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November 19, 2014

Should we raise the minimum wage?

The minimum wage debate is making headlines again, with recent studies fueling arguments on both sides. The discussion is global, from the US to Russia and China. Germany will also gradually introduce a national minimum wage of €8.50 beginning in 2015.

It’s not surprising that so many minimum wage workers are fighting for fairer pay. In the UK, for example, the minimum wage is set at £6.50 ($10.25), which is now significantly lower than the estimated living wage of £7.85 ($12.38). The living wage in London has been set even higher at £9.15 ($14.43).

While the cost of living is rising faster than the general rate of inflation, businesses reason that it is impossible for them to keep up.

But many still argue that higher wages can lead to faster growth. Interestingly, the 13 US states that increased minimum wages this year saw jobs increase by 0.85% on average from January to June, compared to the 0.61% average job growth realized by the other 37 states.

But can minimum wage levels alone account for this? Or is this just a correlation, and the causal relationship runs differently: is it that US states with a strong economy see larger job increases and can afford higher minimum wage levels?

Research suggests there are also many potential downsides to raising minimum wages. David Neumark finds that it may lead to job destruction, as employers are discouraged from using the low-wage, low-skill workers that minimum wages are intended to help. He also posits that minimum wage laws do not tend to help the poorest workers unless combined with a subsidy program, like targeted tax credit.

Tim H. Gindling looks more specifically at developing countries, finding that their relatively large informal sectors prevent minimum wage laws from affecting the majority of poor workers. Overall, the positive impact of minimum wage laws is modest, and can even push some workers further into poverty.

Clearly, while policies aimed at raising the minimum wage should not be discounted, they cannot be seen as a "cure-all." Other factors are at work, and the characteristics of specific labor markets need to be considered.

IZA World of Labor held a seminar in conjunction with the Organisation for Economic and Social Development (OECD) on Monday, November 17, to discuss some of these issues. To set effective minimum wages policies, we must understand their overall impact on labor markets around the world.

© Klaus F. Zimmermann 

This blog was originally published by Klaus F. Zimmermann on LinkedIn with the title: More and higher minimum wages?

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We recognize that IZA World of Labor articles may prompt discussion and possibly controversy. Opinion pieces, such as the one above, capture ideas and debates concisely, and anchor them with real-world examples. Opinions stated here do not necessarily reflect those of the IZA.