Impact of Higher Minimum Wage on the Estonian Labour ... - Eesti Pank

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Employers' Confederation (ETK) the minimum wage will be gradually raised until it reaches ... growth does not meet the increase of wages, labour costs increase and companies will cut .... principles of fair remuneration in general. ... France, Great Britain, Greece, Ireland, Luxembourg, Portugal, Spain and the Netherlands.
TAIRI RÕÕM

IMPACT OF HIGHER MINIMUM WAGE ON THE ESTONIAN LABOUR MARKET Tairi Rõõm1

Introduction As in most EU acceding countries, minimum wages2 have been considerably increased in Estonia over recent years. This trend is likely to continue also in the near future since under the agreement between the Confederation of Estonian Trade Unions (EAKL) and the Estonian Employers’ Confederation (ETK) the minimum wage will be gradually raised until it reaches 41% of the average wage by 2008. The aim of the current article is to give an overview of the development of the minimum wage and analyse the impact of its increase on Estonian labour market. The article discusses how the minimum wage has affected employment, labour earnings and wage distribution in recent past. Most studies analysing the growth of minimum wages focus on the impact it has on employment. According to orthodox economic analysis, the increase of the minimum wage has a negative impact on employment: it leads to the growth of wages and if productivity growth does not meet the increase of wages, labour costs increase and companies will cut the number of employees. However, theoretical economic models do not give a unique answer about the relationship between employment and minimum wage. According to the theory, the impact of the minimum wage on employment depends on the competitive structure of the labour market. If the labour market is perfectly competitive, the impact of the minimum wage on employment is negative. In case of a monopsonic or oligopsonic3 labour market the increase of the minimum wage may, however, affect employment positively. Empirical studies on the impact of minimum wage on employment have yielded controversial results. In the USA, where the number of studies on this topic is the largest, a consensus was reached by the early 1990s that the raise in minimum wages will lead to higher unemployment. However, in the mid-1990s David Card and Alan B. Krueger published a study that aroused a lot of controversy showing that the increase of minimum wage helped to boost employment4. The authors analysed changes in employment levels in fast-food restaurants along the border of two US neighbouring states, New Jersey and Pennsylvania.

1 The author is thankful to Marit Hinnosaar, co-author of the work ‘Labour Market Impact of the Minimum Wage in Estonia: An Empirical Analysis’, which the present article is based on. 2 The minimum wage is the smallest legally mandated payment that the employer may pay to workers. 3 Monopsonic labour market has only one employer; oligopsonic market is characterised by a small number of employers. 4 Card, D., Krueger, A. ‘Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania’, 1994.

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KROON&ECONOMY No 3, 2003 In New Jersey the minimum wage was increased while in Pennsylvania it remained unchanged. Card and Krueger discovered that after the minimum wage increase employment in New Jersey increased faster than in Pennsylvania. The authors explained this result, which contradicted the then consensus, by monopsony power of fast-food restaurants in the labour market. Later, several economists have criticised the work of Card and Krueger, pointing out the unreliability of a telephone survey method as the main shortcoming of the study. The majority of empirical studies in other countries have indicated that higher minimum wage has a negative effect on employment. Besides the USA, positive impact has only been registered in Great Britain, but the labour market analysis there covered the years of economic growth and it is therefore hard to determine whether the positive impact resulted from higher minimum wage or other reasons. The degree of changes in employment due to higher minimum wage (ie employment elasticity to the minimum wage) depends on several factors, which, in turn, affect the outcome of the analysis. The most important among these factors is the degree to which the minimum wage acts as a constraint on the labour market, ie the share of the labour force affected by the minimum wage. If it affects a considerable part of the labour force, the empirical studies usually find that higher minimum wage reduces employment of low-paid workers. While the US labour market studies in the 1970s and 1980s usually indicated that the minimum wage had a negative impact on employment, the later controversial research results can be explained by the decrease of the real value of the minimum wage in the 1980s and 1990s and by the fact that the respective legislative acts affected the wages of a very small part of the labour force (1–2%). Yet, in France, for example, the minimum wage is more binding than in the USA – it affects directly the wages of nearly 14% of workers – and the labour market studies there have shown the minimum wage to have a significant negative impact on employment5. In conclusion we can say that in both empirical studies and economic theory (with some exceptions) a consensus has been reached that when the minimum wage is a binding constraint it has a negative impact on employment in sufficiently competitive markets. As the increase of the minimum wage has a negative impact on the employment of those workers whose welfare it is meant to improve, the overall impact of the particular economic policy measure on the well-being of employees is questionable. In order to evaluate the impact of the growth of minimum wage on welfare, it has to be determined whether the aggregate income of workers increases or decreases as a result. (The income decreases for those who lose their jobs as a result of raising the minimum wage, but increases for those who retain their jobs and have their wages increased due to a higher minimum wage.) When aggregate income decreases, the overall impact of higher minimum wage on welfare is negative. However, due to a decreasing marginal utility of income the reverse relation may not exist – the increase of aggregate income does not necessarily lead to an increase in welfare.

