Volume 1 April 2007

China in international imbalances
Yu Yongding

International trade and poverty: cause or cure?
L. Alan Winters

Making the boom pay
John Freebairn

Reforming Australian industrial relations
Joe Isaac

Minimum wages and inequality
Andrew Leigh

Does the Fair Pay Commission decision matter?
Mark Wooden

The corporate political environment and big business response
Geoff Allen

Stock return predictability in rational markets
Bruce D. Grundy

Passive profits from accounting indicators
John D. Lyon

A 'Battle of Ideas'
Tom Elliott

On painting one's life picture
Peter Yates

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By Mark Wooden

A few weeks ago the new Australian Fair Pay Commission (AFPC) raised the Federal Minimum Wage from $12.75 to $13.47 per hour, a rise of 5.6 per cent.

This decision was received very differently by different sectors of the community. Employer groups were highly critical, claiming that the rise would be harmful to employment, while the Australian Council of Trade Unions (ACTU) was full of praise, believing that the decision vindicated their claims that wage rises for the low paid were necessary to protect their real living standards and would not be harmful for employment growth. So who has got it right?

The easiest claim to deal with is the oft-heard argument that minimum wage increases help the poor. The reality is that most of the poor are not employed and so, by definition, rises in the minimum wage can do little to help them. The AFPC, however, appears to support the union view, stating in its decision that ‘lower paid workers are relatively concentrated in lower income households.’ At best, this can only be described as an interesting interpretation of the evidence.

HILDA survey reveals impact of wage rise

Data from the 2004 wave of the Household, Income and Labour Dynamics in Australia (HILDA) Survey – the same data source used in the research commissioned by the AFPC – reveals that the lowest paid are actually spread quite evenly throughout the income distribution. Indeed, and as shown in Figure 1, the 20 per cent of wage earners with the lowest hourly wage rates (the group most likely to be reliant on industrial awards for pay increases) are actually underrepresented in the bottom part of the income distribution – only 27 per cent of these employees are living in households in the bottom three deciles (i.e. the bottom 30 per cent) of the distribution.

The picture changes slightly if we focus both on adults (and thus exclude many children who are still living at home with their parents) and on the very low paid – the bottom 10 per cent. The proportion of this group that are in the bottom three deciles of the income distribution now rises to almost 38 per cent, meaning they are slightly overrepresented in the bottom of the distribution. Much of this higher representation, however, can be explained by income support recipients who are able to work part-time while still receiving a government benefit. For most of these people the number of hours worked are relatively small. Further, beyond some very minimal income levels, government income is withdrawn at the rate of either 50 or 60 cents for every extra dollar earned. Together, these two facts mean that minimum wage rises do relatively little to raise the incomes of these types of workers.

Even if low-wage workers were, at a single point in time, heavily concentrated in low-income households, it does not follow that such workers will necessarily benefit much from minimum wage rises. This all depends on how much they would have earned in the absence of minimum wage rises. We can never know this with any certainty, but with the new longitudinal data gathered from the HILDA Survey we do know how much earnings for low-wage workers have risen in the recent past.

Specifically, the HILDA Survey tracks earnings growth for the same people over the period 2001 to 2004 and reveals an unexpected result. As shown by the solid bars in Figure 2, growth in hourly earnings has been overwhelmingly concentrated among the people earning the least at the start of the period. In fact, the median rate of growth in usual hourly earnings for adult employees (persons aged 21 years or older in 2001) who were among the bottom 10 per cent of wage earners in 2001 was a staggering 66 per cent. For the next 10 per cent the figure is much lower, but still a healthy 28 per cent. These rates of growth gradually fall until we reach the top of the earnings distribution, where median earnings remained unchanged (meaning a fall in real terms).

Provided they remain in employment, the vast majority of low-paid workers have experienced earnings increases that are well in excess of the rate of increase in the minimum wage. Indeed, the HILDA Survey data indicates that about 80 per cent of adult employees in the bottom decile of wage earners who were also in work three years later experienced earnings increases in excess of the rate of growth in the Federal Minimum Wage over the same period. For most low-wage workers the minimum wage is largely irrelevant.

Increases in the hourly wage, however, do not necessarily translate into large increases in annual income. This depends on what happens to the number of hours worked over the year. Figure 2 thus also reports for all adult employees in 2001 how their annual labour earnings changed over the next three years. As can be clearly seen, a focus on annual earnings, as distinct from hourly earnings at a point in time, suggests markedly different conclusions. We can now see that the lowest paid do not stand out so obviously from other employees. While annual earnings growth has been greatest for the low-paid, the differences across the hourly wage distribution are relatively small.

In conclusion

The empirical evidence suggests that the decision of the AFPC is unlikely to do very much to either alleviate poverty or reduce earnings inequality. Most low wage employees are not found living in the poorest households, and among those that are, many are income support reliant and are only working because the income support system enables individuals to combine part-time hours with receipt of a government benefit. The evidence also suggests that minimum wage increases are unlikely to be all that effective in protecting the living standards of the ‘working poor’. This is because the large increases in hourly wages experienced by most low-wage workers do not always translate into similarly large increases in annual earnings, presumably because low-wage workers are most at risk of both spells of unemployment and of underemployment (working fewer hours than desired).

This last observation leads naturally to the question of whether minimum wage rises do more harm than good, by damaging the long-run employment prospects of both the unemployed and the low-skilled. The AFPC (correctly) emphasises that effects on aggregate employment depend on both demand and supply responses, and that given our income support system, the incentive to work may not be great for some groups at the minimum wage. In other words, higher wages may be needed to induce some people to work. Nevertheless, this seems small consolation for those people (mostly young single people with few job skills) who want work but are unattractive to employers at the minimum wage.

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