fiat is a poor way to implement public policy.

Two organizations, Canadian Union of Public Sector Employees (CUPE) and the Canadian Centre for Policy Alternatives (CCPA) have publicly released their proposals on how the minimum wage should be increased in Ontario, with the CCPA proposal in particular showing some promise.

In their report Towards a Living Wage, CUPE advocates an immediate increasing to the Ontario minimum wage to $14 an hour. The $14/hour level was chosen such that a single-earner that works 35-hours, with no other sources of income, would see their monthly salary rise above Statistics Canada’s Low-Income Measure (LIM).  Tying the minimum wage to a full-time 35-hour a week benchmark is somewhat strange as most minimum wage earners do not work full time hours. If the goal is to have minimum-wage incomes exceed StatsCan’s LIM, we probably want to account for the actual labour market conditions minimum wage workers face.

Should we worry about any side effects from a $14/hour minimum wage, including possible job loss? Absolutely not, according to CUPE:

Generally, increasing the minimum wage does not drive jobs away – any claim to the contrary ignores the basic reality that job creation reflects the growth of the economy. In addition to a comprehensive provincial job growth strategy, increasing the capacity for low-wage earners to spend will strengthen the economy.

The CUPE report goes to some length describing how a higher minimum wage will boost the economy through higher consumer spending. This raises the obvious question: “Why stop at $14?” If there are such enormous benefits to raising the minimum wage by nearly $4, and no drawbacks whatsoever, why not double the increase to $18? Would this not double the economic benefits?

There is a real risk of job loss due to a higher minimum wage. While there have been studies, such as the Card and Krueger study referenced by the CUPE report that show little or no job loss from a higher minimum wage, other studies have found instances where raising the minimum wage had a negative effect on employment. A number of economists have worked on reconciling this literature in order to determine why some minimum wage increases to have a negative effect on employment while others do not. The current thinking, as outlined by Stephen Gordon, is that the minimum wage only has a negative impact on employment when it gets “too high”. This intuitively makes sense, as a 1 cent/hour minimum wage is likely to not have much of an impact on employment, whereas a $100/hour minimum wage would.

The question then becomes, “how high is too high”? Prof. Gordon cites an English translation of a research paper by Pierre Fortin:

The actual state of knowledge of the impact that the minimum wage has on employment in North America, and especially in Québec, leads to the conclusion that a minimum wage that is greater than 50% of the average wage is harmful to small wage earners and that a minimum wage that is less than 45% has very little risk for this group of workers. Between these limits, the area of 45% to 50% would represent an increasing danger to employment.

To put these figures into context, the Ontario minimum wage has been under this 45% “average hourly wage” threshold for at least 15 years and was under 40% for nearly a decade.

Ontario Minimum Wage vs. Average Wage

Ontario Minimum Wage vs. Average Wage

Since that 45% threshold is important, here is a magnification of the above data, leaving only the 40%, 45% and minimum wage thresholds.

Ontario Minimum Wage vs. Average Hourly Wage

Ontario Minimum Wage vs. Average Hourly Wage

Given this data, there does appear to be room to increase the minimum wage without causing significant job loss. The Canadian Centre for Policy Alternatives advocates using this average hourly wage benchmark in their proposal in a report Making Every Job a Good Job. I believe the CCPA has made the right choice in doing so; I am delighted to see a recognition between the trade-off between a higher minimum wage and employment. Overall the CCPA report is a well-researched document that is worth the time to read for those interested in the minimum wage.

The CCPA proposal, however, suffers from three problems:

  1. It sets the average hourly wage target for the minimum wage too high at 60%. The best evidence we have suggests that a minimum wage this high would cause significant unemployment. The report’s justification for the 60% target is that it is a current policy goal in Europe and matches the minimum wages in “France and New Zealand, Australia, Belgium and Ireland”. It would be interesting to see what research is available in those countries that supports this 60% target.
  2. It cites “economic stimulus” as a reason for increasing the minimum wage but then advocates increasing the minimum wage at a slower rate when the economy is doing poorly and stimulus is most needed. Specifically, it advocates tying year-over-year increases in the minimum wage with realized inflation rates. However, as we’ve seen over the last few years, inflation is nearly non-existent during recessions and high during booms. If you believe in the minimum wage as a tool for economic stimulus, then the last thing you would want to do is tie it to a procyclical economic indicator such as inflation.
  3. The dollar values the CCPA suggests for the minimum wage are significantly below the 60% threshold, so the report somewhat ignores its own advice.