5 Abowd, J. M., Kramarz, F., Lemieux, T., Margolis, D. ‘Minimum Wages and Youth Employment in France and the United States’, 1997.

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TAIRI RÕÕM As the increase of the minimum wage does not always have a positive impact on the prosperity of workers, the question arises whether higher minimum wage that should, first and foremost, be an economic policy measure aimed at reducing poverty serves its purpose. What then are the reasons behind the growth of minimum wages in Estonia and other EU acceding countries in recent years? The second and third part of this article is devoted to analysing this issue, discussing the EU economic policy guidelines regulating the principles of fair pay and minimum wage trends in the EU member countries and acceding countries. The fourth part of the article analyses the impact of the increase of minimum wage on Estonian labour market in the second half of the 1990s, and the final part offers conclusions.

The Principles of Minimum Wage and Equal Pay in the EU Looking for grounds to increase the minimum wage in the EU legislation, an often referred document in accession countries is the Community Charter of Fundamental Social Rights compiled in 1989. The Charter is a document on the fundamental social rights of employees, which is not obligatory for the Member States but has an advisory nature. It does not mention the need to implement the minimum wage but rather discusses the principles of fair remuneration in general. For example, the Charter contains the following guidelines: all employment should be fairly remunerated; workers shall be assured of an equitable wage, ie a wage sufficient to enable them to have a decent standard of living. Several later strategic documents of the European Commission and the Council of Europe discuss the principles of fair remuneration of employees. Besides the fairness of remuneration, these documents also emphasise the idea that higher employment, too, will help to reduce poverty and secure a higher standard of living. Thus, the Social Exclusion Strategy published at the Lisbon summit in 2000 says that the best safeguard against social exclusion is to have a job. There is no universal definition of poverty or low wage (wage lower than the wage guaranteeing a decent standard of living) in the EU. The Social Charter drawn up by the European Commission in 1977 contained a recommendation that the minimum decency threshold should amount to 68% of the average wage of a particular country. According to the Organisation for Economic Co-operation and Development (OECD) definition, the wage below two thirds of the median wage is considered low. Among the EU countries this definition has been adopted by Austria, France, Greece, Ireland, Italy and Portugal. Eurostat regards as low the wages below 60% of the median wage and a similar approach is used in Denmark. In Germany, wages below 75% of the national average are considered low. Thus, the definition of the low wage and the minimum wage do not correspond one-to-one in the EU. In 2000, the minimum wage in all member countries was smaller than the OECD definition of the low wage. In recent years, the minimum wage discussion in the EU Member States has gained more attention. The discussion mostly focuses on the issue of whether the minimum wage serves

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KROON&ECONOMY No 3, 2003 its purpose. The enlivenment of the debate can be attributed to the extensive changes in the labour markets of EU countries over the past 20 years. Compared to the early 1980s the distribution of wages has become more uneven in most member countries and this has gained support to the increase of the minimum wage. On the other hand, high unemployment rate in many countries has prompted discussions on the possible negative impact of the minimum wage on employment and doubts about the minimum wage serving its purpose.

