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The price of labour

Boladavui Uluitavuki
Saturday, November 10, 2012

The real consequences of minimum-wage laws — weighing both the effects that can be seen and those that must be foreseen.

BRAVO to the A-G for bravely defending the government's decision to apply restraint in recent increases in minimum wages, which was heavily criticised by the former Wages Council Chairman Father Kevin Barr, who labelled it as "..simply a joke of government's commitment of alleviating poverty".

Before I proceed, let me state at the outset that a minimum-wage law is a form of taxation.

And while almost every economist will agree that a heavy tax burden is harmful to wealth creation in any society, many still fail to comprehend the damage done by minimum-wage legislation and openly advocate it in this country today despite overwhelming evidence on the harm it creates.

As with all economic fallacies, this is of course a result of analysing a policy by only considering its immediate and observable effects — such as higher wages on existing workers — and completely ignoring the second-order effects of the policy, which are not seen, as well as the unintended effects on other groups within the economy.

Firstly, to have a real sense of what is meant by the second-order effects of minimum-wage laws, it is instructive to take a look at the testimony of the Governor of American Samoa, Togiola Tulafono, who appeared before a US congressional subcommittee in September last year and pleaded for an exemption from the federal government in implementing this politically popular but economically unsound policy.

One can virtually sense the depth of the Governor's desperation in his testimony: "We are watching our economy burn down," he said. "Our job market is being torched. Our businesses are being depressed. Our hope for growth has been driven away. We are still ordered (by the US federal government) not to interfere" as he described the devastating effects of the passage of a legislation in 2007, mandating some 40 per cent increase in the minimum wage across all US states and territories.

In 2009, one of the island's two canneries, Samoa Packing, which once employed over 2000 workers, closed its plant down, citing increases in the minimum wage as a significant factor in the plant's closure.

It is this second-order effect of minimum-wage laws, which play out through the erosion of competitiveness in businesses — eventually costing the job of workers who initially benefited from higher wages but now find themselves jobless — that are ignored by well meaning minimum-wage advocates like Father Barr, who continue to blindly champion this policy in this country.

It must be emphasised that these are empirical consequences — they are real life evidence of humanitarian policies that ignore the role of prices in the economy (note: wage is simply the price of labour) and the unobserved effects of policy, which may not be seen immediately but are as equally important in determining its final outcome and effectiveness.

From hindsight, it is clear that minimum wages destroy the long-run competitiveness of businesses in the small-open economies of Pacific Island countries, because it adds to the burden of doing business in our geographically-isolated, low-labour-productivity and technologically-constrained economies.

Again, the above-mentioned outcomes of minimum-wage legislation are not directly observable initially by policymakers and the difference between a good and bad economist — as described by the famous 19th century French economist and political philosopher, Frédéric Bastiat — is that the good economist will always attempt to foresee them and weigh them in his assessment of the policy.

Secondly, minimum-wage legislation also inadvertently affect a second group of workers who are usually ignored in the rhetoric of minimum-wage advocates, i.e. those whose skill set currently attract a lower rate of wages than the government-mandated minimum wage.

The harm done by minimum-wage laws on this group can be better understood by tracing the incentive that the policy creates for businesses in hiring them. The law practically makes it unprofitable (and illegal) for businesses to hire low-skill workers at a wage rate commensurate with their current skill set, which effectively denies them the opportunity to acquire on-the-job learning and training that can provide them a realistic chance of progressing on the socio-economic ladder in society.

Again, this is not just an imaginary consequence of the policy — there is a wide array of studies documenting the harmful effect of minimum-wage laws on the young and black subgroups of the US population, most of whom fall into the least-skilled worker category. A 2011 study by Professors William Even and David McPherson titled Unequal Harm: Racial Disparities in the Employment Consequences of Minimum Wage Increases documents the harm done by minimum wages on low-skilled workers in the US in detail.

The study revealed that in the 21 states fully affected by federal minimum wage increases during 2007-09, 40 percent more jobs were lost by black young adults as a result of the federal wage mandate than that lost as a direct result of the recession. What this means is that the best way to sabotage chances for upward mobility of a youngster from a single-parent household, who resides in a violent slum and attended poor-quality schools, is to make it unprofitable for any employer to hire him.

The way to accomplish that is to mandate an employer to pay such a person a wage that exceeds his skill set — needless to say, minimum-wage laws achieves exactly this.

Meanwhile, minimum-wage laws have considerable political support, including that of well-intended social workers like Father Kevin Barr and the politically-active unionists in Fiji.

But intention alone doesn't determine the outcome of policies and, as usually the case in the real world, policies that blithely disregard the economic incentives it gives birth to very often produce results that are quite different from the goal of its advocates and many times inflict real and great harm to society as a whole — which is why the following reprimand from American economist, Murray Rothbard, is fitting for all:

"It is no crime to be ignorant of economics, which is, after all, a specialised discipline and one that most people consider to be a 'dismal science.' But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance."

* The author is an economist by profession. The views expressed here are his own and are in no way or form representative of his employer.

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