Economic and Social Impacts of Wage Floors

Leading Canadian economist Richard Lipsey (with co author Swedenboorg) has written quite an interesting paper for the NBER, “Explaining Product Price Differences Across Countries.”

The abstract reads as follows:

“A substantial part of international differences in prices of individual products, both goods and services, can be explained by differences in per capita income, wage compression, or low wage dispersion among low-wage workers, and short-term exchange rate fluctuations. Higher per capita income is associated with higher prices and higher wage dispersion with lower prices. The effects of higher income and wage dispersion are moderated for the more tradable products. The effects of wage dispersion, on the other hand, are magnified for the more labor-intensive products, particularly low-skill services. The differences in prices across countries are reflected in differences in the composition of consumption. Countries in which prices of labor-intensive services are very high, such as the Nordic countries, consume much less of them. For some services, the shares of GDP consumed in high-price countries are less than 20 percent of the shares in low-price countries. Since these are services of very low tradability, the low consumption levels of these services imply low employment in them.”

This is quite relevant to the long-standing debate on the impacts of reducing pay differentials for lower-paid workers through higher minimum wages, or collective bargaining. We on the left like to argue that a higher wage floor raises productivity – which is true to a point. Freeman and others have found that workers at the bottom of the skills ladder in Germany – with higher relative wages than in the US or Canada – are also more skilled, suggesting that higher wages push employers to change the labour process in a positive way by investing in capital and skills.

I think Lipsey is correct, however, to note that higher wage floors also raise the relative prices of goods and, especially, services with high ‘unskilled’ labour content, and thus reduce the demand for these kinds of goods and services. He provides a few rather compelling examples – prices in restaurants in Sweden are 25-30% higher than in Canada, and the share of restaurants in Sweden’s GDP is just 55% of the OECD average.  Relatively high labour costs boost Swedish restaurant prices, in tandem with higher consumption taxes, so people eat out less, especially in fast-food operations, and cook more at home.

Lipsey argues that this is pretty self-evidently a bad thing. However, he misses a few important things.. As my friend Wally Clement pointed out to me a while ago, in Sweden, a lot of people eat a good quality, subsidized hot meal in workplace canteens, and then eat a lighter meal at home.  Missing out on McFood doesn’t seem like such a bad thing.

More importantly, Sweden – with an even higher employment rate than in Canada – has created a lot more jobs in public and social services, especially child and elder care and recreation.  People get less cheap fast food, but much more in the way of free or very cheap labour intensive public services. So-called low skill workers get to be employed providing decent, often skilled services to people rather than slinging burgers.

In short, the debate about wage differentials is not just about economics. Yes, wage floors can be economically validated by higher productivity to a degree, but in the end the choice is between quite different kinds of economies and societies.

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