Development of the Minimum Wage in Estonia and EU Member and Acceding Countries On national level, the minimum wage has been fixed in nine EU Member States – Belgium, France, Great Britain, Greece, Ireland, Luxembourg, Portugal, Spain and the Netherlands. In the other six member countries (Austria, Denmark, Finland, Germany, Italy and Sweden) the majority of the employees are covered by agreements regulating the minimum wage, due to an extensive coverage of collective agreements. In Austria, Germany and Italy the minimum wage covers practically all the employees, as the rights guaranteed by collective agreements also apply to those not belonging to trade unions. In the Nordic countries, the majority of the employees are covered with collective agreements, which guarantee the de facto extension of minimum wage agreements to most workers. Figure 1 shows the levels of nationally fixed minimum wages in the EU member countries and Central and Eastern European countries in January 2003. Due to the differences in

1,600 1,400 1,200 1,000 800 600 400 200

Luxembourg

Netherlands

Belgium

France

Great Britain

Ireland

Greece

Malta

Spain

Slovenia

Portugal

Hungary

Poland

Czech Republic

Estonia

Lithuania

Slovakia

Latvia

Romania

Bulgaria

0

Figure 1. Nationally fixed minimum wage in the EU member countries and Central and Eastern European countries in January 2003 (EUR per month) Source: Clare, R., Paternoster, A. ‘Minimum Wages in EU Member States and Candidate Countries’, Eurostat, January 2003.

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TAIRI RÕÕM average earnings, the level of the minimum wage in those countries varies greatly. In Bulgaria the minimum wage was 56 euros at the beginning of this year, while in Luxembourg, for example, the minimum wage – 1,369 euros – exceeded the Bulgarian level by more than 20 times. On an average, EU member countries’ minimum wage differs approximately five times from the minimum wage of acceding countries. As the difference in the lowest wage level expressed in euros is very large across countries, several EU members have expressed the fear that the opening of borders after the EU enlargement would lead to extensive migration of low-paid labour from east to west. At least partly, this fear is the reason why EU members (first of all, their trade unions) want the acceding countries to increase the administratively regulated minimum wage. The majority of the first round acceding countries have been regularly increasing the minimum wage in recent years. In inflationary environment the annual increase of the minimum wage ensures the stability of the real minimum wage. In Central and Eastern European acceding countries the growth of minimum wages has been faster than inflation and it has exceeded the growth of average wages in almost all countries. Most of the candidate countries (including Estonia) have set the goal of bringing the minimum wage to at least 40% of the average wage. Figures 2 and 3 characterise the level of minimum wage as a percentage of the average wage in the OECD and Central and Eastern European countries. In the OECD countries the minimum wage is usually measured as a percentage of the median wage, while acceding countries calculate their minimum wage as a percentage of the mean wage. The use of different ratios makes it difficult to compare the level of minimum wage in the EU Member

70 60 50 40 30 20 10

Korea

Spain

Japan

USA

Portugal

Estonia

Great Britain

Canada

New Zealand

Netherlands

EU average

Luxembourg

Belgium

Ireland

Australia

France

0

Figure 2. Minimum wage as a percentage of the median wage in Estonia and OECD countries in 2000 Sources: Keese, M., Puymoyen, A. ‘Changes in Earnings Structure: Some International Comparisons Using the OECD Structure of Earnings Database’, OECD Labour Market and Social Policy Occasional Papers, 2001. Estonia– author’s calculations.

