Look to Germany to resolve Qantas

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Germany, the current European workhorse, is one of the nine OECD countries without a national statutory minimum wage. As election time rolls around, Angela Merkel is considering adopting the opposition party’s position on regulating a Germany-wide minimum wage as a political tactic. Given Germany’s great economic success and historically low unemployment, why bother?

Germany has a history of organised labour bargaining, and the hands off approach of government allows various industry sectors to negotiate their own wage agreements that can be responsive to sector specific conditions. Almost all workers in Germany are part of their relevant union. Germany also has an extensive, and comparably well structured, welfare system.

In Australia, QANTAS recently showed just how vicious our battleground for wages can be. In such an environment one can only think that minimum wage laws are a necessity for the small proportion of our workforce with extremely poor negotiating positions.  However, Australia has just a tiny fraction of the workforce on minimum wages (stable around 3% of the workforce), and very high minimum wage levels (as measure by the ratio of minimum wage to average wage. See graph below.) Wage bargaining in Australia appears to have been very successful, but with some declines in relative minimum wage levels seen since 2000 (along with the US). Of course, the income tax structures on low paid workers also has a large effect on the take home pay of minimum wage earners, and I expect the increased tax-free threshold coming into force next year to have a substantial impact on the net incomes of Australia’s minimum wage workforce.

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This divergence in approach between Germany and Australia leads to some interesting questions about minimum wages. For a start, is Germany’s sector specific bargaining the optimal market outcome, or does it pervert market outcomes? Which leads to the unsolved problem of minimum wage research – do minimum wages have employment impacts?

I want to frame my response to these questions by looking at minimum wages as a social choice within a welfare state. The existence of welfare (such as unemployment benefits) represents a de facto minimum wage, and any statutory minimum wage needs to be ratcheted up over time to stay ahead of the welfare curve. To promote an effective welfare system, there needs to be an incentive to begin work, and welfare recipients are often the same people with limited bargaining power in the workforce (due to lack of specific skills and often poor understanding of their rights at work). Thus, the minimum wage needs to ensure there is a gap between earning on welfare and the bottom rungs of the workforce.

The level of this whole system of welfare is simply a social choice. Minimum wages are simply part of the social decision about the minimum standards of living expected in the country. Other social decisions include regulations of minimum working conditions, which are a form of non-financial ‘wage’ that costs the employer and benefits the employee.

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Even without this social framework, economists remain unconvinced about the market impacts of minimum wage laws. A number of effects exist in the real world, which aren’t captured in neoclassical theory, which predicts strong impacts on unemployment, and there are a number of world-class researchers assessing minimum wage impacts in real world conditions. Here are a couple of ‘general equilibrium effects’ that negate traditional supply and demand analysis of the labour market.

  1. Labour supply effects. A higher wage encourages labour supply from the margins (from the pool of unemployed)
  2. Investment effects. Employers may have monopsony power in the labour market (meaning wages are below the optimal level). Olaf Storbeckdescribes how this provides a disincentive for investmentImagine a fast food restaurant in a small city. Opening a second outlet might be profitable for the owner of the restaurant. However, he might have to pay higher wages for hiring the extra staff he needs in the second restaurant. Since he is not able to differentiate the wages between both restaurants, he would drive up his labour costs in the existing restaurant. This effect harms the profitability of the first restaurant less and might discourage the expansion of the business completely. However, if the government introduces a minimum wage, labour costs rise anyway and the second restaurant might become more attractive again.
  3. Demand effects. Low paid workers are earning more money and can then consume more and increase demand, boosting local economic activity.

I will also add that supply and demand analysis assumes that markets are optimal in the ‘before’ scenario when estimating minimum wage impacts. But above real world effects result from shifting between two different suboptimal scenarios.

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On balance, the net employment and income effects are anything but certain and are likely to depend on local conditions at the time, including the relative level of the minimum wage, the characteristics of employment, the level of unemployment and so on.

The lesson in all this is that sometimes social improvements can be achieved with very little, indeed immeasurable, cost. I propose that is bargained outcomes, whether statutory or through industry specific negotiations, are likely to be in what I describe as the ‘zone of efficiency’. Simply put, there is no optimal price, even under neoclassical market assumptions, and there are a range of prices that can be bargained that will have no impact on output levels. I would argue that it would be almost impossible to implement a statutory minimum wage above this zone. Hence, in both cases, Australia and Germany, minimum wages in various sectors, even with the vastly different approached, are likely to be in this zone, but perhaps Germany is at the lower end given the strong push for government intervention.

In situations where labour markets are not well organised to bargain for themselves, statutory minimum wages can do the bargaining for them. In most cases however, the bargaining of organised labour in that industry is likely to achieve a similar outcome for itself. The question for the Germans is whether there has been a loss in power of the unions for some reason, and that would explain the need for government involvement. This is they Merkel is playing it, choosing only to get involved in industry sectors that have not reached their own negotiated agreements, essentially ensuring 100% coverage of union-like negotiation, rather that a national minimum wage. Seems like common sense to me, and fairly consistent with all the evidence to date.

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