Since 1997, the average hourly wage in Ontario has increased, on average, by 2.6% a year. Even if we assume a more modest 2% growth in wages over the next few years, the proposed CCPA minimum wage tops out at 56% of Ontario’s average hourly wage.

CCPA Minimum Wage Proposal

CCPA Minimum Wage Proposal

Both the CUPE and CCPA proposals strike me as unusually conservative. The CUPE proposal suggests that there are only benefits and no costs to a higher minimum wage, but then caps the minimum wage hikes to a level where only single-earner full-time minimum-wage workers (with no other sources of income) cross the LIM. The CCPA proposal suggests that we can safely raise the minimum wage to 60% of the average hourly wage, then advocates a minimum wage that does not reach this mark.

I believe the CCPA is on the right path, and the issues in their report are easily fixed. Here is my proposal on how Ontario should set its minimum wage.

First, given the rather modest benefits to a higher minimum wage, the minimum wage should be set to the 45% threshold as to minimize job loss.

The benefits to a higher minimum wage are modest, in fact it is not at all clear what we are trying to accomplish with a higher minimum wage. It certainly is not to reduce poverty; my colleague Stephen Gordon has written on why the minimum wage is an ineffective tool in this area. The reason why the minimum wage does little for poverty is very simple—there is an incredibly weak correlation between a person’s hourly wage and their family’s monthly after-tax income. This correlation is weak for a number of reasons:

  • The link between an hourly wage and a monthly salary diminishes sharply when you drop the unrealistic assumption that everyone in the economy has a full-time job.
  • A person’s hourly wage does not reflect the income of the family as a whole, which is important given that the majority of minimum wage workers live with a parent or other family member.
  • Using an hourly wage as a proxy for monthly income does not consider income from other jobs or investments. This can be important, as many minimum wage workers are seniors who wish to “keep busy”.
  • Just examining a person’s hourly wage does not consider the effects of taxation, social programs or tax credits on their after-tax income.

The stimulus arguments made by proponents of a higher minimum wage tend to both fairly weak (not a lot of empirical support) and the benefits fairly small relative to the size of the economy. As well, if we truly believed that minimum wage policy is an effective tool for moderating the business cycle, groups like CUPE and CCPA would advocate reducing the minimum wage during booms. I cannot imagine we will ever see that proposed.

So what is the goal of the minimum wage? It appears to be to ensure there is a minimum dollar figure attached to someone’s hourly labour, though with a raft of unpaid internships in Ontario that are jobs in disguise, we should question how effectively we are meeting even that modest goal. However, as long as there is not significant job loss or reduction in economic growth, there does not appear to be a great deal of harm in having a higher minimum wage even if the benefits are relatively modest.

I agree with the CCPA that the minimum wage should automatically increase over time. However, altering the minimum wage every year based on average wages or realized inflation rates is difficult in practice, as there is a lag in collecting that data. It also creates uncertainty, as businesses and workers will not know what the minimum wage will be in the future. Furthermore, tying the minimum wage to average wages or realized inflation rates is counterproductive if you believe higher minimum wages are stimulative (I do not, but I should hold out the possibility that I may be wrong). Automatic increases in the minimum wage need to be tied to something else.

With that in mind, my proposal has three parts:

  1. Increase the minimum wage to $11.25 on January 1, 2014, a level that will be roughly 45% of the average hourly wage entering that year. Then increase the minimum wage by 2% once a year from January 2015 to January 2018; the 2% level is chosen as it is the Bank of Canada’s inflation control target.
  2. Plan a 2nd Minimum Wage Advisory Panel for mid-2018 and set aside a small budget to conduct research on the minimum wage to learn more about the benefits of raising the minimum wage along with the costs.
  3. Create a broader advisory panel with the task of developing policy proposals designed to raise the living standards of low-income households.

The first part of the proposal would see the minimum wage increase as follows:

  • January 1, 2014: $11.25
  • January 1, 2015: $11.48
  • January 1, 2016: $11.70
  • January 1, 2017: $11.94
  • January 1, 2018: $12.18

The two panels I advocate are not costless, in a financial sense, for the government. But  given how destructive unintended consequences can be from poorly thought-out public policy, these research costs are a small price to pay.

Mike Moffatt holds the rank of assistant professor in the Business, Economics and Public Policy group at the Ivey Business School, Western University and is a Fellow at the Lawrence National Centre for Policy and Management.