The minimum wage is the subject of a long-running and contentious debate in economics. One side of the debate says employers react to the higher costs by simply employing fewer people, meaning a minimum wage makes low-skilled workers worse off. The other side says that it is possible to pay low-income earners more without affecting their job prospects.
In China, the first argument appears to be more convincing.
When looking at minimum wages, economists have historically focused on developed countries. A new working paper (PDF), however, has brought emerging markets into the debate by focusing on China. The conclusion? Higher minimum wages seem to lead to lower employment.
For every 10% increase in the minimum wage, the International Monetary Fund (IMF) paper finds, employment in China falls by 1%. The effect is even greater for low-wage jobs. The researchers split firms in China into 10 groups (“deciles”), ranked by average income levels. In the lowest-income group, a 10% increase in minimum wage lowered employment by nearly 1.8%, compared to just 0.6% in the highest.
That’s a pretty big effect, but is consistent with patterns in the developed world. In the US, for example, the Congressional Budget Office estimated earlier this year that a minimum wage increase from $7.75 an hour to $10.10 would lead to a drop in employment somewhere in the neighborhood of 1.5% for “low-wage” American workers.
Learning from New Jersey
“Teasing out the impact of the minimum wage on employment is a difficult task,” the IMF researchers admit. That’s because employment can grow or shrink for any number of reasons completely unrelated to wages. The researchers made their analysis more robust by using a technique pioneered by American economists David Card and Alan Krueger.
Card and Krueger, in a 1994 paper (PDF), wanted to analyze the effect of New Jersey’s minimum-wage increase from $4.25 an hour to $5.05. To account for other factors that might be affecting employment, they used a natural experiment: they compared employment changes in New Jersey fast-food restaurants to those in nearby eastern Pennsylvania, where the minimum wage remained unchanged.
The IMF researchers did the same for China, comparing pairs of counties with significantly different levels of minimum wage changes. Here’s a map of the county pairs they looked at.
Beijing should be paying attention
The IMF’s findings are troubling for Beijing: minimum wage hikes are part of its strategy to increase domestic consumption (paywall) and reduce inequality. Wages have already risen considerably in the past few years. In Shanghai—now boasting the country’s highest minimum at 1,820 renminbi (about $300) per month—it has nearly doubled since 2009. The Chinese government wants to replicate such gains countrywide, announcing in 2012 a target of doubling urban and rural income by 2020.
The research shows that the easy policy of increasing the minimum wage won’t help achieve that goal without first harming employment levels. “Minimum wages can help the cause of equity by ensuring that workers, particularly low-wage workers, have enough to live on,” writes report co-author Prakash Loungani in a blog post on the research. “But if raising the minimum wage lowers employment, and ends up excluding low-wage workers from employment prospects, it may have adverse effects on both welfare and efficiency.”