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KROON&ECONOMY No 3, 2003 States and acceding countries. Such a comparison is made in the dataset of the European Trade Union Confederation6. According to their data, the minimum wage to average wage ratio in the EU member countries ranged between 34% (Spain) and 57% (Portugal). Data given in Figure 3 shows the respective range in the acceding countries to vary from 30% (Estonia) to 54% (Slovenia). Thus, the relative level of the minimum wage in the EU members and acceding countries is more or less similar.

2000

2001

2002

60 50 40 30 20 10 0 Latvia

Lithuania

Slovakia

Hungary

Poland

Czech Republic

Bulgaria

Estonia

Slovenia

Figure 3. Minimum wage as a percentage of the mean wage in Central and Eastern European countries between 2000–2002 Source: Mermet, E. ‘Wage Formation in Candidate Countries. Second Part: Answers to the ETUC Questionnaire’, European Trade Union Institute, April 2002.

Figures 2 and 3 indicate that the current minimum wage is relatively low in Estonia, compared to both the acceding countries and the EU member countries. However, as a ratio to the average wage our minimum wage is larger than for example in the USA, Japan and South Korea. Considering the agreement between the EAKL and the ETK referred to at the beginning of the article, it is expected that in the near future the minimum wage to average wage ratio in Estonia will rise above the average level of both acceding countries and EU Member States. The extent of the impact of minimum wage increase on the labour market – on the distribution of wages and employment – will first of all depend on the proportion of employees directly affected by the increase. It will directly affect workers whose wages in the pre-rise period are above the old level of the minimum wage and below the new, soon-to-be-established level. The increase of the minimum wage may also affect employees earning wages above

6 Mermet, E. ‘Wage Formation in Candidate Countries. Second Part: Answers to the ETUC Questionnaire’, European Trade Union Institute, April 2002.

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TAIRI RÕÕM or below this range, but the impact on them is indirect and manifested through the substitution effect. Figure 4 shows the minimum wage as a labour market constraint in Estonia and a number of industrial countries for which the respective data is available. In 2001, the share of employees affected by the minimum wage was the biggest in France and Luxembourg where 13.9 and 15.5% of employees, respectively, earned a wage equal to the minimum pay. In Estonia the minimum wage directly affected 5% of the employees. In other countries in Figure 4 the impact of the minimum wage was smaller, ranging from 0.9% in Spain to 4% in Portugal.

18 16 14 12 10 8 6 4 2

Luxembourg

France

Estonia

USA

Portugal

Ireland

Netherlands

Great Britain

Spain

0

Figure 4. Full-time employees in 2001, whose wages were equal to minimum wage (% of all full-time employees) Sources: Clare, R., Paternoster, A. ‘Minimum Wages in EU Member States and Candidate Countries’, Eurostat, January 2003. Estonia – author’s calculations (average percentage between 1995–2000).

Impact of the Minimum Wage on the Estonian Labour Market In 2003, the author of the present article and analyst Marit Hinnosaar from the Research Department of Eesti Pank carried out an empirical study in order to evaluate the impact of minimum wage increase on employment and wage distribution in Estonia in the second half of the 1990s7. The study was prompted by the recent, and probably continuing, increase of the minimum wage to the average wage ratio. We posted a hypothesis that the increase of minimum wage would reduce employment and our empirical research implied that the hypothesis was correct. This presumption was based on the fact that the Estonian labour market is complicated, first of all, for low-paid workers. The rate of unemployment is highest

7 Hinnosaar, M., Rõõm, T. ‘Labour Market Impact of the Minimum Wage in Estonia: An Empirical Analysis’, Eesti Pank, mimeo 2003.

