The Global Voice of Business GUIDANCE PAPER OF THE INTERNATIONAL ORGANISATION OF EMPLOYERS THE MINIMUM WAGE DEAR MEMBERS In recent years, IOE members have expressed a renewed interest in discussing the minimum wage issue, which also emerged as an area requiring guidance for employers’ organisations at the fi rst meeting of the IOE Industrial Relation Policy Working Group (June 2013), where the participants exchanged views on diff erent wage policies in various regions of the world. This note aims to clarify the concept of the minimum wage, to present its objectives, intended benefi ts and potential drawbacks, and to guide companies and employers’ organisations in approaching the discussion on minimum wage setting and adjustment at national level. We hope you will fi nd it useful. Yours sincerely, Brent H. Wilton Secretary-General Executive Summary THE ISSUE OF THE MINIMUM WAGE IS OFTEN CONTROVERSIAL. Minimum wages are essentially labour market be set by statute, collective bargaining agreements, interventions used by governments either as decisions of national boards, or arbitration awards. instruments of political macroeconomics or as social They can be diff erentiated by region, by sector, or tools. Opponents argue that the minimum wage is too according to country-specifi c criteria. Other sectors/ blunt an instrument to be useful, can have detrimental regions may remain uncovered by minimum wage eff ects on employment, growth, and incentives to legislation. work, and can negatively impact opportunities for The concept of the living wage has been developed lower-skilled workers and youth. Supporters of the from the concept of the minimum wage, and refers to minimum wage conversely argue that it is an eff ective the level of wages that allows workers to meet their instrument in protecting the lower paid and in and their dependents’ basic needs1. combatting poverty. The minimum wage is not to be confused with the MINIMUM WAGES REPRESENT THE LOWEST LEVELS concept of “minimum income” which is a social OF PAY, ESTABLISHED THROUGH A MINIMUM WAGE welfare policy guaranteeing a minimum standard FIXING SYSTEM, TO BE PAID TO WORKERS BY VIRTUE of living for individuals and their dependents when OF A CONTRACT OF EMPLOYMENT. they have no other means of fi nancial support. It is Minimum wages have three aspects: a) the important to emphasise that wages are not the same remuneration for work performed by the worker, b) as incomes. Incomes to the lower paid are a mix of the workers’ basic income (and source of purchasing wages from the employer, the government’s approach power), c) a production cost. Minimum wages can to taxation, social transfers and government services. 1 A guidance paper on the living wage was published by the IOE in February 2014. What is the general objective of minimum wage policies? TO UNDERSTAND MINIMUM WAGE SETTING POLICIES, A WIDER ANALYSIS OF THE GENERAL OBJECTIVES FOR SETTING MINIMUM WAGES COULD BE USEFUL. Governments introducing minimum wage policies acknowledged as ineff ective in alleviating poverty basically aim to protect low-income workers through as they are not well targeted to the poor. the introduction of minimum wages based on country- iii. Imbalance of power in the employment specifi c factors such as the cost of living, welfare relationship policies, labour market conditions, the infl ation rate and other economic factors and trends. Minimum wages are said to mitigate the potential eff ects that could arise from the power The rationale driving decisions to introduce or increase imbalance between enterprises and workers, minimum wages is related to: which might lead to workers accepting lower i. Fairness/ reducing inequalities wages to obtain employment. Minimum wages aim at decreasing wage iv. Incentives to work inequalities between the bottom and the middle Minimum wages could be justifi ed within of earnings distribution. The same idea of the framework of incentives, by motivating fairness is often incorporated into social welfare, unemployed individuals to enter the workforce which governments seek to maximize, also as a if the minimum wage is greater than benefi ts political strategy. received through social support. Furthermore, ii. Poverty alleviation minimum wages can increase the eff ort made by workers, as the rewards increase and the Minimum wages are often associated with opportunity costs of losing the job become higher. poverty reduction, but in reality have been Specifi c diffi culties to achieving the general objectives of minimum wage policies PROTECTION OF LOW-INCOME WORKERS IS NOT ALWAYS ENSURED THROUGH MINIMUM WAGE FIXING POLICIES. THE MAIN DIFFICULTIES RELATE TO: - The concrete defi nition of fairness and its could not directly contribute to their poverty measurement: how to properly