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KROON&ECONOMY No 3, 2003 among low-paid workers with low levels of education. Figure 5 shows unemployment rates across the levels of education in 1997–20028. Among employees with higher education unemployment rate was more than three times lower than among those with basic or lower education. Among labour force with basic education, ie those who traditionally apply for lowpaid jobs, unemployment rate exceeds 20%. The wide gap between supply and demand at the bottom of the wage scale gives us grounds to claim that the increase of the minimum wage has a negative impact on the employment of low-paid employees.

basic or lower education

secondary and vocational education

higher education

25

20

15

10

5

0 1997

1998

1999

2000

2001

2002

Figure 5. Unemployment rate (%) in Estonia by level of education between 1997–2002 Source: Statistical Office of Estonia

The fact that a large part of the unemployed would be willing to work for less than the minimum wage also indicates that the minimum wage is distorting the Estonian labour market. Table 1 illustrates reservation wages of the unemployed in 1998–2001. Reservation wage is the lowest wage level an unemployed person would accept. Table 1 shows that although the share of workers willing to work for less than the minimum wage has decreased in recent years, it could increase considerably if the minimum wage were to be raised rapidly9. The share of people willing to accept payment below the minimum

8 As there is no wage data on the unemployed, it is impossible to evaluate the level of unemployment by income. In order to get an overview of unemployment across incomes we can take advantage of the positive correlation between wages and educational level. According to the Estonian labour market survey, in 1995–2000 the wage level of workers with secondary education exceeded the wage level of workers who had finished only nine grades by 12.8%, and the wages of workers with higher education were 39.7% higher than the wages of workers with secondary education. 9 The distribution of the unemployed in Table 1 is statistically inaccurate since the reservation wages are given as a discrete, not a constant variable in the data files of the Estonian Labour Force Surveys (ie an unemployed is asked if he/she would be willing to accept a job if the wage was over 500, 1,000, 2,000, etc kroons). Therefore, the data on the jobless willing to accept a pay below the minimum wage in Table 1 are smaller than the actual figures, and this shift increased over the period studied (being larger in 2001 than in 1998).

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TAIRI RÕÕM Table 1. Share of unemployed, whose reservation wages were below the minimum wage. Fixed minimum wage Such unemployed persons, total

Q2 1998

Q2 1999

Q1-Q4 2000

1,100

1,250

1,400

Q1-Q4 2001 Q1-Q4 2002 1,600

2,259

15.6

11.7

7.1

4.1

33.4*

(4.3)

(2.8)

(3.9)

(1.6)

26.2

(13.5)

(13.7)

(8.0)

(2.3)

20.9

19.7

20.8

13.3

7.5

41.8

(18.8)

(13.2)

(4.6)

5.9

35.3

18.4

10.1

(1.9)

4.9

30.5

Region Nor thern Estonia: Harju Central Estonia: Jär va, Lääne-Viru, Rapla Nor th-Eastern Estonia: Ida-Viru Western Estonia: Hiiu, Lääne, Pärnu, Saare Southern Estonia: Jõgeva, Põlva, Tar tu, Valga, Viljandi, Võru Economic sectors Agriculture, forestr y, fishing

25.0

(12.1)

(8.8)

(5.0)

46.0

Industr y

14.1

10.1

6.2

4.5

31.7

Ser vices

10.8

11.7

6.7

(3.7)

31.7

Elementar y occupation

29.8

17.5

18.0

(9.6)

49.7

Skilled workers

13.3

10.4

4.5

(3.1)

29.8

Other

(6.3)

(5.3)

(4.7)

(3.5)

32.6

Basic education or lower

27.0

18.5

10.0

(4.3)

40.0

Secondar y and vocational education

12.1

9.7

5.2

3.8

32.0

Higher education

(9.5)

(7.4)

(10.5)

(4.9)

28.6

Occupation

Level of education

Other demographic indicators Estonians

15.4

11.1

7.2

4.7

34.8

Non-Estonians

15.8

13.0

6.9

3.7

32.5

Women

19.6

15.7

9.6

5.7

44.1

Men

12.3

8.9

5.0

2.8

24.2

Aged 15-24

16.1

10.9

(6.4)

(2.3)

28.4

Aged 25-49

12.9

9.5

5.6

3.4

31.5

Aged 50-74

23.8

20.1

11.8

8.2

44.0

* Share of the unemployed whose reservation wages would have remained below the minimum wage if the net wage had been 2,000 kroons in 2001. (In 2001 the minimum wage had accounted for 41% of the average wage, the latted would have been 2,259 kroons. Taking into account the 26% income tax and the 1,000-kroons tax-exempt minimum, 2,259-kroons gross wage constitutes to 1,931-kroon net wage). Source: Rõõm, M. ‘Reservation Wages in Estonia’, Working Papers of Eesti Pank No 1, 2003. Data in brackets are based on less than 20 observations.

wage was higher than the average among the population of Ida-Viru County, agricultural workers and women. The last column of Table 1 gives the percentage of the employees whose reservation wage would have been below the minimum wage if the minimum wage had amounted to 41% of the average wage already in 2001 (2,259 kroons). It turns out that in case of such a minimum wage a third of the unemployed (33.4%) would have been willing to work for a lower pay.

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KROON&ECONOMY No 3, 2003 Thus, if the minimum wage is raised to 41% of the average wage – as it has been agreed between EAKL and ETK –, the negative impact of this economic policy measure is likely to deepen. In the study carried out by Eesti Pank in 200310, the workforce was grouped according to wages and the impact of the minimum wage on different groups was measured. The study analysed the impact of the minimum wage from three different aspects. Firstly the impact of higher minimum wage on employment was analysed, secondly, the impact of the minimum wage on the real wage growth, and finally the relations between the minimum wage and the distribution of wages. Micro-data from the Estonian Labour Force Surveys’ (ETU) files for 1995–2000 were used in the analysis11. Since the beginning of 1996, the minimum wage has been regularly increased at the beginning of each year, usually in January. An overview of the minimum wage developments is given in Table 2.

Table 2. Developments of the minimum wage in Estonia Date of raising the minimum wage

01.07. 01.10. 01.09. 01.01. 01.02. 01.01. 01.01. 01.01. 01.01. 01.01. 01.01. 1992 1993 1994 1996 1997 1998 1999 2000 2001 2002 2003

New minimum wage level (EEK)

200

300

450

680

845

1,100

1,250

1,400

1,600

1,850

Average wages (EEK)

549

1,066

1,734

2,985

3,573

4,125

4,440

4,907

5,510

6,144 6,448*

Minimum wage-average wage ratio (%)

36.4

28.1

26.0

22.8

23.6

26.7

28.2

28.5

29.0

30.1

33.5

50.0

50.0

51.1

24.3

30.2

13.6

12.0

14.3

15.6

16.8

1.6

16.3

22.8

11.7

20.3

10.0

7.7

8.0

12.3

13.4

Growth of nominal minimum wage (%) Growth of real minimum wage (%)

2,160

* average wage forecast Source: Hinnosaar, M., Rõõm, T. ‘Labour Market Impact of the Minimum Wage in Estonia: An Empirical Analysis’, Eesti Pank, mimeo 2003.

The wage groups used in the analysis were formed on the basis of their ratio to the average wage. The rules of the formation of the wage groups are described in the first column of Table 3. The share of the workers in each wage group is given in the second column of the same table. The table shows that 8% of the workers earned wages that were smaller than the current minimum wage. The relatively large proportion of such workers indicates a low compliance with the minimum wage regulations in Estonia. The share of workers earning less than the minimum wage varies greatly by counties. According to the ETU data for the second half of the 1990s, the percentage of such workers was the highest in Jõgeva County (15.7%) and Põlva County (11.2%). Their share was the smallest

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Hinnosaar, M., Rõõm, T. ‘Labour Market Impact of the Minimum Wage in Estonia: An Empirical Analysis’, Eesti Pank, mimeo 2003. The wage data of the Estonian Labour Force Survey files have been collected from interviews with workers. Such data are more adequate than those collected from the tax declarations of companies, which do not reflect wages paid “under the table”.

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TAIRI RÕÕM Table 3. Statistics of wage groups Proportion Women The whole sample wage