estimate the reduction. trade-off between wage inequality and other - The competition among employers that leads factors in any welfare function? businesses to compete against each other to fi nd - The ineffi cacy of minimum wage policies in a the best candidates able to respond to their needs. context of poverty alleviation. Poverty and low - The motivating eff ect of having attractive minimum pay are indeed only weakly related. Research wages, which may cause side eff ects on the shows that in most countries only around 10% employment market, such as unemployment of low-paid workers are in poor households2. increase whenever employers are forced to Indeed statistical evidence demonstrates that the suspend their business due to their incapacity to poorest households are those where no one is pay the minimum wage. working, and therefore minimum wage policies 2 OECD, 1998 1 THE MINIMUM WAGE Benefi ts and Drawbacks MINIMUM WAGE SYSTEMS, DESPITE SIGNIFICANT DIFFERENCES, ARE IN FORCE IN MORE THAN 90% COUNTRIES3 Some countries with high living standards, such as higher productivity who are not directly Austria, Germany, and the Scandinavian countries do aff ected by minimum wage policies are not have statutory minimum wages, but collectively preferred by employers, given the cost versus agreed wages cover directly or indirectly almost all value added for labour, in comparison with workers in the country (between 50% and 100%). lower-skilled workers/workers with low productivity. Furthermore, as fi rms increase There are diff erences of opinion over the benefi ts and their productivity due to wage increases, drawbacks of minimum wages. workers may be replaced in the medium- According to the World Bank publication, “Labour long term through automation. As a result Regulations in Developing Countries: A Review of unemployment may increase. the Evidence and Direction for Future Research” (World Bank, 2008) many countries try to improve the b. General application of minimum wages, welfare of low-wage earners, through the mandating covering all sectors and categories of workers, of paid minimum wages but: “Whether such a policy in all regions of the country do not necessary actually achieves the intended outcome has been a correspond to the employers’ capacity to pay, subject of great controversy for decades. Theoretical nor take into account disparities between predictions of the eff ects of minimum wages vary, and regional costs of living and the sectoral the empirical evidence has so far yielded contradictory fl uctuation of profi ts. This has led to some results, depending on the country, the source of sectors being obliged to suspend their minimum wage variation, the methods of analysis, investment in certain regions. and the assumptions required for each particular c. Failure to fi nd employment due to minimum econometric framework.” wages being higher than the market-clearing Demonstrated benefi ts of minimum wages include level pushes workers to seek employment improved worker effi ciency and higher productivity. in sectors not covered by minimum wage Broadly speaking, higher minimum wages could have legislation or in the informal economy where positive impacts on workers’ purchasing power, thus wages are even lower. increasing their consumption expenditure, and in turn d. Although minimum wage legislation should be stimulating aggregate demand and economic growth. applied to all workers, it is diffi cult to enforce Also, fi rms may increase their investment in plant and in the informal economy. The situation is more machinery to improve productivity to counter rising severe in developing economies with large labour costs (for instance labour costs directly related informal sectors. The role of minimum wages to the increase in minimum wages). in many developing countries as a means of Drawbacks are diverse. Minimum wages are widely establishing a social fl oor is therefore much seen as having a distortionary impact on the labour more questionable. market. • Minimum wages may drive workers into • They have resulted in higher unemployment “uncovered” jobs, thus lowering wages in rates; higher labour costs for business; in some those sectors; reduce employment in low- countries, and increased employment in the wage industries, such as retailing; hurt small informal economy. businesses generally; cause employers to Some of the reasons for these negative impacts cut back on fringe benefi ts and job training; are the following: encourage employers to install labour-saving devices; impact adversely on low-wage regions; a. Minimum wages that are set too high can increase the number of people on welfare; lead to unemployment among low-skilled increase infl ationary pressures4. workers. Indeed, workers with higher skills/ 3 ILO, Global Wage Report